Leverage is the key to wealth. There’s more than a kernel of truth in this truism, but leveraged investing can lead to large losses as well as large profits. In fact, as Sumit Roy of ETF.com points out, it theoretically possible for a leveraged ETF to lose 100% of its value in a single day.
Roy credits ETF Analyst Boris Valentinov of FactSet for alerting him to the fact that ETFs can indeed go to zero in a single trading session.
“There is a way to actually go to zero, although very unlikely,” Valentinov explains. “If you have, say, a 3x-leveraged fund and the market goes down by 34 percent that day—the fund is done.”
That means if oil prices drop by more than 33.33%, an ETF like 3X oil leveraged UWTI will lose 100% of its value and holders will lose everything.
UWTI and other oil ETFs have seen huge single day losses before
Although this situation has not been seen in three and a half years since UWTI’s launch, a complete loss is a possibility. The largest daily drop for UWTI so far was on November 28, 2014, when the ETN lost 24.8% of its value. That came when crude oil sank 10.2% in one day, one of the biggest plunges in recent memory.
That said, the volatility in the crude markets over the last year and a half are not anything near the extreme swings seen at times in the past, especially the 1980s and 90s. Roy points out that the 10.2% decline in oil prices on Nov. 28, 2014 was actually just the 21st-largest one day drop in history.
The largest moves in crude oil prices were seen in the late 1980s, early 1990s and 2001, long before UWTI’s in early 2012.
At the top of the list is the move in January 1991, when crude oil sank a mind boggling 33% during the first Gulf War, when it became obvious that the conflict would not cause major supply disruptions in the Middle East. The rest of the top five all-time largest one-day drops in oil prices were all 16% or less.