Exchange-traded funds have been around since the 1990s. They started out as a cheaper alternative to mutual funds for investors just wanting to track broad stock indexes. As is typical, their success prompted Wall Street bankers to come up with riskier iterations that offered the potential for bigger returns by employing derivatives. Hence, the “leveraged” ETF was born. Many traders and investors have become disillusioned with these products because of the hidden risks and “decay” around the daily rebalancing. Nevertheless, the Securities and Exchange Commission has just approved leveraged and inverse ETFs on single stocks. As they say on social media, I’m left SMH.
There’s nothing complex about these products, and the mechanics are the same for a leveraged ETF tied to an index as they are for a single-stock ETF. The issuer has a basic swap or, in the case of an inverse ETF, is short a swap on the underlying stock, one that is adjusted on a daily basis. The real question is, what is the motivation for these products in the first place?