By Kevin Grewal, Editorial Director at www.SmartStops.net
Both leveraged and inverse ETFs are index funds that amplify the returns of an underlying index. They are relatively new to the market, but are gaining tremendous ground as traders and investors become more knowledgeable of both their benefits and drawbacks.
Leveraged ETFs are index funds which try to amplify returns from an underlying index using leveraged money. They keep a constant leverage level, which can double or triple daily returns. Leveraged ETFs use derivatives like index options, index futures and equity swaps to reduce to increase or reduce market exposure and they do this on a daily basis, therefore there is no guarantee of amplified annual returns. Take for example, a fund that doubles returns, if the index returns 1% for the day, then the leveraged fund rises 2%.
Inverse ETFs are ETFs that are created by using derivatives to create profits when the underlying index declines in value. In layman’s terms, inverse ETFs track the reverse, or opposite of the market. They short the market and make money when the market is falling. Some of the most common inverse ETFs include the following: