1. Initial allocation
If the 2x ETP has $100 in net assets, $200 of net exposure to the ETP assets needs to be maintained.
2. Underlying stock price increases by 5%
When the index rises 5% during the trading day, the ETP rises by twice that amount (10%) and the total exposure to the ETP rises to $210.
3. ETP exposure modified
As exposure needs to be two times that of the ETP assets ($110 x 2 = $220) at the beginning of each trading day, an additional $10 of underlying securities must be purchased to maintain the needed exposure of 2x.
In the opposite scenario, where the ETP value falls to $90 due to a 5% decline in the underlying stock (meaning a $10 fall in ETP value), the exposure would fall to $190 during the day. Thus, to maintain the 2x multiple, the total exposure to the ETP would need to be reduced by $10 ($90 x 2 = $180).
So where does the additional capital for the needed leverage come from? When an ETP is issued, that entire proceeds plus a matching margin loan provided by Interactive Brokers is invested in the underlying security (stocks like Amazon and Netflix). Moreover, additional cash proceeds (like dividends received from the underlying securities) are also invested to purchase additional securities. In this manner, the 2x ETPs are always fully collateralized.
SOURCE:
1. Wisdomtree, “SHORT & LEVERAGED ETPs Global Flows”, December 2019.