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SEC Approves New Investment Product, Single-Stock ETFs: Proceed With Caution

·4 min read
Here Come Single-Stock ETFs. Proceed With Caution
Here Come Single-Stock ETFs. Proceed With Caution

A brand new product has hit the market: the SEC has approved the use of single-stock ETFs, the first eight of which have been introduced by AXS Investments. These leveraged products are built to magnify the gains and losses from a specific underlying stock, generating larger outcomes from a single position. Though called ETFs, they bear little resemblance to normal ETFs. That has led to both confusion as well as warnings, and investors should absolutely proceed carefully.

Consider working with a financial advisor as you pick securities that match your goals, timetable and risk profile.

How Ordinary ETFs Work

Normally, ETFs are built like a traditional portfolio asset. They rely on a diverse collection of assets to balance growth against stability. Most are pegged to specific benchmarks. For example, a NASDAQ-indexed ETF will hold a collection of assets intended to mirror the performance of the tech-heavy NASDAQ overall. If the NASDAQ  goes up by 5%, ideally the fund will as well.

The upshot is that a traditional ETF is built to smooth out market volatility. It allows you to capture the gains of the stock market, but not necessarily the outsized gains of an individual stock. In trade, the fund's diversity mitigates the biggest losses when a single company falls. You get the highs and the lows, but neither the highest highs nor the lowest lows.

How Single-Stock ETFs Work

Here Come Single-Stock ETFs. Proceed With Caution
Here Come Single-Stock ETFs. Proceed With Caution

A single-stock ETF, which the SEC just approved in July, reverses that. These products are built to amplify the volatility in a single stock. Instead of smoothing out the market through a diversity of assets, a single-stock ETF invests in only a single equity. They can take a long position on that stock (a levered single-stock ETF) or short (an inverse single-stock ETF). But unlike simply buying or shorting a stock, the single-stock ETF is built to magnify the performance of the underlying asset. They will return $1.50 or $2 for every $1 change in the stock's price, or drop $2 for every $1 that the stock loses.

The underlying structure of a single-stock ETF isn't new. It is basically a type of leveraged fund. This means that it relies on debt and derivative products in addition to, or instead of, holding stocks directly. Most leveraged ETFs rely on options and futures contracts to magnify any gains or losses in the underlying stock, buying some mix of shares, futures and options in a single position. In other cases, a leveraged ETF can be built around total return swaps.

Each of the single-stock ETFs just issued by AXS Investments track shares of either Nike, Pfizer, Nvidia, PayPal or Tesla.

Pros and Cons of Trading Single-Stock ETFs

These securities offer an opportunity for investors who feel confident in their position. If you are extremely bullish or bearish on a given asset, a single-stock ETF can let you amplify your returns quickly. And in the process it can provide some safety net for short investors, since unlike shorting a stock directly you can only lose up to the value of your original investment.

This potential benefit, however, comes with a couple of cons: their risk and their complexity. "As with other complex exchange-traded products, single-stock ETFs may be useful to certain investors who understand their unique features," SEC Commissioner Caroline Crenshaw said in a statement. "However, they are risky products for investors and potentially for the markets, as well."

The Bottom Line

Here Come Single-Stock ETFs. Proceed With Caution
Here Come Single-Stock ETFs. Proceed With Caution

The SEC has recently approved single-stock ETFs for general trading. At time of writing, the only single-stock ETFs currently issued were eight products from AXS Investments. However, several other firms are reported as having an interest in launching similar products, so investors will likely see this space grow in the near future. These securities use derivatives and leverage to invest in a single stock, magnifying the gains and losses of that underlying position. Prospects for gains and losses are, therefore, outsized in comparison to just buying that one stock. In other words, proceed with caution.

Tips on Investing

  • One of the best ways to maximize your investment strategy and tactics is by working with a financial advisor. Finding a qualified financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.

  • Use our free investment calculator to see how your investments will grow.

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