Turbo-Charge Bullish Investment Strategies with Leveraged ETFs - dummies

Turbo-Charge Bullish Investment Strategies with Leveraged ETFs

By Paul Mladjenovic

If you want to really turbo-charge your bullish strategies, consider using leveraged exchange-traded funds (ETFs). Leveraged ETFs (as the name clearly indicates) seek to amplify returns by using leverage. Leverage means either using margin or options combinations.

These ETFs are certainly risky and more volatile than other ETFs, but if you’re looking for high potential in the short term and don’t mind the commensurate risk, then leveraged ETFs may be just what you’re looking for. The leverage factor may be double or triple the intended move of the underlying security.

Keep in mind that although leveraged ETFs attempt to double or triple the gains of the underlying asset, that’s easier said than done. Due to market fluctuations, getting the exact leverage percentage gain is almost impossible. The ETF seeks the stated gain on a daily basis, not an annualized return.

Much more important than the chance you won’t realize a perfectly leveraged gain is the loss potential of a leveraged ETF. Here, risk versus reward is a brutal way of life. If you’re wrong with a leveraged ETF, then your loss will be extra painful. If the investment in question goes down 5 percent, then your double-long ETF will lose about 10 percent in value (and at that point, the only “double” you’d be interested in would be at the local bar).

The double-long ETF

A typical leveraged ETF may be called “ultra-long,” “bullish double-long,” “2X,” or a similar name indicating leverage. A double-long ETF is seeking to double the potential move of the security or investment asset in question. In other words, if the security or investment is going up, say, 5 percent, then the ultra-long or double-long will seek to go up 10 percent. To achieve this, margin credit would be used.

That ETF will likely have 50 percent direct ownership in that particular investment and would use margin debt to pick up the other 50 percent. If the asset is, say $1 million in oil futures contracts, then the ETF would have $500,000 in equity ownership and use $500,000 in margin debt. If the market value of the asset goes up to $1.5 million (a 50 percent move up), then the equity of the position rises significantly ($1.5 million minus the margin debt of $500,000) to equal $1 million, and at that point equity ownership has doubled. Instead of a 50 percent gain, the ETF realized a 100 percent gain.

The triple-long ETF

The triple-long ETF (or “3X” or “mega-super-ultra”) will kick up the ETF returns a notch by employing more elaborate means than just margin. Bearish option strategies will also be used.

If you want a “safe” way to speculate — as a bull — then consider the triple long or 3X ETF. Yes, you can do options, as they’re the go-to vehicle for uber-speculators, but leveraged ETFs give you a solid bang for the buck with one added benefit for newbie speculators: They don’t have an expiration date.

With a bullish perspective, leveraged ETFs are most comparable to call options. Options have a finite shelf life; they can expire worthless. Leveraged ETFs, on the other hand, have nearly the same upside potential as options, but they don’t expire. When compared to call options, the leveraged ETF is a safer choice.