Leveraged ETF vs Inverse ETF
An exchange traded fund or ETF can be understood as a basket of securities that tracks an underlying index. These can contain investments such as stocks, bonds, currencies or any other asset class.
A leveraged ETF is a leveraged fund, i.e., it will borrow money for the purpose of investing more in the index or it will invest in options and futures in order to amplify the returns of an underlying index. These are created to deliver a greater return than the returns from holding long or short positions in a regular ETF.
For instance, if you have invested in a 2X leveraged ETF on Nifty and it goes up by 5%, then you will stand to gain twice i.e. 10% less transaction & management fees
Similarly, if Nifty goes down by 5%, you would be losing 10% in addition to transaction & management fees.
Leveraged ETFs are just like any other Normal ETFs, except the risks and the stakes are too high due to high transaction fees and higher leverage.
Inverse ETFs is similar to Leverage ETF but it’s actually like buying put options on the index. Inverse ETFs are designed to profit from a fall in the value of the underlying benchmark.
Both Leveraged & Inverse ETFs use derivative instruments and include borrowing for the purpose of amplification of consequences. These instruments should only be dealt with when you have a risk appetite.
DO YOU HAVE THE RISK APPETITE?
If one wants to trade a stock or an index, then he/she will have to buy it through a broker on margin. Then one will have to buy options which are once again costly. Instead, one can simply go for a Leveraged ETF which not only provides inherent leverage but also offers economies of scale.
If you have bought a Leveraged ETF on Nifty, then in the long -term, the returns of the two cannot be compared. This is because a Leveraged ETF is a suitable instrument only for short-term (a few days or a fortnight). You cannot buy a Leveraged ETF thinking that it will replicate Nifty’s returns over a longer horizon as the fees can turn out to be quite substantial.