Taking a Closer Look at Leveraged ETFs

by: Bennington Investment Ideas
Interest in leveraged ETFs has risen along with interest in regular ETFs. These amplified versions of base ETFs provide investors an easy way to gain more exposure with fewer investing dollars. However, leveraged ETFs carry their own risks that might leave unsuspecting investors surprised when the end of the year rolls around. Here is a quick overview of some common leveraged ETFs:

Leveraged ETFs
Ticker Name Effective ETF Benchmark Leverage/ Direction Assets ($ billions)
SSO ProShares Ultra S&P500 SPY 2x 1.82
SDS ProShares UltraShort S&P500 SPY -2x 2.03
QLD ProShares Ultra QQQ QQQ 2x 0.91
QID-OLD ProShares UltraShort QQQ QQQ -2x 0.69
TQQQ ProShares UltraPro QQQ QQQ 3x 0.17
SQQQ ProShares UltraPro Short QQQ QQQ -3x 0.08
DGP PowerShares DB Gold Double Long ETN GLD 2x 0.58
DZZ PowerShares DB Gold Double Short ETN GLD -2x 0.07
XPP ProShares Ultra FTSE China 25 FXI 2x 0.05
FXP ProShares UltraShort FTSE China 25 FXI -2x 0.18
UDOW ProShares UltraPro Dow30 DIA 3x 0.05
SDOW ProShares UltraPro Short Dow30 DIA -3x 0.03
Source: Assets from Yahoo!Finance and downloaded on June 5, 2011. Assets were typically from month end April according to Yahoo.

The above list is by no means exhaustive. If there is significant interest in an ETF, there is most likely a leveraged version of the ETF for both bulls and bears. Direxion offers several sector specific leveraged ETFs. One interesting observation is that the assets for the Ultra Short China ETF are 3-4x the assets of the Ultra Long China ETF, suggesting an overall bearish stance on China.

Leveraged ETFs often seek to mimic some multiple of the day’s performance on an index. The simple mathematics of gains and losses over time will erode some of the value of the position if it is not all positive gains or losses. The following example illustrates this point very dramatically:
Leveraged ETF Returns vs. Unleveraged ETF Returns Example
Basic ETF Price
Basic ETF Return
Leveraged ETF Price
Leveraged ETF Return
Initial Purchase
Day 1
Day 2
Day 3
Day 4
Day 5
Day 6
Day 7
Day 8
Day 9
Day 10
Total 10 Day return

Source: Data is author's example.

This table shows that after 10 days a leveraged position actually lost 5.3% to 2.1% for the unleveraged variation. This gives a multiplier of 2.54 which is bad since it was a bullish leveraged position. By choosing the initial starting price at 100, I made it easy to see the cumulative return multiplier which shows the leveraged ETF lagging behind the basic ETF, even when the cumulative return is positive. Note that on day 7, the basic ETF is up 1.1% while the leveraged ETF is up only 1.4% giving a multiplier of just 1.24x – not exactly the 2x a casual investor might initially expect. For example, SSO provides approximately 2x the daily returns of SPY. However, this does not necessarily mean that a 1-year investment in SSO will provide 2x the annual return of SPY. In fact, it often provides somewhat less. The 1-year return on SSO at June 3, 2011, was 38.9% while SPY posted a 20.1%. This gave SSO a 1.93x multiplier. Note that these returns were based on dividend adjusted pricing. SPY pays a substantially higher dividend than SSO and many leveraged ETFs do not pay dividends irregardless of what their benchmark provides.

Furthermore, leveraged ETFs often do not even capture the consistent 2x or 3x multiplier. This is especially true on very low change days. There are even rare instances of the base ETF showing a slight positive return while the bullish leveraged ETF shows a slight negative return or vice versa. This could be attributed to the functioning and cost of the various derivatives that provide the underlying leverage. Even more exotic ETFs and leveraged counterparts show even greater deviations from the target multiples. The following table compares SPY and SSO and shows the implied leverage multiple based upon returns from daily closing prices:

