can leveraged etf go to zero

Leveraged ETFs amplify gains and losses, exposing investors to the risk of losing their entire investment if market conditions lead to a precipitous decline in the underlying asset's price.

Oct 16, 2024 at 11:54 pm

Can Leveraged ETFs Go to Zero?

1. Understanding Leveraged ETFs

   • Leveraged exchange-traded funds (ETFs) use borrowed funds or derivatives to amplify the returns of an underlying index or asset.
   • They can provide significant returns during periods of market upside, but also magnify losses during market downturns.

2. Leverage Risk

   • The primary risk associated with leveraged ETFs is leverage.
   • When the underlying asset price falls, the ETF will lose more value than the underlying due to its leverage.
   • This can lead to a situation where the ETF's net asset value (NAV) approaches zero.

3. Market Volatility and Liquidity

   • Leveraged ETFs are particularly sensitive to market volatility.
   • During periods of high volatility, the underlying asset can experience sharp price swings, which can be amplified by the ETF's leverage.
   • Illiquidity can also exacerbate losses, as it can prevent investors from selling their shares when the ETF is underperforming.

4. Reset Mechanism

   • Some leveraged ETFs use a reset mechanism to maintain their leverage.
   • If the NAV falls below a certain threshold, the ETF may issue new shares or adjust its leverage ratio to bring the NAV back to the level.
   • However, this mechanism may not always prevent the ETF from going to zero.

5. Reasons for Potential Loss to Zero

   • Extreme market downturns: If the underlying asset experiences a precipitous decline, the ETF's leverage can accelerate the NAV's path to zero.
   • Sustained underperformance: If the underlying asset underperforms the market for an extended period, the ETF's NAV can gradually erode.
   • Structural issues: Some leveraged ETFs may have structural flaws that make them more prone to reaching zero.

6. Examples of ETFs That Have Gone to Zero

   • VelocityShares VIX Short-Term ETN (XIV): A leveraged inverse ETF tracking the volatility index (VIX), it lost 98% of its value and halted trading in 2018.
   • Direxion Daily S&P Oil & Gas Exp. & Prod. Bear 3X Shares (DRIP): A leveraged inverse ETF tracking the oil and gas sector, it lost over 90% of its value and halted trading in 2020.

7. Conclusion

   • While leveraged ETFs can offer high returns in certain market conditions, they carry significant risk.
   • Investors should carefully consider their investment goals and risk tolerance before investing in leveraged ETFs.
   • It is important to be aware that these ETFs have the potential to lose their entire value and go to zero.