Leveraged ETFs - Natural Decay

Apr. 28, 2015 3:35 PM ETBIB
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Contributor Since 2013

I have a track of investing in biotechnology and technology industry. Recently involved in leveraged 2X and 3X ETFs.

Leveraged ETFs are known for their natural decay. As the previous post emphasizes, leveraged ETFs are meant for day trading. As the chart below depicts, a traditional ETF in a volatile downward trending market will return 0% at the end of Day 3, resulting in a portfolio value of $$9680. However, in a 2x leverage ETF, in the same market environment (meaning same percent increase/decrease in the market at any given day with the same amount of monetary input) will bear a return of 0% as well but with a portfolio value down almost 14% at $8640. This example shows the time decay of leveraged ETFs. It is vital to understand the concept of leveraged financial products as a day trading instrument. While the return in both scenarios bear 0% (market down -20% in day 1, and up 10% in day 2 and day 3) but the portfolio value differs widely. For example, the 10% gain in day 2 is 10% gain from the preceding day (not from your original investment of $10,000). If we were to model this out to a longer time frame, then we would have an even greater possible gain/loss in portfolio value.

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Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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