Leveraged ETFs, designed for one-day trading, have seen explosive growth, with U.S. assets under management (AUM) surging from approximately $120 billion in early April to over $200 billion at their peak. The Asia Pacific region witnessed even more dramatic growth, expanding from around $12-$13 billion to $50-$55 billion in mere months. This expansion is largely driven by price performance in the U.S., with funds like ProShares UltraPro S&P 500 (UPRO) up 25.29% year-to-date and 55.23% over the past year, and ProShares UltraPro QQQ (TQQQ) returning 45.38% year-to-date and 81.32% over the trailing year.
The core concern surrounding leveraged ETFs is their daily rebalancing requirement. To maintain their target leverage, these funds must sell futures or swaps when markets drop and buy more when markets rise. An analyst explained that a 10% drop in the underlying index can trigger more than $10 billion in mechanical selling. This daily rebalancing creates "leverage decay," where choppy sideways markets erode returns even if the underlying index ends flat, essentially forcing a "buy high, sell low" scenario every day. These mechanics introduce a new source of volatility risk, amplifying both rallies and selloffs in the broader market.
The growing size of the leveraged ETF market has shifted the market's overall gamma profile. While covered-call and overwriting ETFs provide "long gamma" that dampens volatility, leveraged ETFs add "short gamma" or "negative gamma" due to their rebalancing, which amplifies market moves. The analyst suggests that the leveraged cohort is now large enough to overpower the stabilizing effect of overwriting products, making the market's net gamma profile more negative. This means that during a selloff, the number of "forced sellers at 3:50 p.m." is considerably larger than it was a year ago, potentially exacerbating market declines.
While the total AUM of leveraged ETFs might not be inherently terrifying, the "meteoric" or "asymptotic" growth in recent months is a significant concern, especially when considering the potential for increased volatility. This awareness of market structure, rather than a direct call to action, is important for long-term investors. Regulators are also taking note, with the U.S. Securities and Exchange Commission (SEC) launching a public comment period on June 30 for "Novel ETFs" that use leverage, options, cryptocurrencies, and event contracts, highlighting the need for updated regulatory safeguards amidst increasingly complex product structures.
