Leveraged ETFs — Price Dynamics and Options Valuation

The ETF industry now consists of more than 2,000 funds with well over $4 trillion in assets. Within the ETF universe, some funds are designed to replicate a constant multiple (called leverage ratio) of the daily returns of a reference index. These relatively new financial products are called leveraged ETFs (LETFs).

This book aims to provide an overview of the major characteristics of leveraged ETFs, examine their price dynamics, and analyze the practical problems that arise from trading LETFs and pricing options written on these funds.

When writing this book, we aim to make it useful not only for graduate and advanced undergraduate students but also for researchers interested in financial engineering, as well as practitioners who specialize in trading leveraged or non-leveraged ETFs and related derivatives.

Table of Contents (pdf)

1. Introduction
2. Price Dynamics of Leveraged ETFs
3. Risk Analysis of Leveraged ETFs
4. Options on Leveraged ETFs
5. Conclusions

In the first part of the book, we assume very little background in probability and statistics in our discussion of the price dynamics of LETFs. Nevertheless, new insights and trading strategies are discussed with mathematical justification and illustrated with a host of examples using empirical data.

Our emphasis is on the risk analyses of LETFs and associated trading strategies. New risk management concepts, such as admissible leverage ratios and admissible risk horizons, are introduced. We also derive and analyze several trading strategies, including static portfolios, pairs trading, and stop-loss strategies involving ETFs and LETFs.

In the final part, we present the analytical and empirical studies on the pricing and returns of options written on LETFs. Our objective is to examine a consistent pricing.