Can inverse ETFs go to zero?
It is also important to note that leverage also means it is possible that a leveraged inverse ETF can go to zero or near zero with a large enough daily move in the price of the underlying asset or index.
Inverse ETFs are designed for speculative traders and investors seeking tactical day trades against their respective underlying indexes. For example, an inverse ETF that tracks the inverse performance of the Standard & Poor's 500 Index would reflect a loss of 1% for every 1% gain of the index.
Leveraged ETF prices tend to decay over time, and triple leverage will tend to decay at a faster rate than 2x leverage. As a result, they can tend toward zero.
Over the long-term, inverse ETFs with high levels of leverage, i.e., the funds that deliver three times the opposite returns, tend to converge to zero (Carver 2009 ).
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.
Inverse ETFs aren't intended for long-term bearish movements or for hedging your portfolio against longer-term downswings because of the disadvantage of daily rebalancing.
It's also important to note that inverse ETFs produce their returns based on the daily change in the underlying security's value. Holding an inverse ETF for more than a day can produce returns that don't track with the total return of the underlying security.
The Bottom Line
Investors who buy index funds will not lose all of their investment. That's because they're investments buoyed by hundreds or thousands of underlying securities. As such, they're highly diversified, making it almost impossible for them to reach a value of zero.
Liquidation of ETFs is strictly regulated; when an ETF closes, any remaining shareholders will receive a payout based on what they had invested in the ETF. Receiving an ETF payout can be a taxable event.
"They all go to 0 over time." "If you hold them for more than a few days, you will lose money." The 3x Long Nasdaq 100 ETF (TQQQ) was launched in February 2010, over 8 years ago. Since its inception, it has advanced 4,357%, versus a gain of 378% for the unleveraged Nasdaq 100 ETF (QQQ).
Why are inverse ETFs risky?
The two main risks of inverse ETFs are leverage and asset management responsibilities. Leverage: Because trading derivatives involves margin, creating leverage, certain undesirable situations can arise. Leveraged futures positions can and do fluctuate dramatically in price.
Inverse or leveraged ETFs typically try to track the daily performance of their target asset. So, holding this kind of asset over a long period of time could compound losses. And the higher the leverage of an inverse ETF, the greater the potential decay of value due to its structure.
Inverse ETFs aren't for long term investors since they are designed to be held for a period of not more than a day. At the end of most trading days, instruments such as ETFs and inverse ETFs, especially if they are leveraged, undergo an operation called rebalancing.
Leveraged ETFs decay due to the compounding effect of daily returns, volatility of the market and the cost of leverage. The volatility drag of leveraged ETFs means that losses in the ETF can be magnified over time and they are not suitable for long-term investments.
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.
Conclusion. TQQQ can be a powerful tool for investors seeking short-term exposure to the tech-heavy NASDAQ-100 Index. However, it's crucial to approach this leveraged ETF with a clear understanding of its risks.
Investors can hold the ETF for longer than a day, but returns can vary significantly from 2x exposure over longer periods. That's because the ETF resets its leverage daily. In oscillating markets, the leverage reset can significantly erode returns.
ProShares UltraPro Short QQQ (SQQQ)
If the Nasdaq-100 falls 1% over a day, then the fund is expected to return 3%. Since SQQQ's leverage resets on a daily basis, holding the fund beyond a single day may compound returns and provide results that are different from the target return.
Here's why leveraged and inverse ETFs reset daily: Daily Rebalancing: Leveraged and inverse ETFs use financial derivatives that provide returns based on the daily performance of the underlying index. To maintain their desired leverage or inverse exposure, these ETFs must rebalance their positions daily.
While the Fund has a daily investment objective, you may hold Fund shares for longer than one day if you believe it is consistent with your goals and risk tolerance. For any holding period other than a day, your return may be higher or lower than the Daily Target. These differences may be significant.
What is the 30 day rule on ETFs?
Q: How does the wash sale rule work? If you sell a security at a loss and buy the same or a substantially identical security within 30 calendar days before or after the sale, you won't be able to take a loss for that security on your current-year tax return.
- ProShares UltraShort FTSE Europe.
- AXS 1.25X NVDA Bear Daily ETF.
- Max Auto Industry -3X Inverse Lvrgd ETN.
- ProShares Short QQQ.
- Gotham Short Strategies ETF.
- ProShares UltraPro Short Dow30.
- ProShares UltraShort MSCI EAFE.
And while theoretically possible, the entire US stock market going to zero would be incredibly unlikely. It would, in fact, take a catastrophic event involving the total dissolution of the US government and economic system for this to occur.
A leveraged ETF's price can theoretically go negative, but it's extremely rare and usually only happens in extreme market conditions. Leveraged ETFs use financial leverage to amplify the returns of an underlying asset, such as the S&P 500 Index.
If Vanguard ever did go bankrupt, the funds would not be affected and would simply hire another firm to provide these services.
