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Leveraged ETFs: How Are They Built and What's Hot Now?

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Is there a topic more misunderstood in the ETF world than leveraged and inverse funds?

It is hard to think of one, and extra education is always a good idea for this product class as a result. This is especially true as more traders try their hand at using leverage and inverse funds in order to either hedge out risk, or make a play on a surging (or tumbling) category.

In order to shed some light on this topic, I went right to the source and spoke with Direxion Investments, one of the leaders in leveraged and inverse ETFs. In particular, I talked with Sylvia Jablonski, Managing Director at Direxion for some insights into this important market.

In the interview, which you can see at the top of this article, we discuss some of the basics regarding construction of leveraged and inverse funds, including how the exposure is achieved, differences between 200% leverage and 300% leverage funds, as well as swaps and risks in this market.

We also talk about arguably the most misunderstood part of the entire leverage and inverse process, the daily resetting feature. This can make returns different from the underlying index over time periods longer than a single session—as you can see in the chart below—and Sylvia walks us through how this happens. She goes over why this is the case for leveraged and inverse funds that reset each day, using their 3x bull S&P 500 product, SPXL, as an example.

What’s Popular Now?

Once we have a handle on how these funds trade and how they are constructed, we take a closer look at some leveraged and inverse products which are seeing a bit more interest thanks to recent trends. Obviously, leverage targeting the Treasury market—which includes TMF for bulls and TMV for bears—has been a hot topic thanks to big moves in rates lately. And since Direxion’s funds focus on the long end of the curve, they have seen even more volatility than most.

And for sectors, the 3x/-3x funds tracking a levered version of XBI—LABU for the bull and LABD for the bear—have been more in focus thanks to renewed investor interest and volatility in the biotech sector. Meanwhile, investors are also seeing something similar in the oil exploration and production market. This area is tracked by XOP in an unlevered form, but Direxion is focused on its 3x bull product GUSH and -3x product DRIP for traders targeting this space.

We take a look at why these products have been in-focus as of late, and how their holdings could impact returns. Lastly, we also discuss what is on the horizon for the leveraged and inverse ETF world, is innovation dead or are there more interesting—and useful—products ahead? Direxion’s CSI China Internet Index Bull 2x Shares (CWEB - Free Report) —which tracks double the daily return of the CSI Overseas China Internet Index—definitely fits the bill, but what else is out there for expansion in this market?

Bottom Line

For a more in-depth look at leveraged and inverse ETFs from one of the main players in the space, make sure to listen to the podcast for additional information. You’ll definitely feel more knowledgeable about the trading approach, and more comfortable with the idea of leveraged and inverse investing too.

So, make sure to listen to this edition of the Dutram Report for a closer look at this important, but often misunderstood, segment of the fund world for some key insights. And for more news and discussion regarding the world of ETFs, make sure to be on the lookout for the next edition of the Dutram Report, and check out the many other great Zacks podcasts as well!

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