SPY vs. SSO Daily Returns
Date SPY Close % Change from Previous SSO Close % Change from Previous SSO/SPY Ratio
6/3/2011 130.42 -0.99% 51.34 -1.97% 1.98
6/2/2011 131.73 -0.11% 52.37 -0.19% 1.80
6/1/2011 131.87 -2.25% 52.47 -4.58% 2.04
5/31/2011 134.90 1.04% 54.99 2.17% 2.09
5/27/2011 133.51 0.38% 53.82 0.77% 2.00
5/26/2011 133.00 0.46% 53.41 0.89% 1.93
5/25/2011 132.39 0.33% 52.94 0.59% 1.77
5/24/2011 131.95 -0.08% 52.63 -0.15% 1.82
5/23/2011 132.06 -1.16% 52.71 -2.35% 2.03
5/20/2011 133.61 -0.79% 53.98 -1.53% 1.93
5/19/2011 134.68 0.24% 54.82 0.49% 2.08
5/18/2011 134.36 0.89% 54.55 1.72% 1.92
5/17/2011 133.17 -0.02% 53.63 0.02% (1.24)
5/16/2011 133.19 -0.63% 53.62 -1.29% 2.03
5/13/2011 134.04 -0.77% 54.32 -1.56% 2.02
5/12/2011 135.08 0.48% 55.18 0.88% 1.84
Total Period NA -3.45% NA -6.96% 2.02

Source: Data is from Yahoo!Finance downloaded on June 5, 2011.Daily returns are measured from previous day's close to current day's close.

The above data set does show the interesting case of SPY going negative while SSO goes positive. However, since this seems to only happen around 0% return, it has essentially no impact on overall investment returns. However, even over these 16 trading days, one can see a slight degradation in SSO returns relative to SPY. This also provides a real life example of the effect I illustrated earlier.

One might comment that closing price to closing price is not the right metric and that open to closing price for a single day would be more appropriate. However, looking at this data for SSO and SPY showed the variation around the approximate average multiple of 2x to be even larger.

It should also be noted that the target leverage is sometimes before fees are accounted for and some times after. Compare the following quotes from Yahoo!Finance on SSO and QID:

The investment seeks daily investment results, before fees and expenses, which correspond to twice the daily performance of the S&P 500 Index. - Yahoo!Finance

The investment seeks daily results, net of expenses, which correspond to two times (200%) the inverse (opposite) of the daily performance of the NASDAQ-100 Index. - Yahoo!Finance

QID vs. QQQ Daily Returns
Date QID Closing Price Return QQQ Closing Price Return QID/QQQ Ratio
6/3/2011 52.33 2.97% 56.35 -1.50% (2.0)
6/2/2011 50.82 -0.47% 57.21 0.21% (2.2)
6/1/2011 51.06 4.20% 57.09 -2.18% (1.9)
5/31/2011 49.00 -3.05% 58.36 1.62% (1.9)
5/27/2011 50.54 -0.96% 57.43 0.51% (1.9)
5/26/2011 51.03 -1.33% 57.14 0.62% (2.2)
5/25/2011 51.72 -0.79% 56.79 0.39% (2.0)
5/24/2011 52.13 1.30% 56.57 -0.61% (2.1)
5/23/2011 51.46 2.88% 56.92 -1.47% (2.0)
5/20/2011 50.02 1.56% 57.77 -0.76% (2.1)
5/19/2011 49.25 -0.67% 58.21 0.29% (2.3)
5/18/2011 49.58 -1.63% 58.04 0.83% (2.0)
5/17/2011 50.40 -0.57% 57.56 0.28% (2.1)
5/16/2011 50.69 3.51% 57.40 -1.73% (2.0)

Source: Data from Yahoo!Finance downloaded on June 5, 2011.

While the SSO seeks the multiplier before fees and the QID seeks the multiplier after fees, both seem to show substantial variation from the multiple when looking at daily returns. Annual fees appear to be around 0.9-1.0% for leveraged ETFs vs. .09% for SPY, .20% for QQQ, and .72% for FXI. These fees are in addition to the degradation effect for leveraged ETFs and any other fees including bid-ask spreads and brokerage commissions incurred for any security.


Leveraged ETFs have a place in many but perhaps not all portfolios. In my opinion, leveraged ETFs are less appropriate for individuals with:
  1. Lower risk tolerances – by their nature leveraged ETFs are inherently riskier.
  2. More conservative portfolios with larger cash and cash equivalent positions - In today’s low interest environment, an investor with a significant cash position who wants $100 of S&P 500 exposure might as well buy $100 of SPY as opposed to $50 of SSO.
  3. Less interest in actively following markets and longer term time horizons - a more passive investing approach is very suitable for many investors.
I see leveraged ETF investments as good shorter terms plays as opposed to longer buy and hold strategies. In this case, my perspective on longer term is buy and pass the investments along to your kids while shorter term could be even around a year. Leveraged ETFs maintain their leverage as long as the market is moving more or less in one direction. Massive volatility and swings to the upside and downside will quickly erode the effective leverage. I have successfully used leveraged ETFs in the past, most notably during the spring and into the summer of 2009. I expect to use leveraged ETFs in the future.

Disclosure: I am long SPY, FXI.

Additional disclosure: Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.