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Leveraged ETF’s -- similar to regular ETF’s but supercharged to deliver higher returns than that of their benchmark indices -- are growing in popularity. Traditional ETFs seek to match the performance of an index on a 1:1 basis. In a leveraged ETF, the fund is designed to produce some ratio of its normal 1:1 return. One very important point about leveraged ETFs that often escapes notice: the funds are not designed, nor guaranteed, to produce the stated higher returns for anything longer than a single day. Since each daily move is compounded over time, losses much higher than the fund’s stated leverage ratio can occur. Adding to an already bad situation, leveraged fund managers must rebalance, increasing or decreasing their exposure as the market changes. This can force traders to buy into expensive markets, and vice versa. It also assumes that there is sufficient liquidity to do so, which is not necessarily the case for some single stock leveraged ETFs. And finally, since markets are inconsistent from day-to-day, this can lead to high expense loads. When it comes to investing, there are few things more frustrating than getting the market right but not making any money. And yet, when it comes to leveraged ETFs, that’s what can happen. Take the fabulously named and the . Both are based on Strategy (MSTR, née MicroStrategy), the bitcoin treasury company and, arguably, one of the hottest, and most controversial, stocks out there. The two funds have the same strategy but differ in expense ratios. Products that combine leverage, volatility, bitcoin, and MSTR’s business plan -- what could go wrong? Plenty. Misunderstanding the performance characteristics over time of leveraged ETFs can be fatal. As you may recall, leveraged ETFs have a particularly pernicious feature called “volatility decay” or “volatility drag” (FYI, this has nothing to do with options volatility). Rather, volatility decay refers to how daily leverage and compounding can erode performance and cause a leveraged ETF to diverge from its underlying index, sometimes significantly. Below is a comparison of the year-to-date performance of MSTR vs. MSTX. Notice the significant divergence starting mid-July: Source: OptionMetrics How does this happen? Leverage combined with compounding. Suppose a hypothetical index starts at 100 on day one, drops to 90 (a 10% loss) on day 2, and then recovers back to 100 (11.1% gain) on day three. Over the three days, the index was unchanged. However, a 3X ETF would amplify each daily move by 3: 30% down on day two (index moves down to 70), and a 33.3% gain on day three (index backup to 93.31). After all this, the index would wind up 6.69% lower from its start at 100, despite the fact that it was unchanged over the period. The difference can be quite a shock to uninformed investors. Back to MSTU and MSTX. As of 11/05/2025, they closed down 71.84% and 65.18% year-to-date, respectively. Their index, MSTR, closed down 11.95% YTD (btw, bitcoin, which is MSTR’s only asset, was up 12.49% YTD). As mentioned, leveraged ETFs can diverge if they are held for more than one day and the negative effect of leverage and compounding has time to work. In this case, the effect was spectacular, with the leveraged ETFs losing 5.5 to 6 times as much as MSTR. And that’s before fees. If you started the year super-bullish on bitcoin and bought any of these leveraged funds thinking that you could make even more money by deploying 2X leverage, you would be disappointed, to say the least. To be fair, leveraged ETF providers make it clear that the products are designed to achieve daily performance objectives; anything longer-term can lead to divergence. Investors, however, need to recognize that and understand why it’s so. It’s important to understand the downside of any financial product, especially those that employ leverage. Although this seems obvious, it’s easy to get caught up in speculative fever and ignore the risk. As Jack Reacher says, “in an investigation, details matter.” Always be skeptical; beware of products that combine hot stocks, leverage, and high fees. Markets can be fickle, and what’s in fashion this week may be old news by the time related derivatives are introduced. *** There is an inherent risk involved with financial decisions. The information in this article is for informational purposes only and is not intended to provide financial advice. Views expressed are those of the author(s) and are not necessarily those of the company.
