Leveraged ETFs: Bigger Wins, But Also Bigger Losses

It is possible to change the returns of your portfolio without changing the asset allocations you have settled on. The two ways I know of to do this are through the use of margin accounts and leveraging with options.

Investing on margin is a fairly easy concept to grasp. All it means is that you borrow money and then invest it. In exchange for the borrowed money, you have to pay interest so it's not a free ride. At the very least you need to earn enough on the investment to pay off the interest or you're not going to get anywhere.

Leveraging with options is another way to “buy” more shares than you actually have money for. You do this by buying what is called an option. The option is an instrument that allows you to lock in a price for shares of a particular company. You then have the “option” of actually buying those shares at that price at some future date. The idea being that if the share price goes up, you can use the options to buy the shares at a lower price and then sell the shares to make a profit. If the price doesn't increase within some specified time range, then your options will expire and become worthless meaning what you paid for the options will be lost.

Both of these techniques have their drawbacks. First off, both magnify losses. This makes sense since they also magnify gains. Margin accounts also impose limits on how much you can borrow e.g. 25% to 50% of what is currently in your account. This limit can be quite restrictive. Options on the other hand don't impose limits, but they're much more complicated to trade for the individual investor.

The good news is that leveraged investing is about to become easier thanks to a company called ProFunds Advisors LLC. This money manager has filed a prospectus for exchange traded funds (ETFs) that aim to return twice what popular indexes such as the S&P 500 and S&P 400 return. This fund will achieve these results by using leverage. This type of investing is commonly used by mutual funds so the idea is legitimate and something worth looking at.

If you want to read more about these leveraged ETFs, check out the article from MarketWatch.