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What Is a 3X Bull Exchange Traded Fund

05 Oct 2023

Introduction

Some financial traders invest in leveraged Exchange-Traded Funds (ETFs). Similar to traditional ETFs, these financial instruments are pooled investment vehicles that allow you to gain exposure to several related assets with a single investment. They also track a stock index or a specific industry. 

What are leveraged ETFs?

Leveraged ETFs are a distinct type of ETFs. They use debt to increase equity positions. Compared with other ETFs, they have greater risk and return attributes. Moreover, while a typical ETF tries to match the returns of the index, a leveraged ETF aims to amplify the returns of the index by 2X or 3X.

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What is a 3X ETF?

A 3X ETF is a leveraged ETF that gives you leveraged exposure to a particular underlying asset or index. The use of ‘3X’ in the name indicates that the ETF attempts to provide three times the daily returns of the underlying asset or index it tracks. 

3X ETFs are relatively riskier because they have a higher exposure in an attempt to achieve higher returns. 

Here’s an example to help you understand a 3X ETF better: 

The stocks of the 50 companies listed on the NIFTY index make the NIFTY 50 ETF. The ETF performs just like the NIFTY index. So, if there is a 1-point gain in the index, the 3X ETF will earn a 3-point return. The same stands true for a loss. If the index drops by a point, the 3X ETF suffers a 3-point loss. 

ETF stocks are listed on the stock exchange like individual stocks. You can trade them at any time during trading hours. An important thing to note about 3X ETFs is that their expense ratio is higher than traditional ETFs. This means your fund manager will take a significant part of your returns as a fee. 

How does a 3X ETF work?

A 3X ETF amplifies its performance by investing in other instruments, not just equities. The funds are allocated in complex financial instruments, including forward contracts, futures contracts, options, swap agreements, equity caps, reverse repurchase agreements, etc. 

Here is an example to show how the performance of the index tracked by the ETF affects its returns: 

Suppose you place Rs. 80 in a 3X ETF. If the price of the index rises by 3% on the first trading day, the 3X leveraged fund increases by 9%. If the price of the index falls by 4% the next day, the triple-leveraged ETF goes down by 12%. The return is three times, regardless of the direction of the change. 

On the day when the price index rises, your investment’s value increases to Rs. 87.20. The next day, when the price falls, the investment is valued at Rs. 76.70. Consequently, the overall movement in the investment’s value is a loss of 4.1%. 

From the above example, you can observe that ETFs have compounding effects. This feature forces traders to buy and sell the funds in the short term. Typically, financial traders hold 3X ETFs for only a day or week. This helps to minimize the risk of compounding losses, which, if not kept under control, can lead to losing the principal investment. 

Who should buy a 3X ETF?

A 3X ETF is suitable for you if you fulfil the following criteria:

  • You understand short-term trading
  • You can handle a loss
  • You are an expert in the market and know how it works
  • You have the time and energy to manage your investments

A 3X ETF is not ideal if you are looking to invest for the long term to build funds for retirement. It is also not preferable if you are considering low-risk options.

Conclusion  

It is important to have good knowledge of the financial markets if you want to invest in 3X ETFs. In addition to this, you must have the capacity to invest comparatively more significant amounts and take a hit. Also, remember to understand its working and associated risks carefully. 

 

Related Articles:  A Comprehensive Guide to Exchange Traded Notes A Guide to Exchange Traded Commodities | What is the difference between AI trading and Algo trading

 

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