From single-stock to inverse exchange-traded funds (ETFs), firms have been promoting more intricate strategies that promise substantial returns to individual investors. However, recent market volatility might be escalating the risk of substantial losses.
Mike Khouw, co-founder and chief strategist at Openinterest.Pro, cautions that when markets decline or experience sharp swings, these leveraged products may underperform the assets they track and face challenges. 'Leverage is an attractive concept when you've only seen prices rise over the past few years,' Khouw, a CNBC contributor, mentioned on 'ETF Edge' this week. 'But leveraging is a double-edged sword.'
The issue lies in the fact that leverage often introduces an additional layer of risk. Khouw explains that many lightly leveraged ETFs deploy tools like total return swaps or options to deliver the advertised extra exposure. To maintain leverage, portfolio managers must consistently adjust their positions, which becomes complicated in an unstable market.
Khouw, whose firm specializes in options-focused research and analytics, noted that the rise of weekly and even daily options has made the market so time-sensitive and complex that most retail investors would find it challenging to handle these trades independently. 'Finding a product where essentially someone else can manage part of that for you democratizes those products. That's the good news,' Khouw remarked. 'The bad news is that sometimes investors' education or understanding of both options and these products aren't keeping up with their rapid development and issuance.'
Nate Geraci, president of NovaDius Wealth Management, identifies two primary trends driving the growth of inverse and leveraged products in the complex ETF space. He attributes it to a shift in retail investors' mindset as they pursue products promising significantly higher, 'astronomical' returns, even if they do not completely comprehend the underlying risks.