Leveraged ETF Wiped Out: A Cautionary Tale for Investors

Sometimes, the pursuit of amplified returns can lead to devastating losses. A recent event involving a 3x leveraged short ETF tied to AMD serves as a stark reminder of the dangers lurking within complex financial products.

The Demise of a 3x Short AMD Fund

The GraniteShares 3x Short AMD Daily ETP, traded in Europe, recently went to zero, obliterating the investments of those betting against AMD. This implosion was triggered by a significant surge in AMD's stock price following its announcement of a major deal with OpenAI. The fund, designed to deliver triple the inverse of AMD's daily return, couldn't withstand the stock's rapid ascent.

How Leveraged ETFs Work (and Why They Can Fail)

Leveraged ETFs don't directly hold the underlying stocks. Instead, they utilize derivatives to achieve their targeted leveraged exposure. In this case, the fund aimed for -300% of AMD's daily return. However, this daily reset mechanism, combined with volatility drag and leverage decay, makes them unsuitable for long-term investments.

When AMD's stock price jumped, the 3x short fund faced an escalating crisis. A 33.33% gain in AMD translates to a 100% loss in the inverse 3x ETF. Once that barrier was breached, an "index cancellation redemption event" was triggered, resulting in the fund's liquidation and a total loss for investors.

Key Takeaways:

• Leverage Amplifies Losses: Leveraged ETFs magnify both gains and losses.
• Daily Resets Matter: The daily reset feature makes them unsuitable for holding longer than a day.
• Understand the Product: Before investing in leveraged ETFs, thoroughly grasp their mechanics and inherent risks.
• Total Loss is Possible: In adverse market conditions, a leveraged ETF can go to zero, resulting in the complete loss of invested capital.

Protecting Yourself from ETF Blowups:

• Diversify: Build your portfolio with a core of high-quality stocks and bonds.
• Limit Exposure: Only allocate a small portion of your portfolio to leveraged ETFs—an amount you're prepared to lose.
• Seek Simpler Alternatives: Explore sector ETFs for targeted exposure without excessive leverage.
• Use Stop-Loss Orders: Implement stop-loss orders to mitigate potential losses.

Historical Precedent

This isn't the first time a leveraged product has collapsed. The 2018 "Volmageddon" saw the VelocityShares Daily Inverse VIX Short Term ETN go bust, destroying billions in investor wealth.

The collapse of the 3x Short AMD ETF serves as a crucial reminder: leverage cuts both ways. Investors must exercise caution and fully comprehend the risks before venturing into these complex instruments.