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[Editor's Note: This article originally appeared on March 11, 2020.]
Leveraged and inverse funds are common in commodities, particularly in energy ETPs, where more than one-fourth of all available exchange-traded products (ETPs) use some leverage or inverse factor.
While leveraged and inverse ETFs can help traders exploit extremely short-term market movements, they definitely aren't for the faint of heart. Typically, their holding periods are on the order of days, or even hours.
But even a holding period that short can still burn you if you aren't careful—as some discovered during Monday's market sell-off.
On Monday, the VelocityShares 3x Long Crude Oil ETN (UWT)—which offers triple leverage on front-month WTI futures—tanked 73.8%, or just shy of the threshold set in its prospectus for automatic acceleration
UWT Just Barely Escapes Closure
Most ETNs have automatic termination, or "acceleration," clauses baked into their prospectuses. "Accelerating" an ETN means closure: Its due date is moved up, such that investors receive the note's closing indicative value in cash immediately (or almost immediately), rather than whenever the note was originally scheduled to close.
The most notable example of automatic acceleration occurred back in 2018, when the VelocityShares Daily Inverse VIX Short Term ETN (XIV) was shuttered after losing 96.3% of its value in a single trading day. At the time, the ETN held $1.9 billion in assets (Read: "Inverse VIX ETN Shuts Down").
UWT's prospectus specifies a 75% drop in iNAV from the previous day's value as the trigger for automatic acceleration. Monday's decline fell just 1.2% short.
Importantly, that 75% decline is not cumulative. As a leveraged fund, UWT's triple leverage factor resets at the start of every trading day.
And for whatever it's worth, the steep decline didn't appear to scare off traders. On Monday, UWT saw one-day inflows of $289 million.
Steep Declines in GUSH, GASL
Several other leveraged energy ETFs saw extreme declines on Monday, including the Direxion Daily S&P Oil & Gas Exp. & Prod. Bull 3X Shares (GUSH) and the Direxion Daily Natural Gas Related Bull 3x Shares (GASL). Both are ETNs offering exposure to their relevant commodity equities.
At its lowest point, GUSH had shaved 78.8% off its previous day's iNAV, while GASL had dropped 80.1%.
Those steep declines were still a few percentage points shy of the 90% drop allowed by GUSH and GASL's prospectus, however.
Neither GUSH nor GASL is an ETN, and therefore they aren't in danger of automatic acceleration, as UWT is. However, the funds' prospectus does acknowledge that if their underlying indexes were to fall more than 30% on a given trading day, then their triple leverage factor would mean that investors would lose all their money (Read: "How An ETF Can Drop 100% In A Day").