SPXL Great for Traders, But Keep it on a Short Leash

The Direxion Daily S&P 500 Bull 3X Shares (NYSEARCA:SPXL) is an exciting spin on efficient, but generally boring S&P 500 exchange-traded funds. For the month ending July 16, SPXL is higher by 15.22% while the SPDR S&P 500 ETF (NYSEARCA:SPY) is up 4.82% over that span.

stock market icons of a blue bull and a red bear (overvalued stocks)
Source: Shutterstock

That indicates SPXL is, at least for that period, doing slightly better than its stated objective, which is triple the daily returns of the S&P 500. That means if SPXL performed as intended, it will gain 3% on a day when the S&P 500 adds 1%.

Novice market participants are frequently seduced by that leverage, thinking that it can hold true over long holding periods. That line of thinking is something like: “If SPY rises 10% in a year, than SPXL must rise by 30%.” However, that’s flawed rationale. SPY and its brethren make for ideal long-term investments. SPXL – or any leveraged or inverse ETF for that matter – are anything but ideal for lengthy holding periods.

SPXL ‘Secrets’

Leverage on an ETF doesn’t appear out of thin air. There’s some engineering involved on behalf of issuers of geared ETFs to make those products deliver large near-term gains or losses. A fund such as SPXL uses derivatives and swaps to attain leverage. Those exposures are reset on a daily basis to ensure that when the next trading day arrives, the ETF in question does what it’s supposed to do.

To the credit of issuers of these products, such as Direxion, they don’t run away from the daily resets. If anything, the opposite is true. Issuers of geared ETFs often go to painstaking lengths to inform would-be users that these products are not long-term investors.

“Leveraged and inverse ETFs pursue daily leveraged investment objectives which means they are riskier than alternatives which do not use leverage,” according to Direxion. “They seek daily goals and should not be expected to track the underlying index over periods longer than one day. They are not suitable for all investors and should be utilized only by investors who understand leverage risk and who actively manage their investments.”

The odds are short that over say 12 months, the performance of that fund will deviate wildly from its non-leveraged counterpart. And, there’s a better than fair chance the performance will be disappointing.

Making matters worse regarding SPXL, the higher an ETF’s leverage, the more likely it is to deliver sour returns over lengthy periods. This is according to a November 2019 study by the Securities and Exchange Commission. Currently, triple leverage is the most being offered by any ETF issuer.

Bottom Line on SPXL Stock

One thing newbies need to remember about financial markets is that there’s no such thing as a free lunch. In most cases, the higher an asset’s return potential, the high its risk profile is.

Specific to a product like SPXL, with each passing day a market participant holds the fund, the risk profile increases. And this increase is exponential at that. Unfortunately, the likelihood of SPXL returning 30% in a year in which SPY rises 10% is low. Hoping for SPXL to do that puts investors into a “juice not being worth the squeeze” scenario.

All that said, SPXL is an effective tool for active, sophisticated traders. This is because the fund typically does what it’s supposed to do, which deliver triple the daily performance of the S&P 500.

Todd Shriber has been an InvestorPlace contributor since 2014. As of this writing, he did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2020/07/spxl-is-useful-for-quick-gains-but-its-not-a-long-term-holding/.

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