Spend some time looking at trading volumes, and you’ll notice something interesting: A lot of investors recently are making outsized bets on the stock market.
Most of them are long bets, but some are short.
It’s easy to see this because there is a growing segment of the ETF business that caters to investors who want to make short-term outsized bets on the stock market.
These are leveraged and inverse ETFs. Leveraged ETFs amplify the daily returns of an index or stock using financial derivatives. For example, if an index rose by 1% in a day, a 2x leveraged ETF would deliver a 2% return, a 3x would deliver a 3% return.
An inverse ETF delivers the opposite daily performance. So a 2x inverse ETF would be down 2% on a day when the index rose 1%, and vice-versa.
These leveraged/inverse ETFs are not just growing in assets. They are becoming a greater part of the daily trading volume of the ETF universe, which is becoming a larger part of overall trading.
Who is using these products? It has a lot to do with the general rise in speculative behavior in the market. Trading in options, bitcoin, and other more speculative products has been rising.
“We’re continuing to see more investors lean into leveraged as a way to express short-term views on the market, and given all the volatility and daily market-moving headlines, it’s not surprising we are seeing higher volume and more assets entering the space,” Douglas Yones, CEO of Direxion, one of the largest providers of leveraged/inverse ETFs, told CNBC.
Growing as a share of assets
The first leveraged/inverse ETFs in the U.S. started in 2006 and allowed long or short bets on indexes like the S&P 500 or the Nasdaq 100. Leverage and inverse single-stock ETFs came into existence in 2022, and they too have grown fast.
The largest, ProSharesUltraPro QQQ (TQQQ), which provides 3x leveraged exposure to the Nasdaq 100 (QQQ), has nearly $26 billion in assets. Single-stock ETFs that leverage Nvidia and Tesla also now have substantial assets.
Largest leveraged/inverse ETFs
(assets under management)
ProSharesUltraPro QQQ (TQQQ) $25.7 billion
Direxion Daily Semiconductor Bull 3x (SOXL) $8.5 billion
ProShares Ultra QQQ (QLD) $7.9 billion
ProShares Ultra S&P 500 (SSO) $5.5 billion
Direxion Daily S&P Bull 3x (SPXL) $5.0 billion
Direxion Daily TSLA Bull 2x (TSLL) $3.5 billion
GraniteShares 2x Long NVDA (NVDL) $4.2 billion
Part of this is a bull market effect: Stocks are up meaningfully in the last few years, so overall assets are higher. However, these leveraged/inverse ETFs are not just growing assets, they are becoming a larger part of the ETF universe.
In 2016, when ETFs had about $2 trillion in assets under management (AUM), leveraged/inverse ETFs were about 2% of that AUM, according to Strategas.
Today, ETFs have about $11 trillion in assets under management, but leveraged/inverse ETFs make up about $81 billion of that, or almost 8% of total AUM.
Why are these products growing?
“I do believe there is a generational effect at play, I think there is major appetite among younger traders wanting to play with leverage due to the gains it can provide,” Todd Sohn, head of ETFs at Strategas, told CNBC. “The barriers to entry are extremely low, you can buy these products on your phone.”
Yones estimated that 75% of the ownership of these products were retail traders, and 25% institutional, which included hedge funds, trade desks, large brokerage firms, and “anyone who has a book of positions that wants to be neutral the market.”
He estimated that a small but significant percentage of the retail traders (12%-15% of the total) were from outside the U.S., which aligns with previous reports about growing demand for 24-hour trading coming in part from retail traders in South Korea, Japan, and Europe.
Growing part of daily trading volume
Leverage and inverse ETFs, including leveraged and inverse single-stock ETFs, now routinely show up among the most heavily traded ETFs on a daily basis.
A simple way to look at this is by average daily dollar volume, the total amount of money traded in the ETF on a daily basis.
The top ETFs by daily dollar volume are still ETFs tied to the biggest indexes, mainly the S&P 500, Russell 2000, and Nasdaq 100.
Top ETFs by average 3-month daily dollar volume
SPDR S&P 500 (SPY) $27.7 billion
Invesco QQQ (QQQ) $15.3 billion
iShares Russell 2000 (IWM) $5.7 billion
iShares Core S&P 500 (IVV) $3.9 billion
Source: Strategas
However, the fifth-largest ETF by average daily dollar volume in the last three months is the ProSharesUltraPro QQQ, which provides three times leveraged exposure to the Nasdaq 100.
Altogether, five of the top 20 ETFs by average daily dollar volume are leveraged/inverse.
Leveraged/inverse ETFs: largest avg. 3-month daily dollar volume
ProSharesUltraPro QQQ (TQQQ) $3.8 billion
Direxion Daily Semiconductors Bull 3X (SOXL)$2.1 billion
Direxion Daily TSLA Bull 2x (TSLL) $1.5 billion
ProShares UltraPro Short QQQ (SQQQ) $1.4 billion
GraniteShares 2x Long NVDA (NVDL) $1.3 billion
Source: Strategas
The daily reset
These products are bets on short-term momentum, but they have one additional feature that has proven difficult for investors to wrap their head around: they reset on a daily basis.
Because of compounding effects, it can be fiendishly difficult to figure out what actual returns will be on anything more than a daily basis. This means that holding a 2x leveraged product for anything more than a day may result in making substantially less than a 2x return, depending on the direction of the market.
Here’s an example: Suppose the S&P 500 was up 10% one day, then down 10% the next day.
A $100 investment would look like this:
S&P 500: hypothetical $100 investment
Day 0 $100
Day 1 (up 10%): $110
Day 2 (down 10%). $99
After two days of this, you have $99, so you are down 1%. If you had a leveraged product over those two days, it would seem like you would be down 2%, or that you would have $98.
But because of the daily reset, that’s not what happens.
S&P 500: hypothetical $100 investment in 2x leveraged
Day 0 $100
Day 1 (up 10%, leveraged up 20%): $120
Day 2 (down 10%, leveraged down 20%) $96
You actually have $96, instead of $98, and bear in mind this excludes fees.
As time goes on, these calculations get progressively more complex.
As a result, those offering these products routinely state that they are not meant for buy-and-hold investors.
These funds have very large daily turnovers, so most investors seem to understand the risk of holding these products on anything more than a daily basis.
But Sohn told CNBC that all investors in leveraged products needed to be very careful.
“At some point though, it helps to take stock of the risks involved whenever the market takes a turn south,” Sohn told CNBC.
Doug Yones, CEO of Direxion, will be on the ETF Edge portion of Halftime at 12:35 PM ET on Monday, and will also livestream on ETF Edge from 1:30 PM ET. He will be joined by Todd Rosenbluth, Head of Research at Vettafi.