Frequently Asked Questions

How does leverage work in volatility-linked ETPs?

Many volatility-linked ETPs employ leverage to magnify their returns. Leveraged volatility-linked ETPs will return some multiple (usually 2x or 3x) of the daily returns of a given volatility-linked index. Inverse products, meanwhile, return the inverse of the daily returns of a given volatility-linked index. Note that this isn't the same thing as providing 2x, 3x or the inverse of an index's return over any other period of time, like a month or a year. Consider a very simple example of a hypothetical -2X ETP:

Day1:Level
Index Level:100
-2X ETP100
Day2:(Index up 10%)Level
Index Level:110
-2X ETP80
Day3:(Index down 10%)Level
Index Level:99
-2X ETP96
On day 1, the -2x fund is at 100. On day 2, the index goes up 10 percent to 110, and the fund falls 20 percent to 80. So far, so good. But on day 3, the index falls 10 percent: 10 percent of 110 is 11, so the index falls from 110 to 99. Twenty percent of 80 is 16, so the fund rises from 80 to 96.

This example shows the fund doing exactly what it promises - delivering -2x returns each day. The example also shows how an investor can get unintended performance. The index return was -1% over the two days, but the performance of the negative 2X fund, far from being a "naïve" +2%, was actually -4%.

Leveraged indexes add an additional layer of complexity to an already-sophisticated product. While the returns of a leveraged volatility-linked ETP will be amplified, so too will the losses, and longer holding periods are problematic. Leveraged volatility-linked ETPs are trading tools and should be used with care.

 

 

Investments in ETPs involve risk, including the possible loss of principal, and are not appropriate for all investors. Non-traditional ETPs, including leveraged and inverse ETPs, pose additional risks and can result in magnified gains or losses in an investment. Specific risks are outlined in the fund prospectus and may include concentration risk, correlation risk, counterparty risk, credit risk, market risk, interest rate risk, volatility risk, tracking error risk, among others. Investors should consult with their tax advisors to determine how the profit and loss on any particular investment strategy will be taxed. Tax laws and regulations change from time to time and may be subject to varying interpretations. The information in this program is provided for general education and information purposes only. No statement within this program should be construed as a recommendation to buy or sell a security or to provide investment advice.