Leveraged and inverse products (L&I Products) aim to deliver a daily return equivalent to a multiple of the underlying index return. As a result, trading prices changes are supposed to align with the performance of their underlying index at a specific multiple. However, this is not always the case.
For example, under normal circumstances and before deduction of fees and charges, when the underlying index moves up by 10% on a given day, the two-time leveraged product (2x) tracking that index should deliver a gain of 20% on that day, while the two-time inverse product (-2x) tracking that index should deliver a loss of 20% on that day. However, the trading prices of L&I Products may not fully reflect the multiple of the underlying index return, i.e., a 20% increase for the leveraged product or a 20% decrease for the inverse product mentioned above, because of the following two factors.
Difference between index futures and index performance
Some L&I Products seek to achieve their investment objectives by investing in futures contracts, such as gold futures L&I products. Their returns may deviate from the multiple of the underlying index return because the performance of the futures contracts may not correlate with the underlying assets in the spot markets. This is known as the basis risk.
Changes in premium or discount
Like ETFs, the trading prices of L&I Products are typically determined by market demand and supply. Consequently, the trading prices of an L&I Product may deviate from its net asset value (NAV), which is calculated with reference to the market value of the investments it holds.
Therefore, when trading L&I Products, investors may buy at a premium (market price higher than NAV) or sell at a discount (market price lower than NAV). Investors may suffer losses due to changes in premium or discount. For example, if an investor purchases an L&I Product at a premium and the premium subsequently normalises, the price movement of the product is likely to underperform relative to the NAV movement, and hence the multiple of the underlying index return.
The market information of L&I products, such as their NAV per unit and the real time or near-real time indicative NAV per unit can be found on the product issuer’s website.
Investors interested in L&I Products should first thoroughly understand their characteristics and the factors affecting the trading prices. In addition, it is always a good practice to check the indicative NAV as a reference to the current trading price before trading a L&I Product.
20 December 2024
