Leveraged ETFs pose personal and market-wide volatility risks.Oscar Wong/Getty ImagesInvestors now have $200 billion in ETFs that let them double or triple their bets.Even if an investor gets their directional bet right, they can lose most of their money.These ETFs are causing chaos in the South Korean stock market and are facing regulatory action.ETFs that allow investors to double, or triple, the daily performance of a stock or index are growing bigger than ever,Though the market category is more than 20 years old, more than 400 of 700 US leveraged ETFs have been launched in the last two years, according to Baird Strategas. They now manage roughly $200 billion in investor money, commanding a notional value of $500 billion because they use leverage to drive returns."These leveraged ETFs sound exciting," said Gene Goldman, chief investment officer of Cetera Advisors. "Basically, investors feel that they will double their money if the stock goes up."It's an especially exciting pitch for investors with strong convictions, allowing them to double or triple down on their bets or shorts. But even if they make the right bet, the daily mechanics of these ETFs can still mean they lose almost all of their money. Goldman worries that investors think they're doubling down on the long-term performance of a company, when in reality, they're compounding the daily performance of a stock over and over again, he said.Holding leveraged ETFs that go long or short on individual stocks during a period of volatility, can lead to rapid "wealth erosion," said Brent Coggins, CIO of Triad Wealth."That has to feel terrible as an active investor," Coggins said. "You got something right — nailed it on the head — but the instrument you use resulted in you losing almost all of your money. You would have been better off buying the stock you didn't like."These leveraged ETFs aren't just personally volatile; they're actually contributing to historic stock market volatility in South Korea.Just months after allowing single-stock leveraged ETFs in May, in a drastic about-face, the government announced on Wednesday that it would no longer allow new ETFs and would significantly increase the requirements for investors to buy them.Lee Chan-jin, the governor of the Financial Supervisory Service, the regulatory equivalent of the US Securities and Exchange Commission, said in June that he regretted not standing in the way of the approvals."Maybe I should have lain down on the floor to block it," Chan-jin said.How you can be right and still loseThe key risk of these leveraged ETFs is that they reset daily, and if a stock or index sees big swings, you're pretty much guaranteed to lose money if you hold it. Investors call this concept "volatility decay," said Coggins.Here's a simple example of an investor putting $1000 into a 2x stock ETF:On day one, the stock jumps 10%.As a result, your ETF holding jumps 20% and is now $1200On day two, the stock falls 10%.Now, your ETF falls 20%, and your $1200 sees a $240 loss on the day.Your holding is now worth $960, a $40 or 4% loss.A regular stockholder would be down only $10, or 1%Here's what would happen if the stock followed the same pattern over 20 trading days: ETF sponsors sell products that use debt to double, or even triple, the daily gain or loss. But even though the daily loss and gain is doubled, your volatility decay losses are actually quadrupled, said Coggins. With three times leverage, your losses can be multiplied up to 9 times.Suddenly, that $1 loss for a regular stockholder has become a $4 loss for a two-times leveraged fund and a $9 loss for a three-times leveraged fund.Coggins analyzed two leveraged ETFs offered by Tuttle Capital Management & REX Shares' T-REX ETF platform that offer opposite bets on Strategy, formerly known as Microstrategy. One delivers twice the stock's daily gains, while the other delivers twice its daily losses.Strategy's value is highly volatile as the company owns hundreds of thousands of bitcoin holdings, financed in part with debt.Between the September 2024 launch of the ETFs and the analysis through the end of June, Strategy lost about 38% of its value. During the same time period, both ETFs lost around 95% of their value.In other words, neither side won. The stock was so volatile that the daily resets overwhelmed the directional bet. In order to make money from these products, one needs to time the bet correctly both on the way in and the way out, Coggins said."It takes significantly more upside to break even on any type of downside," Coggins said. And then factoring in leverage, you're "you're not making up enough on what you lost the day before."But the numbers do add up for the sponsors of ETFs and their investment bank partners. Sponsors charge a relatively-high 1% fee for the ETF, and then the swaps required to make leverage work can run 5-6% with an investment bank, said Coggins. Those costs eventually come out of the investors' take, too.'Portfolio gambling'So
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