Leverage Expansion
While much attention is given to volatility decay, the same mathematical principles can work in your favor during trending markets. This effect, known as leverage expansion, can lead to returns that exceed the leveraged multiple of the underlying index.
In this guide, we'll explain how leverage expansion works and why it's an important consideration for long-term leveraged ETF investors.
The Basic Principle
Let's look at a simple example with consistent 5% daily gains:
Scenario: Five consecutive +5% days
Underlying Index:
Day 1: $100.00 → $105.00 (+5%)
Day 2: $105.00 → $110.25 (+5%)
Day 3: $110.25 → $115.76 (+5%)
Day 4: $115.76 → $121.55 (+5%)
Day 5: $121.55 → $127.63 (+5%)
Total Return: +27.63%
2x Leveraged ETF:
Day 1: $100.00 → $110.00 (+10%)
Day 2: $110.00 → $121.00 (+10%)
Day 3: $121.00 → $133.10 (+10%)
Day 4: $133.10 → $146.41 (+10%)
Day 5: $146.41 → $161.05 (+10%)
Total Return: +61.05%
Noticed how the leveraged ETF returns more than double the underlying return? That is leverage expansion in action.
Interactive Example
Experiment with different parameters to see how leverage expansion works in trending markets.
Performance Comparison
- 2x Leveraged ETF
- Underlying Index
Underlying Return
Leveraged Return
Key Takeaways
When Expansion Occurs
- During trending markets
- When volatility is low
- Over longer time periods
- With higher leverage ratios
Important Considerations
- Works in both bull and bear markets
- More pronounced with higher leverage
- Requires consistent trend direction
- Can exceed the leverage multiple