In this article we explore Levered and Inverse ETPs (Exchange Traded Products); their goals, the circumstances in which they tend to succeed and fail, and the research questions related to them.

Leaders and Reverse ETPs: A Blessing or a Curse?

  • Colby J. Pessina and Robert E. Whaley
  • Journal of Financial Analysts
  • A version of this document can be found here here
  • Want to read our summaries of academic finance papers? Check out ours Academic Research Insight category.

What are the research questions?

In 2019, the SEC proposed that all brokers and advisors be required to determine whether their clients understand the risks of investing in leveraged and inverse exchange-traded products before selling them such products. The SEC moved to this requirement in response to a series of fund denials. For example, losing 96% of the value in one day, Credit Suisse closed its daily inverse VIX short-term ETP (XIV). Unfortunately, the problem seemed to go beyond investor education as fund failures continued to occur.

The Citigroup VelocityShares 3x Long Crude Oil (UWT) exchange-traded bond nearly collapsed on March 9, 2020, when its benchmark fell 73.5%, just short of the 75% acceleration provision that would have triggered the shutdown. On March 15, 2020, ProShares announced the liquidation of the UltraPro 3x Crude Oil (OILU) and UltraPro –3x Crude Oil (OILD) exchange-traded funds (ETFs).

One question arises: why do these products even exist?

The authors of this article are motivated to provide an answer. They discuss the intended purpose and under what conditions these funds may fail. They describe the fundamentals of expected performance and consider how issuers actually measure up to target benchmark performance. Highlights are below.

What is academic information?

  1. If standard asset pricing assumptions are used, it follows that is expected return leverage and reverse ETP will be zero. If the benchmark return is positive, the value of the leverage or inverse ETP is zero. If negative, the value is also zero (Cheng and Madhavan, 2009). This theoretical result makes ETP undesirable from a long-term or risk management perspective. The authors perform Monte Carlo-style simulations that confirm these expectations.
  2. Tracking error (TE) analysis provides insight into how well issuers match benchmark returns. Thirty-five funds were examined with the results presented in Table 7 below. TE is defined as the difference between the daily return of the security-based benchmark and the fund. The authors convert TE to risk-adjusted return (RATD). A similar analysis was conducted using futures-based benchmarks. SP500 based ETPs appear to have outperformed other products in terms of risk/return.

Why is this important?

Leverage and reverse ETPs seem to be a blessing, but only under limited conditions. If an investor has a solid understanding of the market, these products offer an attractive opportunity. Trading costs, trading barriers (no minimum accounts, no commission) and bid-offer spreads for leveraged and inverse ETPs are very low, especially compared to similar futures trading. Smaller retail investors may be prohibited from using futures to implement directed trading due to minimum requirements, both on a personal and account basis. Institutions may also be prohibited from using derivatives for various reasons. Leads and return ETPs may qualify for these organizations.

The most important paper scheme

The results are hypothetical results and are NOT indicative of future results and are NOT representative of the returns any investor may actually achieve. The Indices are not managed and do not reflect management or trading fees, and you cannot invest directly in the Index.


Leveraged and Inverse Leveraged Exchange Traded Products (ETPs) are designed to provide long and short exposure to the daily returns of various benchmark indices. Any benchmark index can be used as a benchmark, but stock, bond, commodity and volatility indices are popular. The problem with these products is that they tend to be poorly understood, especially those with futures benchmarks. Leveraged ETPs and inverse ETPs are neither suitable buy-and-hold investments nor effective hedging instruments. They are volatile and exist only as mechanisms for placing short-term directional bets. Leveraged and inverse products are not and cannot be effective investment management tools.

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