Leverage has been around for years and there are many types of leveraged instruments available today – from futures to certificates – listed on exchanges around the world. Not to mention CFDs, which have become very popular over the past decade, despite not being listed and trading over-the-counter (OTC).
ETPs are an alternative to these leveraged products and do not require opening a margin account. Although ETPs are risky investment products, their risk is limited to the amount invested, unlike CFDs or futures contracts.
Due to the combined characteristics of leverage and daily compounding returns, this type of trading instrument can improve returns and are a secure, transparent, and profitable trading tool.
As a provider of leveraged ETPs through our Leverage Shares product line, we want investors to clearly understand how these products work prior to investing or speculating with them.
The advantage derived from leverage allows an investor to amplify the returns of an asset
( both positive and negative).
For example, let’s assume you invest in an ETP that tracks the Facebook, Inc. (FB) stock and offers a leverage factor of 2 (FB2). When the Facebook share increases by 1% during a trading day, your ETP (FB2) will increase by 2% (excluding fees and adjustments*).
Conversely, if the value of Facebook drops by 1% on any given day, ETPs offering 2x exposure will lose 2%, respectively.
Leveraged products allow investors to either use less capital to reach the desired level of
exposure, or to increase their exposure by using the same amount of capital.
In the case of an ETP with 2x leverage, you would actually invest only half of the total exposure desired.
How? For example, if an investor purchases $100 of a 2x leveraged ETP, he receives $200 exposure consisting of $100 invested and $100 of borrowed funds (at the benchmark market funding rate + 1%) to make a total investment of $200.
The cost of borrowing is deducted from the daily return and is included in the calculation of the ETP’s price (with other fees and adjustments*).
If an investor buys $100 of a 2x ETP on a share, $200 of the shares are bought on the reference stock market because Leverage Shares ETPs offer physical replication.
There is a reason why the providers of ETPs integrate a rebalancing mechanism (which is
Leveraged ETPs seek to provide a fixed multiplier (i.e. leverage factor) compared to the performance of their benchmark over a given period.
This period is usually one day. This means that leveraged ETPs must rebalance their leverage at the end of each trading day to ensure that they offer investors the same leverage every new trading day.
Over time, this can lead to extreme results (for example, exposures well above the stated leverage). Since ETPs are open-ended and can be created and traded on a daily basis, daily rebalancing allows investors to buy and sell the ETP on any date and receive the leverage expected.
The compounding effect must be taken into account for ETPs held for periods of more than one
day and can have both negative and positive effects.
Let’s take a scenario where Facebook, Inc.’s stock is moving up and down with no clear trend.
You now know that if the Facebook share price is $100 and increases by +5%, your 2x Facebook Leverage ETP (FB2) will increase by +10%, to reach $110 (excluding fees and adjustments *).
But the next day, if Facebook’s stock drops -5%, the ETP will fall to $99. Over two days, the Facebook share would post an average return of 0% and a price of $99.75, resulting from a two-day compounded return of -0.25%. While you would expect a return on the ETP equal to twice that of the stock (or -0.50%), the return on the ETP compounded over two days will be -1.00%.
Now take a scenario where Facebook’s stock is trending upwards, reporting +5% on each of two consecutive days. $100 invested in Facebook shares earns $5 on the first day and $5.25 on the second day, with an end-of-period value of $110.25 (representing a return of 10.25% over the two days). Our 2x Facebook ETP would have brought in $10 on the first day, then $11 on the second day, for a compound price of $ 121.00, therefore a return of 21.00% over two days.
Daily rebalancing produces “compounding” returns, which can have either a positive or negative impact. The magnitude of this daily compounding effect depends on the length of the ETP holding period, the volatility of the security, and the amount of leverage used.
Utilization and trading strategies
Leveraged ETPs can be used by a wide range of investors and for many different trading strategies:
a. Double the daily return of a strategy, positively or negatively (excluding fees and adjustments*).
b. Cover existing positions with a single transaction, requiring less capital tied up.
c. CFD providers can cover the risks of their products using Leverage Shares ETPs.
d. Use in a pair trade to take advantage of undervalued assets.
e. Use in short term or intraday strategies.
ETPs are available via most brokers and are listed on the London Stock Exchange. Follow us on social media to be informed of new products to come.
More information about our ETPs is available on:
*the fees are 0.75% pa of management fees + 1% pa of margin fees, i.e. 1.75% pa in total.