How Leveraged ETFs Work and Their Risks

A leveraged ETF is a product designed to track the return of an underlying index at 2x or 3x. For example, a KOSPI 200 2x leveraged ETF aims to rise about 2% when the KOSPI 200 rises 1% in a day.

The most important word here is 'daily.' This multiple is only a 'per-day' target—it is not a 'monthly multiple' or a 'yearly multiple.' A leveraged ETF increases exposure with derivatives (swaps, futures) and does 'daily rebalancing,' realigning to the target multiple at the close of every trading day.

Because of this daily reset, the performance over multiple days can differ greatly from 'index return × multiple.'

Let's see the principle with the most famous example. If the index rises +10% one day and falls -10% the next, the final value is 1.10 × 0.90 = 0.99, i.e., -1%.

But a 2x leveraged ETF over the same two days becomes +20% then -20%, so 1.20 × 0.80 = 0.96, i.e., -4%.

The index is roughly flat (-1%), yet the 2x product fell more, to -4%. This phenomenon—where a multiple product is chipped away little by little in a choppy, sideways market of repeated ups and downs—is called 'compounding erosion' or 'volatility decay.'

The greater the volatility, and the longer the holding period, the larger this erosion. In a strong one-directional trending market the multiple effect can be favorable, but during periods when the market churns, it becomes poison instead.

The U.S. Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC) have long warned that daily-reset leveraged and inverse ETFs are 'typically unsuitable' for ordinary retail investors who intend to hold beyond one trading day, and that especially in volatile markets, compounding can cause long-term performance to deviate greatly from the daily target.

Costs can't be ignored either. Because leveraged products involve derivatives management and daily rebalancing, their fees (management fees) tend to be far higher than ordinary index ETFs. Whereas a broad index ETF is around 0.1% per year, leveraged products are often charged fees several times higher.

Korea places stronger entry barriers on leveraged and inverse ETFs than other countries.

From September 2020, to trade a domestically listed 2x leveraged ETF, you need a base deposit of KRW 10 million and completion of mandatory prior education (1 hour). From May 22, 2026, the same KRW 10 million deposit and prior education were applied to overseas-listed leveraged and inverse ETFs as well. For single-stock leveraged products, an additional 1 hour of advanced education is added, for a total of 2 hours.

Since major overseas markets have no such deposit requirement, some call it a 'Galapagos regulation,' but flipped around, it also means the product is that risky.