3x Etfs And Zero-day Options: Is The Asset Management Industry Becoming More Predatory?

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• Zero-day call options gained popularity post-2022, approved by the Securities and Exchange Commission.
• Experts question if asset managers exploit retail investors with such risky financial products.
• One retail investor BI spoke to lost $18,000 trading risky single-day options on major indexes.

Late in the summer of 2023, Rob turned $2,500 into more than $18,000 in a matter of weeks.

He said he did it by trading zero-day put options on ETFs tracking the S&P 500 and Nasdaq 100 indexes. By buying the options, Rob was essentially betting that the market would fall before the close of trading, causing the options' value to increase and allowing him to sell them for a profit.

For a time, it worked with remarkable success. Then, his money quickly evaporated.

Smitten with his fast success, Rob, then a retail investor in his early 20s who asked to be kept anonymous because of his work in the financial sector, said he doubled down on his strategy. He borrowed money from his brokerage firm, buying more than $43,000 worth of put options on the SPDR S&P 500 ETF Trust in a single day. But when the market went up, he took around a $15,000 loss, according to tax records viewed by BI.

Virtually all of his gains were gone.

"Eventually, the trade went against me," he said.

Rob's roller-coaster story with risky investment products has become a familiar story among retail traders in recent years. Single-day options and leveraged ETFs, which were also approved in 2022, have soared in popularity since the pandemic, meme-stock days, when stimulus money flooded brokerage accounts with liquidity.

But as the use of these products continues to increase dramatically, some experts wonder whether the asset management industry has become increasingly predatory toward retail investors in their ever-expanding offering of risky trading devices.

"We have seen the creation of financial products that dig into the worst part of human psychology, which is wanting to get rich quick and thinking we can outsmart very complex systems," Jonathan Treussard, the founder of Treussard Capital Management and the former head of product at Research Affiliates, told BI in January. "Most asset managers have realized that it's very hard to make money in the plain vanilla world of passive investing, so they've come up with all these pretty callous products that happen to tap into that dopamine."

The new casino

Greed and fear sit at the two poles of the forces that drive financial markets. Neither tends to produce particularly good investing outcomes when employed alone.

But the US asset management industry increasingly appears to be leaning into the business strategy of profiting from investors' desires to strike it rich.

The numbers tell the story. According to Morningstar data, 25% of exchange-traded products issued in 2024 could be considered highly speculative products.

Twenty percent of new funds were levered, meaning they amplify returns on the underlying securities by investing with borrowed money. And 5% were tied to cryptocurrencies, an extremely volatile and budding asset class.

There are now 102 single-stock ETFs on the market, 61 of them being leveraged products.

Morningstar data also shows massive inflows into single-stock levered ETFs from the second half of 2022 to year-end 2024. As of December, assets in single-stock ETFs exceeded $24 billion, up from $169 million in September 2022.

Ultra-short-term options are also growing more popular, according to CBOE Global Markets data. In the fourth quarter of 2024, 51% of all S&P 500 options expired the same day. That's an all-time high.

The huge increase in leveraged and options ETFs has coincided with an impressive stock-market rally. The S&P 500 is up 58% since the start of 2023, a favorable environment for long-leveraged products. But what happens when things eventually go the other way?

Investors have started to get flashes in recent days of what can go wrong when the market turns around quickly. When DeepSeek's R1 chatbot was announced, AI-adjacent stocks dropped — perhaps most notably shares of chipmaker Nvidia. Since January 23, the stock is down 10.9%. But the GraniteShares 3x Long NVIDIA Daily ETP is down 43% over that time.

Products tied to ethereum, the second-largest cryptocurrency by market cap, have also gotten smacked. While the digital asset's price is down 17% this year, the ProShares Ultra Ether ETF, a 2x product, is down 48%.

Cashing in on greed or meeting consumer demand?

Despite the constant flow of new products, at the end of the day, no one is forcing retail investors to put any significant sum of money into options or leveraged ETFs, let alone buy them in the first place.

The products are certainly meeting existing demand, and some would argue are providing a service by making leverage trading more accessible to and less clunky for non-professionals.

But whether that demand should be met is another matter.

"It's an interesting philosophical question because there's a difference between what investors want and what investors need," said Ryan Jackson, a manager research analyst for passive strategies at Morningstar. "The best fund providers and investment companies have a duty, in my opinion, to do right by their clients, and make sure they're developing products that are gonna breed investment success."

Some businesses offering the products may also be making a survival choice.

"I can understand that these are businesses that need to make money," Jackson said. "You're not going to compete against the Vanguards, iShares, State Streets of the world on an S&P 500 fund, so you have to find a way to be different."

But there are questions about whether demand is even being properly met, and retail investors can end up duped by leveraged ETFs in particular. For example, at an average of around 1%, their high fees are what Jackson said was "lightyears" ahead of other ETFs, and end up cutting into any gains.

There are also sometimes issues with so-called "decay," according to GraniteShares, which manages 20 leveraged funds. This is where investors can lose out on returns when the funds reset their positions on a daily basis, perhaps slightly off of the actual share price. That's why the Nvidia and ethereum products mentioned above didn't track exactly with the price of their respective underlying assets over a weeks-long period. Given this, investors should usually hold them over very short durations, like a day, the firm said.

And some products have well underperformed their promised returns because of the nature of how they use leverage. For example, a Microstrategy levered ETF that uses swaps to gain leverage without actually borrowing money recently underperformed because it couldn't buy enough swaps.

"Some listed companies have limited derivatives market depth to support the ETF leverage being offered," Maurits Pot, the founder of Tema ETFs, told BI. "This risk is hard for retail investors to identify and may undermine certain levered products."

'We don't hand a butcher's knife to a 2-year-old'

Some top members of the SEC, like Caroline Crenshaw, one of its commissioners, have warned retail investors about the risks of these products. Crenshaw put out a statement about leveraged ETFs the day after they were approved in July 2022.

"While I have expressed concern about leveraged and inverse ETFs before, I worry that these single-stock ETFs pose yet another, perhaps greater, risk for investors and the markets," Crenshaw wrote at the time, citing decay as one problem.

But is there more that regulators can do to protect less sophisticated investors?

Jackson joked about a world where a big scarlet letter is put on the web pages of leveraged ETF products. But in reality, he said regulation in the space is a slippery slope, as some non-leveraged products are also more volatile than average, and it's difficult to know where to draw the line.

Treussard said it doesn't have to be an all-or-nothing solution like banning them completely but argued that there could be standards put in place for who can trade options or leveraged ETFs.

For instance, they might be available just to accredited investors, he said. By SEC standards, that includes individuals who make over $200,000 a year or have a $1 million net worth, those who have certain financial certifications, or those with high-up positions at publicly traded businesses or in the asset management industry.

"For the sharp tools, make sure they're in the hands of the people who can handle them," Treussard said, "much in the same way we don't hand a butcher's knife to a 2-year-old."