3

Suppose I am very confident that the 1 year and 5 year returns of an index-tracking ETF will be positive. How can I lever up the returns?

For example, when the ETF increases by 5%, how can I achieve a 10% return from a 5% rise in the ETF? What financial instruments can I use to do this?

(I know that leverage will also magnify losses)

5
  • 1
    Buy leveraged financial instruments. – Bob Baerker Oct 2 '20 at 3:34
  • @BobBaerker For example? Options? But how can I adjust the leverage to achieve the example given in the question? – Flux Oct 2 '20 at 4:13
  • 2
    Standard equity margin doubles the return as well as the loss. For options, pick one that will yield a return equivalent to a 5% move in the underlying. – Bob Baerker Oct 2 '20 at 5:00
  • @BobBaerker Okay, so buying the ETF on 50% equity margin will do what I want. But I don't quite understand the part about options. – Flux Oct 2 '20 at 7:14
  • Say ETF is $300. Rise of 5% takes it to $315. Determine how long you think it will take to rise 5%. That's your earliest possible option expiration. Look at the option chain and select call (or X number of calls) that will net $15 with ETF at $315 at expiration. Prior to expiration the option gain will be larger but that requires an understanding of option behavior along with an option pricing formula or software. – Bob Baerker Oct 2 '20 at 12:13
2

There are a few ways you might try to approach this, but you have to keep in mind that all of these options are also increasing your downside:

  1. Leveraged ETFs - there are many 2x or even 3x leveraged ETF instruments that are structured in a way that they multiply the returns of the underlying ETFs. However you have to be aware that these types of products are mainly intended for short term trading and are not designed for "buy and hold" strategies.
  2. Options - You can buy call options (if bullish) that allow you to control larger amount of the underlying equity with the fraction of the capital (leverage) but you have to be aware that options have expiration date and if your thesis does not materialise you will loose all of the principal.
  3. Margin - You can buy the security on margin, if your broker allows it. This will provide you with the option to hold larger amount of the security with your capital. The risk is of course that you might get a margin call and be forced to sell at a time that might not be optimal for you.
6
  • 3
    I don't think leveraged ETFs are appropriate for my investment horizon of "1 year and 5 years". – Flux Oct 2 '20 at 7:44
  • Regarding options, how can I construct a portfolio such that a 5% gain in the ETF will result in a 10% gain in the portfolio? – Flux Oct 2 '20 at 7:45
  • You can buy call options on the ETF with smaller amount of your capital. If the ETF price go up 5% your options are going to be worth a lot more than that. – Dbrooks Oct 2 '20 at 7:49
  • Yes, but how many options contracts do I need to buy to achieve the equivalent of 50% margin? Is there some kind of mathematical formula? – Flux Oct 2 '20 at 7:52
  • 3
    A deeper explanation of why leveraged ETF's are not advised for long-term trading, and the time-risk associated with using options could turn this from a good to great answer. – Grade 'Eh' Bacon Oct 2 '20 at 12:47
0

Write near term options, use the proceeds to buy LEAPS with a delta that fulfills your criteria. Or just buy any LEAPS if you are really bullish.

Disclaimer: Not financial advice, consider everything I wrote to be apocryphal.

1
  • 2
    Could you explain this "delta" in terms of how can I achieve a 10% return from a 5% rise in an ETF? – Flux Oct 2 '20 at 7:10

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.