Tony's ETF Buyer's Guide: Single-Stock ETFs

How single stock ETFs work

The most basic type of single-stock ETF is the leveraged long, exemplified by the GraniteShares 2x Long AAPL Daily ETF

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This ETF is designed to deliver daily returns that are twice that of its reference stock, Apple. So, if Apple's stock price increases by 1% over a day, AAPB aims to rise by 2%. Conversely, if Apple's stock falls by 1%, AAPB is expected to decrease by 2%.

It's important to note that the leverage target is only precise on a daily basis. Over longer periods, compounding effects can lead to performance that does not strictly mirror twice the cumulative return of Apple, especially during times of high volatility. This can result in returns that are unpredictable over periods longer than one day.

To achieve this leverage, ETFs like Direxion Daily AVGO Bull 2X Shares

employ financial instruments such as swaps. The AVL holdings, for example, include assets like the Dreyfus Treasury Securities Cash Management money market fund, used as collateral to enter into a swap agreement.

These swaps provide the ETF with synthetic exposure to the underlying stock—meaning the ETF does not hold the actual stock.

Inverse ETFs operate under a similar framework, using collateral and swaps to achieve typically -1x the daily return of the underlying asset. For example, the GraniteShares 1x Short COIN Daily ETF

is designed to increase by 2% if COIN falls by 1% in a day.

Additionally, there are ETFs like those from Tradr ETFs that offer longer reset periods—aiming to match the returns of the reference stock over weekly, monthly, or quarterly periods, with leverage options ranging from 1.5x to 2x. This extended reset period can suit investors looking for leveraged outcomes aligned more closely with longer-term market movements.

An interesting variation in the single-stock ETF space is the YieldMax single-stock ETFs, which target income generation rather than leveraging price movements. These do not employ swaps or hold the underlying stock.

For instance, the YieldMax TSLA Options Income Strategy ETF

uses a combination of a short put and a long call to create a synthetic stock position, then sells a short call to generate income. This strategy trades potential upside for higher income.

Use cases and risks for single-stock ETFs

Most single-stock ETFs are designed primarily as trading tools, offering an alternative to options or margin trading for achieving enhanced exposure to specific stocks.

For instance, if you're bullish on Meta Platforms around earnings time, your choices for capitalizing on potential price movements could include:

1. Buying a call option or engaging in a bullish multi-leg options strategy like a bull call spread. This method limits downside risk to the premium paid, but it's not a direct play on Meta's price movements alone—you also need to consider factors like changes in volatility and time decay (theta).
2. Purchasing shares of META on margin. This option exposes you to potential margin calls if the stock price moves against you and you're not well-prepared with risk management strategies. Additionally, if held long, you will incur interest costs from borrowing.
3. Investing in the Direxion Daily META Bull 2X Shares
   METU
   . This ETF provides a straightforward way to size your position and execute trades, even after hours, with minimal bid-ask spreads post-close. The maximum loss is limited to the amount paid for the shares, with no risk of margin calls, offering a simple direction-only bet on Meta's price movements.

However, these tools come with their own set of risks. Leveraged ETFs like METU face significant risks if the underlying stock plunges dramatically in a single day—potentially up to 50%—which could lead to substantial losses and even the liquidation of the fund. The risk is compounded for ETFs that reset over longer periods like a week, month, or quarter.

As explained earlier, the daily reset feature common in most of these ETFs means that holding them for more than one day can lead to performance deviations from twice the return of the underlying stock, especially in volatile or choppy markets. This compounding effect can enhance gains but also exacerbate losses, making them less predictable over longer periods.

Finally, single-stock ETFs often have higher expense ratios due to the costs associated with swaps and other derivative instruments. For example, METU carries a 1.09% expense ratio, and some ETFs in this category can charge as high as 1.5%.

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.