Key Takeaways
- Single-stock ETFs allow investors to take leveraged or inverse positions on individual stocks through exchange-traded products.
- These ETFs carry higher risks due to their leveraged nature and are not recommended for long-term investments.
- They are intended for short-term trading, with regulators warning of their unsuitability for ordinary investors.
- Single-stock ETFs can lose value over time because of their construction, making them fit only for day trading or very short-term strategies.
- The SEC and FINRA have raised concerns about the high risk these products present to individual investors.
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What Are Single-Stock ETFs?
Single-stock exchange-traded funds (ETFs) allow leveraged or inverse trading of a single stock, unlike ETFs that track broader indexes. They first appeared in Europe in 2018 and reached the U.S. in 2022 through AXS Investments, giving investors tools to navigate volatile markets and short stocks without selling them short. Regulators warn these ETFs carry higher risks and are generally suited for short-term trading rather than long-term investment.
Understanding the Mechanism Behind Single-Stock ETFs
Exchange-traded funds (ETFs) are single securities that can hold a portfolio of stocks. Indeed, the first ETFs were created to track broad-based indexes such as the S&P 500 or the Russell 2000. ETFs can also hold derivatives such as futures and options contracts in addition to, or instead of, shares of stock.
This allowed for the advent of leveraged ETFs, which provide a multiple of the return of the underlying index or benchmark. For example, a leveraged ETF could provide two or three times the daily returns of the S&P 500 index. It also allowed for inverse ETFs (and inverse-leveraged ETFs), which provide negative returns (for example, -1 time or -2 times the return of the index).
Single-stock ETFs do not hold a portfolio of stocks; rather, they track just a single stock but employ derivatives contracts to provide leveraged and/or inverse returns. Leverage is a double-edged sword, meaning that it can lead to significant gains but also lead to significant losses. Investors should be aware of the risks of leveraged ETFs because the risk of losses is far higher than with traditional investments.
For example, a 1.5× leveraged bull single-stock ETF would likely own short-dated call options that provide a net delta of +150. A 2× bear single-stock ETF would instead hold put options in an amount resulting in a delta of -200.
Potential Risks of Investing in Single-Stock ETFs
Because of how leveraged and inverse ETFs (including single-stock ETFs) are constructed, they tend to have a negative roll to maintain the proper derivatives position geared at returning a multiple of daily performance. This means that they naturally exhibit time decay and will tend to lose value over medium and long holding periods, regardless of the performance of the underlying assets. As a result, these products are intended only for day trading or very short-term holding periods.
Single-stock ETFs also may be prone to quickly lose value in volatile markets. An interview posted July 15, 2022, on Yahoo! Finance illustrates this point. Yahoo! Finance anchor Jared Blikre said, “If we take a hypothetical stock and it’s three times leveraged ETF, and we just kind of chop around with some volatile action. Let’s say they both begin at $100. And then let’s say we have a 20% up day followed by two 10% down days, a 20% up, a negative 20%, a negative 10%, another [negative] 20%. At the end of the day, guess what, the stock is worth $100.78, basically flat. Guess what, the ETF lost 40% of its value.”
The Emergence of Single-Stock ETFs in the U.S. Market
Single-stock ETFs first appeared on European markets in 2018, and entered the U.S. market in the summer of 2022.
In July 2022, AXS Investments, a New York-based asset manager, listed eight such products giving leveraged investments on Telsa, Nvidia, PayPal, Nike, and Pfizer: However, these investments struggled to gain interest, and six of them were removed from the market within a year of their launch.
In mid-2023, Direxion launched 12 single-stock ETFs, offering leveraged bets on tech companies like Google, Amazon, Tesla, and Nvidia. Rex Shares followed suit with single-stock ETFs for Tesla and Nvidia.
Case Study: An Example of a Single-Stock ETF in Action
TSLQ is the ticker symbol for the AXS TSLA Bear Daily ETF. It seeks to return -1× the daily performance of Tesla (TSLA) shares. In other words, if TSLA drops 5% over the course of a trading day, the TSLQ Bear ETF should gain 5% on the same day. However, due to management expenses and other costs, the fund will return slightly lower profits over time.
Let’s see how the two securities performed on Nov. 27, 2023. As shown in the chart below, comparing the two, TSLQ provides a close mirror image to the intraday returns of TSLA. Note, however, that the daily returns were not identically inverse: TSLA gained 1.08% at the close of that day, while the single-stock ETF TSLQ lost 1.03%. While this difference may be small for a single day, the tracking error between the two could compound over time, especially if the price swings up and down repeatedly.
How Are Single-Stock Exchange-Traded Funds (ETFs) Allowed to Trade?
Single-stock exchange-traded funds (ETFs) have been labeled as extremely risky by regulators and market commentators. Nonetheless, in 2022, the United States listed them for the first time. However, single-stock ETFs appear to fall under Rule 6c-11 under the Investment Company Act of 1940. In combination with recent changes to the listing standards at stock exchanges, that rule created a framework that allows ETFs meeting certain criteria to come directly to market without first obtaining explicit permission, through what is called an exemptive order from the U.S. Securities and Exchange Commission (SEC).
Are Single-Stock ETFs and Single-Stock Futures the Same Thing?
No. Single-stock ETFs are exchange-traded securities that use derivatives contracts (options) on individual stocks to provide leveraged returns. The ETF itself is a security. Single-stock futures (SSFs) are not securities but instead are futures contracts, with an individual stock as the underlying security. Each contract typically controls 100 shares of stock. While the reception for single-stock futures was positive when they launched in the U.S., activity has faded over time.
Are Single-Stock ETFs Good Investments?
Single-stock ETFs are intended for very short holding periods, such as intraday, and are not meant to be held as longer-term investments. The SEC states that, “[b]ecause of the features of these products and their associated risks, it would likely be challenging for an investment professional to recommend such a product to a retail investor while also honoring his or her fiduciary obligations or obligations under Regulation Best Interest. However, retail investors can and do access leveraged and inverse exchange-traded products through self-directed trading.”
The Bottom Line
A single-stock ETF lets investors trade a single stock with leverage or inverse exposure using derivatives. They can offer high returns but carry significant risks, making them suitable only for experienced traders and short-term strategies, not buy-and-hold investing.