Best leveraged ETFs: A high-risk, high-reward bet on short-term market volatility

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There are a multitude of leveraged strategies aimed at retail investors. Most of these follow the performance of major indexes, while others track niche areas of the market like the semiconductor and biotech industries. With leveraged strategies, investors hope to capture additional return using the power of debt.

What is leveraged trading?

Leveraged investing lets traders use debt to increase their buying power. Investors borrow money and then purchase extra shares of an investment. If the investment goes up, they’ll make more than if they had purchased only what they could afford with their cash on hand. By taking additional risk, traders seek to capture outsized returns.

Also known as margin trading, this strategy can be risky because those bets become outsized losses when a trade goes south. Plus, traders need to pay back the borrowed funds along with interest and any transaction fees.

Apart from these factors, traders are on the hook for capital gains taxes if the assets are held in a taxable account.

Leveraged ETFs: What they are and how they work

Leveraged exchange-traded funds (ETFs) take this principle of leverage and use it to juice the potential returns on a broad index such as the S&P 500. Leveraged funds use what are known as financial derivatives to help boost the fund’s performance. For example:

• If the benchmark index is up 1 percent, a basic S&P 500 index fund should also rise about 1 percent. But a leveraged ETF may try to boost that daily performance by two or even three times.
• When the S&P 500 is up 1 percent, a leveraged ETF tracking the index could rise 2 percent or even 3 percent. The exact performance depends on the amount of leverage used.

While that might sound tempting, the potential losses can be just as pronounced. Using the hypothetical example above, when the stock market drops 2 percent, a triple-leveraged ETF could plunge around 6 percent, depending on the underlying assets.

It’s worth noting that leveraged ETFs aim to enhance the daily performance of certain market indexes. If the stock market goes up 10 percent this year, you may not get a 20 or 30 percent return by using these leveraged ETFs. For this reason, these funds don’t make sense as long-term holdings and should only be used by short-term traders.

The best leveraged ETFs

With that in mind, here are some of the most popular leveraged ETFs, with data as of August 12, 2024:

ProShares UltraPro Short QQQ (SQQQ)

This highly leveraged ETF offers three times downside exposure to large-cap, tech-heavy companies in the Nasdaq 100 index. The average daily volume for this ETF is about 148 million shares, making it one of the most popular leveraged funds.

• Expense ratio: 0.95 percent
• Assets under management: $2.6 billion

ProShares Ultra S&P 500 (SSO)

This fund offers two times daily upside leverage exposure to the Standard & Poor’s 500 index. The average daily volume for this ETF is about 2.9 million shares.

• Expense ratio: 0.91 percent
• Assets under management: $4.6 billion

ProShares UltraPro Short Dow30 (SDOW)

This ETF offers three times downside leverage exposure to the Dow Jones Industrial Average. The average daily volume for this ETF is about 15.7 million shares.

• Expense ratio: 0.95 percent
• Assets under management: $293.4 million

Direxion Daily Small Cap Bull 3X Shares (TNA)

This fund offers three times leveraged upside exposure to small-cap companies in the Russell 2000 index. The average daily volume for this ETF is around 19.5 million shares.

• Expense ratio: 1.08 percent
• Assets under management: $2.4 billion

Direxion Daily Small Cap Bear 3X Shares (TZA)

On the flip side, this fund offers three times leveraged downside exposure to small-cap companies in the Russell 2000. The average daily volume for this ETF is around 24.1 million shares.

• Expense ratio: 1.04 percent
• Assets under management: $329.7 million

Direxion Daily Semiconductor Bull 3x Shares (SOXL)

This ETF provides three times leveraged upside exposure to an index of companies involved in developing and manufacturing semiconductors. The average daily volume for this ETF is about 68 million shares.

• Expense ratio: 0.76 percent
• Assets under management: $10.3 billion

ProShares UltraPro QQQ (TQQQ)

This fund amps the exposure to the tech-heavy Nasdaq 100, aiming to give traders three times the daily move in that index. The average daily volume is around 54.3 million shares.

• Expense ratio: 0.88 percent
• Assets under management: $20 billion

Direxion Daily S&P 500 Bull 3x (SPXL)

This ETF aims for three times the daily return on the S&P 500, which can run higher quickly in a raging bull market. The average daily volume is 4.4 million shares.

• Expense ratio: 0.91 percent
• Assets under management: $4.1 billion

How to buy leveraged ETFs

Leveraged ETFs can be valuable for seasoned traders as increased volatility provides short-term opportunities to quickly turn a profit on a trade. And with leveraged ETFs that allow traders to profit when the market drops — called inverse leveraged ETFs — traders can profit even if the market falls.

Consider the ProShares UltraShort QQQ ETF (QID), which seeks to return two times the opposite performance of the Nasdaq 100 index. So, if the benchmark is down 2 percent, this ETF should rise about 4 percent.

During increased periods of market volatility, these types of speculative investments can be lucrative.

Depending on your financial situation and risk tolerance, leveraged ETFs can form a key part of your trading strategy. Your level of financial knowledge and engagement with your investments are important factors to consider carefully, however.

Investors should approach leveraged ETFs with prudence. Remember, these types of market instruments are a double-edged sword, since they magnify gains as well as losses.

Once you determine your comfort level, decide what percentage of your total account to allocate into these risky assets. Even experienced traders often start small and have an exit strategy. The key is to stick to your plan and know when to close out of a losing position.

What to consider when buying leveraged ETFs

Usually reserved for sophisticated investors, leveraged trading has gained popularity in recent years among retail investors. Lured by the potential of fast money, many have turned to leveraged ETFs as a way to get in on the action.

Leveraged ETFs are a type of investment that aims to magnify returns through financial derivatives and debt. Essentially, they are ETFs on steroids.

There are plenty of screening tools to find these funds, including those provided by many brokerage firms. While factors like management fees and historical trading performance are important considerations, you should thoroughly review the fund’s prospectus.

A prospectus acts as a legal contract, preventing fund managers from deviating from what they said they would do. By reviewing this information before investing, you can determine whether the fund’s strategy aligns with your investment goals.

As you narrow your options, the key features to consider are:

• Leverage: This metric is qualified by a numeral followed by the letter “x.” So, a fund like the Direxion Daily S&P 500 Bull 3X Shares (SPXL) offers three times the performance of the S&P 500 index. The leveraged expected return is for a single day, not cumulative over time.
• Expense ratios and fees: By default, most ETF providers charge competitive fees. But even at relatively low levels, those costs can add up, so make sure to compare and read the fine print.
• Trading volume: The more liquid a fund is, the easier it will be to buy and sell. Look at how average trading volume compares to similar ETFs.
• Fund performance: While doing your research, take a look at a fund’s longer-term performance. But remember, these funds are not intended as a buy-and-hold strategy.
• Assets under management (AUM): Many investors use this figure as a vote of confidence to assess other investors’ engagement with a particular ETF. Along with AUM figures, it might be helpful to check the longevity of the fund.
• Fund issuer: Brands are powerful. And that’s no different in the ETF space. Some investors feel comfortable investing only with large asset managers, while others see the value in newcomers. Decide what works for you and your financial needs.

Use these criteria as a starting point to do more research. Some investors find it helpful to study the daily performance of leveraged ETFs before committing any money.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.