What Are Single-Stock ETFs?
Single-stock exchange-traded funds (ETFs) are a new exchange-traded product allowing for leveraged or inverse trading of a single stock. They are intended to give ordinary investors a wider range of tools for navigating volatile markets by making it easy to go short on single stocks without having to sell them short. However, because of the way in which they are constructed and their use of leverage, regulators are warning that single-stock ETFs carry greater risk than ordinary ETFs and may be unsuitable for long-term investors.
Single-stock ETFs featuring leverage first appeared on European markets in 2018. Financial firm AXS Investments launched eight such products for the first time in the United States in 2022, allowing investors there to trade them.
- Single-stock exchange-traded funds (ETFs) allow ordinary investors to take leveraged or short positions in single stocks using an exchange-traded product.
- Leveraged single-stock ETFs provide new opportunities for investors in a volatile market, but at greater risk. These complex products are not for new investors and should be treated as high risk.
- People with a strong base of investing knowledge and a high risk tolerance should not treat these as buy-and-hold opportunities.
- Single-stock ETFs are meant to be used for short-term bets and trading.
- The U.S. Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) have both warned about their use among ordinary investors.
How Single-Stock ETFs Work
Exchange-traded funds (ETFs) are single securities that can hold a portfolio of stocks. Indeed, the first ETFs were created to track broad-based indexes such as the S&P 500 or the Russell 2000. ETFs can also hold derivatives such as futures and options contracts in addition to, or instead of, shares of stock. This allowed for the advent of leveraged ETFs, which provide a multiple of the return of the underlying index or benchmark (for example, two times or three times the return of the S&P 500). This also allowed for inverse ETFs (and inverse-leveraged ETFs), which provide negative returns (for example, -1 time or -2 times the return of the index).
Single-stock ETFs do not hold a portfolio of stocks; rather, they track just a single stock but employ derivatives contracts to provide leveraged and/or inverse returns. Leverage is a double-edged sword, meaning that it can lead to significant gains but also lead to significant losses. Investors should be aware of the risks of leveraged ETFs, because the risk of losses is far higher than with traditional investments.
For example, a 1.5× leveraged bull single-stock ETF would likely own short-dated call options that provide a net delta of +150. A 2× bear single-stock ETF would instead hold put options in an amount resulting in a delta of -200.
Because of how leveraged and inverse ETFs (including single-stock ETFs) are constructed, they tend to have a negative roll to maintain the proper derivatives position geared at returning a multiple of daily performance. This means that they naturally exhibit time decay and will tend to lose value over medium and long holding periods, regardless of the performance of the underlying assets. As a result, these products are intended only for day trading or very short-term holding periods.
Single-stock ETFs also may be prone to quickly lose value in volatile markets. An interview posted July 15, 2022, on Yahoo! Finance illustrates this point. Yahoo! Finance anchor Jared Blikre said, “If we take a hypothetical stock and it’s three times leveraged ETF, and we just kind of chop around with some volatile action. Let’s say they both begin at $100. And then let’s say we have a 20% up day followed by two 10% down days, a 20% up, a negative 20%, a negative 10%, another [negative] 20%. At the end of the day, guess what, the stock is worth $100.78, basically flat. Guess what, the ETF lost 40% of its value.”
The Financial Industry Regulatory Authority (FINRA), as well as the U.S. Securities and Exchange Commission (SEC), which oversees securities markets and dealers, have both warned that current regulations may not be adequate to oversee single-stock ETFs, and that these may be inappropriate for most individual investors, presenting unusually high risk.
Single-Stock ETFs in the U.S.
Single-stock ETFs first appeared on European markets in 2018. In the summer of 2022, they were launched in the U.S. for the first time by AXS Investments, a New York-based asset manager, which listed eight such products:
- TSLQ: -1× the daily performance of Tesla (TSLA)
- NVDS: -1.25× the daily performance of Nvidia (NVDA)
- PYPS: -1.5× the daily performance of PayPal (PYPL)
- PYPT: +1.5× the daily performance of PayPal (PYPL)
- NKEQ: -2× the daily performance of Nike (NKE)
- NKEL: +2× the daily performance of Nike (NKE)
- PFES: -2× the daily performance of Pfizer (PFE)
- PFEL: +2× the daily performance of Pfizer (PFE)
As of mid-2022, it is unclear whether the SEC will approve more single-stock ETFs in the U.S.
Example of a Single-Stock ETF
TSLQ is the ticker symbol for the AXS TSLA Bear Daily ETF. It seeks to return -1× the daily performance of Tesla (TSLA) shares.
Let’s see how the two securities performed on July 15, 2022. As shown in the chart below, comparing the two, TSLQ provides a close mirror image to the intraday returns of TSLA. Note, however, that the daily returns were not identically inverse: TSLA gained 0.74% at the close of that day, while the single-stock ETF TSLQ lost -0.63%. While this difference may be small for a single day, the tracking error between the two could compound over time, especially if the price swings up and down repeatedly.
How are single-stock exchange-traded funds (ETFs) allowed to trade?
Single-stock exchange-traded funds (ETFs) have been labeled as extremely risky by regulators and market commentators. Nonetheless, in 2022, the United States listed them for the first time. However, single-stock ETFs appear to fall under Rule 6c-11 under the Investment Company Act of 1940. In combination with recent changes to the listing standards at stock exchanges, that rule created a framework that allows ETFs meeting certain criteria to come directly to market without first obtaining explicit permission, through what is called an exemptive order from the U.S. Securities and Exchange Commission (SEC).
Are single-stock ETFs and single-stock futures the same thing?
No. Single-stock ETFs are exchange-traded securities that use derivatives contracts (options) on individual stocks to provide leveraged returns. The ETF itself is a security. Single-stock futures (SSFs) are not securities but instead are futures contracts, with an individual stock as the underlying security. Each contract typically controls 100 shares of stock. While the reception for single-stock futures was positive when they launched in the U.S., activity has faded over time.
Are single-stock ETFs good investments?
Single-stock ETFs are intended for very short holding periods, such as intraday, and are not meant to be held as longer-term investments. The SEC states that, “[b]ecause of the features of these products and their associated risks, it would likely be challenging for an investment professional to recommend such a product to a retail investor while also honoring his or her fiduciary obligations or obligations under Regulation Best Interest. However, retail investors can and do access leveraged and inverse exchange-traded products through self-directed trading.”