Leverage Cuts Both Ways

The surge in US stocks has relied heavily on leverage, leaving the market at risk if artificial intelligence optimism fades. Recent S&P 500 growth stems from investors rushing into top-performing AI hardware companies. Speculators are using aggressive tactics like call options and leveraged ETFs to gain additional exposure. These speculative trading strategies carry risk not only for the speculator, but for the entire market.

For years, we have argued that Wall Street is not a casino and investing is not gambling. Today, that case is becoming harder to make. Financial innovation combined with relatively strong markets for the past decade, has stimulated a barrage of products built for speculation rather than long-term wealth creation. Brokerage firms now promote prediction markets; zero-days-to-expiration (0DTE) options account for over half of all options volume; and ETF providers are flooding the market with leveraged single-stock funds.

Driven by the desire for immediate gratification, market activity is shifting from active trading to pure gambling. While traditional buy-and-hold strategies rarely trigger an adrenaline rush, they consistently deliver superior returns over the long run. The speculative products feeding this gambling impulse add dangerous volatility to the system. Financial bubbles historically share two core ingredients: leverage and speculation. Even as the artificial intelligence boom proves to be real and transformative, the underlying rise of leverage and speculation adds risk to the market and should not be ignored.

The Rise of Leveraged Single-Stock ETFs

If meme stocks and standard options initialized the gamification of Wall Street, the recent surge of leveraged single-stock ETFs have raised the stakes. Introduced to U.S. markets in mid-2022, these funds have proliferated rapidly. There are now hundreds of these vehicles actively trading, capturing a significant footprint of the U.S. ETF market—and retail investors account for roughly 90% of that volume.

Unlike traditional ETFs designed to track diversified indexes, these instruments intentionally strip out diversification. They utilize complex financial derivatives to deliver 1.5x, 2x, or 3x the daily performance of a single underlying stock. While they offer instant gratification (or instant remorse) they should not be confused with a sustainable investment philosophy.

The Hidden Danger

Uninitiated traders often mistake these funds for standard options without an expiration date, but leveraged ETFs are entirely unsuited for a buy-and-hold strategy. Because these funds reset their exposure daily, they suffer from mathematical decay—called “volatility drag”—which can aggressively eat away at their value in choppy or sideways markets.

Because price returns compound geometrically rather than adding up arithmetically, mathematical decay occurs whenever a stock fluctuates up and down (as most stocks do). Over time, that erodes value, much like a melting ice cube.

Real-World Consequences

This mathematical decay plays out in the market every day. For example, the Direxion Daily Tesla Bull 2X Shares (TSLL) debuted on August 9, 2022, with an opening price of about $24., when Tesla (TSLA) traded around $283. Fast forward to today: while Tesla’s stock has risen roughly 34% to $380, the 2x leveraged Direxion fund has collapsed by about 50% from its opening price.

Regulators like the SEC and FINRA continually warn that leveraged single-stock vehicles present major systemic and personal hazards, yet Wall Street continues to introduce more of these leveraged funds. If the broader market hits a sudden air pocket, mounting losses can force leveraged holders to unwind their positions at any cost, accelerating market selloffs. Ultimately, these products pose a threat not just to individual portfolios, but to market stability as a whole. When that instability triggers a broader panic, however, disciplined investors will find their greatest opportunities to buy high-quality assets at a discount. That is where we fit in with a disciplined long term strategy. Our investment philosophy emphasizes long-term portfolio construction, diversification, and disciplined risk management rather than attempting to anticipate short-term market movements.

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Palumbo Wealth Management (PWM) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where PWM and its representatives are properly licensed or exempt from licensure. For additional information, please visit our website at www.palumbowm.com.

The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status, or investment horizon. You should consult your attorney or tax advisor.

The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

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All information has been obtained from sources believed to be dependable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information, and it should not be relied on as such.

The views expressed in this commentary are subject to change based on the market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that no such statements are guarantees of any future performance, and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

Past performance is no guarantee of future returns.

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By: Adam