In a time when degenerate traders are demanding more leverage and higher yields, one ETF issuer is trying to set the new benchmark for risk in an ETF.
Leveraged ETFs already exist on many sectors, themes and single stocks. Some have become very popular. But none yet use leverage like this. If approved, this suite of leveraged single stock and crypto ETFs that propose delivering 5x the daily returns of their underlying security would be a first for the financial markets.
While the upside potential of these 5x leveraged ETFs would be huge, the risks involved in investing in these products would be almost unprecedented. They’d be as dangerous and risky as anything you’d find in the markets today.
Given the demand for investing in leveraged products today, investors and traders would probably love them. But are they prepared for the risks that come from investing in such a high volatility ETF?
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Why 5x leverage now
On October 15th, Volatility Shares filed for 27 new leveraged ETFs that would offer 500% exposure to single stocks and cryptocurrencies, including Tesla, NVIDIA, Coinbase, Palantir, Microstrategy, Bitcoin and Ethereum. These stocks and crypto coins are volatile enough as they already are. Volatility Shares is going to put them on steroids.
The maximum amount of leverage approved in an ETF by the SEC to date is 3x. This exists solely in leveraged ETFs targeting sectors, themes or regional markets. If you want to invest in leveraged single stock ETFs, the maximum leverage currently is 2x.
A 5x ETF targeting the S&P 500 trades in Europe, but nothing like it has been approved yet in the United States.
The current soft cap on leverage allowed in ETFs is 2x thanks to the passage of SEC Rule 18f-4 (the existing 3x ETFs at the time were grandfathered in). Without getting too far into the weeds, some ETF issuers are using various machinations and interpretations of the rules in order to get ETFs with higher leverage approved.
Volatility Shares seems to be going for the home-run swing and attempting to get 5x leveraged ETFs approved right out of the gate. The $64,000 question is whether they can get the SEC to approve them.
Related: 3x leveraged fund goes to zero; investors lose everything
Regulations & hurdles: The chances that 5x leveraged ETFs get approved
Not long ago, the chances of a 5x leveraged ETF getting approved by the SEC were about as close to 0% as you could. Today, we live in a different world.
The Trump administration and the SEC have already warmed up to cryptocurrencies. We’ve gotten spot bitcoin ETFs approved when that looked unlikely for the longest time.
He’s also made deregulation one of his priorities in his second term. Loosening the SEC’s current restrictions and smoothing the path for more exotic products to get approved would certainly fall under that.
So it’s possible that the regulatory environment has changed enough to allow 5x leveraged ETFs. It just seems really unlikely that the SEC would be OK with THIS much risk, especially given that a 3x leveraged product just went bust over in Europe.
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What to watch next: Timeline, filings, and market signals
The current rules state that the SEC has 75 days to rule on new ETF filings, which would put the deadline for the Volatility Shares products right around the end of 2025.
What’s interesting is that technically, the SEC doesn’t need to “approve” them. They just need not to reject them. Don’t forget that there’s a government shutdown right now. It’s possible, if the shutdown drags on for a while, that these 5x ETFs make it to market while effectively bypassing SEC oversight. It’s a long shot, but it’s not outside the realm of possibility either!
In isolation, it’s really tough to see these getting approved by the SEC under normal circumstances. There’s just too much risk to investors either using them improperly or not understanding what they’re actually investing in or not understanding the risks. It’s not the SEC’s job to protect investors from themselves, but there should be some guardrails in the process.
Key Takeaways
- ETF issuer Volatility Shares is attempting to launch a series of 5x leveraged ETFs.
- 2x and 3x leveraged ETFs already exist in the United States, but not 5x.
- The odds of approval by the SEC seem slim.
- These ETFs come with extreme risk and losing 100% of an investment is possible.
Conclusion: Proceed with extreme caution
Most investors will only think about the potential upside with leveraged ETFs. They should think more about the downside.
It’s certainly possible that investors in these ETFs lose everything if they own them on just the wrong day. It would only take a 20% decline in one of these stocks for investors to get completely wiped out. For some of these stocks, that’s already happened following a missed earnings report.
Traders should sample these very judiciously, if at all. The downside risk is significant.
Related: Vanguard may finally allow bitcoin ETFs
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