## Summary

Beta-slippage can lead to a leveraged ETF underperforming its stated performance goal versus its underlying index, a phenomenon known as leveraged ETF decay.

In some cases though, beta-slippage can have the opposite effect, causing a leveraged ETF to outperform its performance goal, e.g., for a 2x levered ETF to return >2x its index.

Since the effect of beta-slippage can't be predicted ahead of time, holders of leveraged ETFs may want to consider adding downside protection.

We lay out two ways of adding downside protection to levered ETFs and offer examples.

## A Consideration For Leveraged ETF Investors

Leveraged ETFs offer investors a way to magnify a directional bet on an index, and inverse leveraged ETFs are sometimes used to by investors to

One of the better explanations of this slippery phenomenon causing leveraged ETF decay was provided by Seeking Alpha contributor Fred Piard in an 2013

To understand what is beta-slippage, imagine a very volatile asset that goes up 25% one day and down 20% the day after. A perfect double leveraged ETF goes up 50% the first day and down 40% the second day. On the close of the second day, the underlying asset is back to its initial price:

(1 + 0.25) x (1 - 0.2) = 1

And the perfect leveraged ETF?

(1 + 0.5) x (1 - 0.4) = 0.9

Nothing has changed for the underlying asset, and 10% of your money has disappeared. Beta-slippage is not a scam. It is the normal mathematical behavior of a leveraged and rebalanced portfolio.

As Piard noted though, sometimes beta-slippage can lead to leveraged ETFs outperforming; however, it's impossible to predict whether they will do so ahead of time:

In a trending market, beta-slippage can even become positive. Let's go back to the math: the simplest trending market is two consecutive days in the same direction. Imagine an asset going up 10% two days in a row.

On the second day, the asset has gone up 21%:

(1 + 0.1) * (1 + 0.1) = 1.21

The perfect 2x leveraged ETFs is up 44%, more than twice 21%:

(1 + 0.2) * (1 + 0.2) = 1.44

A leveraged ETF in a steady bullish trend may outperform its leveraging factor. But it depends on the sequence of losses and gains, and cannot be predicted or even calculated with a statistical model.

Since you can't predict the effect of beta slippage, some investors holding positions in leveraged ETFs may want to consider adding downside protection to them by hedging. We'll look at two ways of doing that below, for the five most widely-traded leveraged ETFs, per

- ProShares UltraShort S&P 500 ETF (NYSEARCA:
SDS ) - ProShares Ultra S&P 500 ETF (NYSEARCA:
SSO ) - Direxion Daily Financial Bull 3x Shares ETF (NYSEARCA:
FAS ) - ProShares UltraPro QQQ ETF (NASDAQ:
TQQQ ) - ProShares UltraPro S&P 500 ETF (NYSEARCA:
UPRO )

## Hedging Leveraged ETFs

The main drawback with hedging is its cost. At