The Magic of 3X ETFs

This data in this post is as of 2/10/25.

On January 29, 1982, trading began in the Chicago Mercantile Exchange S&P 500 futures contract (symbol ES). This futures contract was designed primarily for institutional and large speculative investors. (Today there’s the micro e-mini and many other index futures contracts.)

On January 29, 1993, State Street’s S&P 500 SPDR (symbol SPY) became the first index exchange traded fund (ETF) which offered indexers the ease and liquidity of regular stock trading.  And finally, on November 6, 2008, a controversial innovation, the S&P 500 Bull 3X Direxion ETF (symbol SPXL) began trading. SPXL is a “3X fund”, it targets three times the daily return of the S&P 500 index each day. SPXL may have three times the risk, but this is where the magic happens!

To start, let’s compare the 5-year chart for the three liquid index products: SPY (the plain vanilla S&P stock index ETF), ESn (the continuous “nearby” S&P 500 futures contract) and SPXL (the jacked up 3X leveraged S&P 500 ETF):

Continuously compounded performance, normalized where 1/3/2020 = 1000.

 

Table 1

SPY = S&P 500 SPDR

ESn = S&P 500 “E-mini” continuous nearby futures contract

SPXL = S&P 500 Bull 3X Direxion ETF

Continuously compounded annualized return and standard deviation.

Source: barchart.com closing prices adjusted for dividends and splits.

 

First let’s note the chart has 2 major market breaks, one in 2020 and the other in 2022. Also note Table 1 in no way shows SPXL (or any other 3X ETF we look at, for that matter) delivers 3X for extended periods. The one month is close: 8% versus the 9% target. Going further out the SPXL definitely has a higher return than the index but the farther out you go, volatility takes its toll. SPXL’s 1 year 43% is good but far off the 3X 60% target. For the 2, 3 and 5 years, the gap only gets worse. To Direxion’s credit, the SPXL prospectus makes no claims for periods over ONE DAY! Even the 3X daily target has no guarantee. The prospectus does point out the risk that a 33% one day drop in the index is a 100% loss in the 3X.

 

Looking again at the chart, SPY fell roughly 30% in the 2020 market break. At the March 2020 low, SPXL was down 70%!  You COULD claim that SPXL outperformed, beating its -90% target, but this was no comfort as we lived it. The 2022 market break took SPY roughly from up 50% on Jan 1, 2022, to up only 20% by October, a 30% decline.  At the same time, SPXL went from roughly +100% to -20%, a 120% decline-this time exceeding its 3X target!

 

Before leaving returns, let’s point out that SPY and nearly ALL broad-based index ETFs have de minimis tracking error. They are excellent proxies for their underlying indexes. Also note that the index futures contract lags the index generally in all periods. This is due to the cost of maintaining a futures position-rolling futures from the March contract to June, to September and finally the “Christmas” December expiration month and so on.

 

We see the risks, let’s see the magic!

 

To see this, assume you throw caution at the wind and recklessly want to maximize your exposure to the S&P 500 stock index with the least amount of cash possible. The E-Mini S&P 500 futures contract value equals $50 per point ($50 x 3642.25 =) $182,113. The “exchange minimum margin” on January 3, 2020 was $6,300. $6,300 controlled $182K! This is insane 30X leverage! If the E-mini falls 126 points, you are wiped out. But long before that happens, your broker will give you a margin call or sell you out. Or, more likely, will NOT honor exchange minimums and demand a much larger initial deposit.

 

Next, you buy $182,000 SPY on maximum 50% margin, borrowing half of the purchase and paying half in cash or $91,000 . Finally, buy $182,000 worth of SPXL. Since this is 3X, you cannot buy on margin but your $60,000 purchase allegedly controls $180,000.

 

Table 2

  

In Table 2, we see the market price and starting account value for each of our investment comparisons.

 

Table 3.

 

In Table 3 we assume the investor holds their ETFs or rolls their futures and meets ALL margin calls with no withdrawals from the 1/3/2020 start date to the current 2/10/2025 end date. Commissions and interest not included.

 

Here comes the magic! While the returns are all roughly the same, leveraged futures and marginable stock have the risk of margin calls. Your 3X ETF will have NO MARGIN CALLS no matter where the market goes. Due to the hocus-pocus of 3X money managers, 3X can give you a dollar certainty the other choices cannot. You are one and done with 3X. You are one and maybe many margin calls- not done- with the others. In the end, the total dollars for futures and 3X, were not much different (roughly $60K) nor did they affect the returns. But on day one, who knew? While not an endorsement of 3X ETFs, take this as an illustration of the three basic ways to leverage a position.

 

Caveats: these kinds of results can only be expected with the broadest based index products with the lowest tracking errors. The more exotic the underlying or complex the product is, the greater the variation in returns. Why volatility affects total return is for another article.