All About 3X Bull ETF's

Folklore is filled with stories about brave people such as Sindbad, the Sailor, who did something that was either extremely dangerous or very rewarding. His keen awareness and knowledge of the environment helped him plan his maritime adventures despite the risks. He was also well aware of the potential rewards.

This term is also used to describe a small group of financial traders that trade in leveraged exchange traded funds. These ETFs are also known as triple leveraged ETF or 3x ETF. They can offer three times, or even 3x, the performance of the index they track.

This is because of the inherent risk involved in trading in ETFs. We can compare them to ambitious Sindbad.

What's a 3x ETF?

Let's briefly look at what an ETF is to understand what a 3xETF means.

ETFs, or exchange-traded funds, are a group of securities that track an underlying index. A NIFTY 50 ETF, for example, includes stocks from 50 companies that are listed on the NIFTY Index. The ETF's performance will closely match that of the NIFTY Index. The stocks of the ETF can also be traded on the exchange, just like individual stocks.

What does a 3x ETF actually mean? A 3x ETF will provide three times the performance of an index it tracks, as you might have guessed. The 3x ETF holder will receive 3 points for every index point gained. The same holds true for a loss. The 3x ETF holder suffers a loss of 1 point.

Traders will typically trade 3x bull ETFs, which is a sign that they are counting upon the market's growth to increase their profits.

Traditional ETFs have a lower expense ratio than 3x ETFs. The fund manager will take a substantial portion of your returns as a fee.

What does a 3x ETF do?

Perhaps you are now wondering how an ETF that is 3x can increase its performance. The ETF can invest in more than just equities to achieve a 3x performance. The ETF can invest in options, futures contracts, forward contract, swaps, reverse repurchase agreements and equity caps, as well as other complex financial instruments.

Let's now look at a simple example that shows how the ETF's returns are affected by the performance of an index the ETF tracks.

Let's say Mr XYZ placed Rs. 100 in a 3x ETF. What happens if the price of an index moves up 5 percent and down 5 percent the next trading day. The leveraged 3x fund rises 15 percent, regardless of the direction it takes, and falls 15 percent over the following days. The initial Rs.100 investment at the end of the tradingday is Rs. 115 The initial investment was now worth Rs.97.75 at the close of the second trading session. This is a 2.25 percent loss on the investment.

This compounding loss feature is what compels traders to sell and buy in the short-term. To reduce the risk of compounding loss, 3x ETFs should be held for a week or less. This will decrease the chance that investors/traders could lose all their principal investment.

Who is a suitable 3x ETF?

You might have already concluded that a 3x ETF is not the best option for people who want to invest in long-term, low-risk securities or build their retirement funds. A 3x ETF is an option for someone who meets the following criteria:

1. Market savvy, knows how the market works

2. Does the person have the energy and time to manage their investments?

3. Can take a loss

4. Understanding short-term trading

The 3x ETF should only be considered by people who have a good knowledge of the financial markets, are able to invest relatively large amounts and can take a hit.

You now understand the reason why the analogy between Sindbad (individual trading in 3x ETFs) is fair.