How does decay work in 3X ETF?
This means that a 3X leveraged ETF would decline by 30% initially. The next day, it would increase by 33.3%. However, since this 33.3% return is on a substantially lower price than that of our non-leveraged ETF, the non-leveraged ETF underperforms. This concept demonstrated here is called "volatility decay."
3x ETFs get their leverage by using derivatives, which introduce another set of risks. Since they maintain a fixed level of leverage, 3x ETFs eventually face complete collapse if the underlying index declines more than 33% on a single day.
Yes, although most would liquidate before they got there, paying shareholders off at some non-zero price. For example, suppose a 3x levered ETF is initially offered at $100/share. Even if the underlying declined by more than 33%, the ETF price would not be zero, because it rebalances daily.
In terms of leveraged ETFs, decay is the loss of performance attributed to the multiplying effect on returns of the underlying index of the leveraged ETFs. In the example, the decay took $1 or 10% off the performance of the leveraged ETF. This decay is compounded with the volatility of returns.
Leveraged ETFs decay due to the compounding effect of daily returns, also known as "volatility drag." This means that the returns of the ETFs may not match the returns of the underlying asset over longer periods.
Nearly all leveraged ETFs come with a prominent warning in their prospectus: they are not designed for long-term holding. The combination of leverage, market volatility, and an unfavorable sequence of returns can lead to disastrous outcomes.
Because they rebalance daily, leveraged ETFs usually never lose all of their value. They can, however, fall toward zero over time. If a leveraged ETF approaches zero, its manager typically liquidates its assets and pays out all remaining holders in cash.
The Direxion Daily Junior Gold Miners Index Bull 3x Shares (JNUG) and the Direxion Daily Junior Gold Miners Index Bear 3x Shares (JDST) are the two most volatile exchange-traded funds of all. Each has a one-year volatility reading of about 170.
TQQQ is a 3X leveraged QQQ ETF, meaning it seeks 300% (or 3x) the daily return of the Nasdaq 100 Index (which the QQQ seeks to replicate). Theoretically, if the market were to fall by more than 33.3% in a single day, TQQQ 's Net Asset Value (NAV) would fall to zero, and the fund would be dissolved.
Leveraged ETFs amplify daily returns and can help traders generate outsized returns and hedge against potential losses. A leveraged ETF's amplified daily returns can trigger steep losses in short periods of time, and a leveraged ETF can lose most or all of its value.
How much does SQQQ decay?
Historically, SQQQ decays around 7-8% per month, though this would likely be around 4-5% per month during a flat market such as that experienced so far this year.
The daily rebalancing of leveraged and inverse ETFs creates a situation that for periods longer than a day or two the return of a leveraged or inverse ETF will deviate from the margin account benchmark.
The SQQQ is meant to be held intraday and is not a long-term investment, where expenses and decay will quickly eat into returns.
Direxion launched its first leveraged ETFs in 2008. In November 2008 the company was the first to offer ETFs with 3X leverage, a move that was copied some months later by its competitors ProShares and Rydex Investments.
Single-stock ETFs: An Additional Layer of Risk.
Because leveraged single-stock ETFs in particular amplify the effect of price movements of the underlying individual stocks, investors holding these funds will experience even greater volatility and risk than investors who hold the underlying stock itself.
Leveraged decay refers to the process by which leveraged ETFs strictly adhere to a "daily rebalancing" rule to ensure that they consistently achieve an N-times tracking effect by the end of the day or before the next trading day opens, resulting in decay.
Overall SSO has the least amount of decay, averaging -0.004% daily since inception while TQQQ averages -0.027% daily, a whopping seven-fold that of SSO. QLD was in between and averaged -0.013% decay daily. Also please note that the decays vary with time, agreeing with the equation mentioned above.
Leveraged 3X Inverse/Short ETFs seek to provide three times the opposite return of an index for a single day. These funds can be invested in stocks, various market sectors, bonds or futures contracts.
TQQQ has a draw down risk of -89.60%, which is the largest price decline experienced over the last three years. This fund has a three year standard deviation of 75.4%.
Most leveraged and inverse ETFs reset each day, which means they are designed to achieve their stated objective on a daily basis. With the effects of compounding, over longer timeframes the results can differ significantly from their objective.
Can you lose more than you invest with leverage?
Using leverage can result in much higher downside risk, sometimes resulting in losses greater than your initial capital investment. On top of that, brokers and contract traders often charge fees, premiums, and margin rates and require you to maintain a margin account with a specific balance.
In other words, you could potentially be liable for more than you invested because you bought the position on leverage. But can a leveraged ETF go negative? No. If you own a leveraged ETF you can't lose more than your initial investment amount.
Leveraged ETFs employ daily rebalancing, so while they do multiply the daily returns of an index, this does not equate to providing the same multiple of long-term returns, such as annual returns. In fact, the higher the leverage multiple, the worse the volatility decay becomes.
No, SOXL is not designed as a long-term buy and hold investment. SOXL is a short-term trading vehicle meant to be bought and sold intraday. It is often used by financial advisers and professionals, in particular those who understand leverage and its potential gain and loss impacts.
The TQQQ is a 3x leveraged ETF based on the QQQ (a Nasdaq-100 Index ETF). Because it is leveraged, it uses derivatives contracts to amplify its returns based on how the index performs.
