NVDU: Boosting And Protecting Your Nvidia Holding With A Leveraged ETF

In one of my first Seeking Alpha articles – about the T-Rex 2X Long NVIDIA Daily Target ETF (NVDX) – I mentioned several risks that investors should be aware of when looking at leveraged ETFs. Here’s a snapshot of what I said in that article (although I encourage you to read it):

• The leverage works both ways, so your ‘down days might undo and overwhelm your ‘up’ days if you hold such securities for extended periods of time.

• Due to the daily reset for these ETFs, a 10% gain on day one will NOT fully offset an equal loss on day two. With a $100 investment, you might gain $10 on the first day, but you’d lose $11 on the second.

• Volatility drag can cause a decay in your overall return without you realizing it. I’ll give a different example here:

  • Consider a $100 investment that records a 60% gain on day one and loses 40% on day two.

  • Calculating your simple average return uses this formula: [60%-40%/2], so it looks like a 10% daily average return.

  • However, your actual daily average return looks like this: [Exit Value – Original Investment/Original Investment], so [$96-$100/$100], which is -4%. This happens because your investment at the end of the first day is $160, but losing 40% on that, or $64, brings your exit value down to $96, which is a -4% return. You’re losing money even though your day one return is 50% higher than your day two loss.

  • The effect of this worsens the more volatile your investment is, and NVDA, which is the sole underlying asset in a single-stock leveraged ETF like NVDX, has a beta of 1.74 as I write this.

• Another risk is the liquidity of the ETF shares; low liquidity means you likely can’t open with a large position, and it’s going to be hard to offload that in a hurry.

• The SEC’s Office of Investor Education and Advocacy clearly warns investors that leveraged one-stock ETFs like these tend to amplify your risk as well as the volatility of the security, not to mention that it lacks the benefit of diversification, which is often a highly underrated element for any portfolio. Additional risks are listed here by the SEC.

These same risks also apply to the subject of today’s discussion – the Direxion Daily Nvda Bull 2X Shares ETF (NASDAQ:NVDU). Slightly more so, in fact, because the underlying stock has been even more volatile since my NVDX article was published on Feb. 11 (1.72 vs. 1.74, currently.)

At the end of that article, I also said this: “I’m rating this ETF a Buy, but I trust that investors will treat this as a very short-term holding of a maximum of a few days at a time.”

That’s the preface for my bullish thesis – not only on NVDU, but also my thesis from a more recent article I did on Nvidia (NVDA) itself. For NVDU, my call is Hold, and I’ll explain why.

In this article, I’m going to demonstrate how a pairing of NVDA with a leveraged or non-leveraged single-stock ETF can both boost as well as safeguard your core holding of NVDA stock.

Looking at NVDU against NVDX, (NVDY), and (NVDL), of these, only NVDY is NOT a leveraged ETP or exchange-traded product. That fund uses options to enhance returns, but it hasn’t been able to do that within the time frame between my NVDX article (Feb 11) and April 25, as the graph below shows. As a matter of fact, NVDX has the highest return for the period, thereby validating my bullish call on the security.

Should You Take the Plunge with NVDU or One of the Other Single-Stock ETFs?

Let’s first look at NVDU, the primary target for my thesis. The fund has an AUM of about $135 million and was incepted in September 2023, so it’s not a very mature fund, the concept of a single-stock ETF itself being relatively new. The issuer is Direxion Funds, which offers an impressive range of leveraged, inverse, non-leveraged, and mutual funds.

NVDU has an expense ratio of 1.04%, and that, in itself, requires a discussion.

Tangent – Should You Worry About the Expense Ratios of ETFs?

This is a highly divisive topic.

On the side of the arguable majority is the hypothesis that funds, both ETFs and mutual funds, with lower expense ratios have usually performed better OR will tend to perform better because of the lower expense ratio. This might be true if all else were equal; meaning, their underlying assets are the same, the derivatives they use are the same, they both use the same holding period strategies, and so on. In a ceteris paribus situation, in other words, you would naturally expect the fund with the lower ER to have performed better because the funds’ expenses themselves are netted out when calculating your returns, whether it’s the NAV of a mutual fund or the market price of an ETF.

In reality, however, no two funds are ever alike. It’s practically near-impossible because even if both funds are using derivatives such as options, their contract periods may differ, the bids at the time of entering into the contract might be different, the strike prices might be different, and so on. There are basically too many variables for them to be identical in all respects.

The other side of the argument is that since the expense ratio is already priced in to the price and total return, it’s those returns that are more important.

Regardless of which side wins the argument, though, the fact remains that historical performance can’t be used as an accurate measure of future returns. It can be used as a guidance of sorts, but at the end of the day, you’ll only know after the fact.

As such, my personal view is that if a fund consistently delivers strong returns, the expense ratio doesn’t really matter – again, assuming that there’s no other fund with a similar strategy as well as returns, but a lower expense ratio.

The real costs you should be thinking of are your transaction fees and taxable gains, not to mention adjusting for inflation on a longer timeframe to calculate your ‘real’ return vs. the ‘nominal’ return. Of course, this last cost item doesn’t apply as much to leveraged ETFs because you’d only hold these for a few days, at the most.

Now that we have that out of the way, let’s see how this type of stock-ETF pairing might help boost your returns or protect them during market downturns like the one we just faced.

Assessing the True Power of Leveraged ETFs Like NVDU

Although I’ve stated that historical performance can’t guarantee future returns, I also said that it can offer some sort of guidance. That guidance comes from momentum more than anything else. Still, let’s look at how these funds have performed over different time frames.

On a YTD basis, NVDX is the clear winner. However, if you’re keen on taking advantage of a higher AUM and more share liquidity, then NVDL is probably the better choice, the latter being more than 4x the size of NVDX. This difference is likely due to the difference in expense ratios and the greater liquidity, among other factors, but my opinion is that the fund managers should get most of the credit because they clearly used the available leverage in a more productive way.

Zooming into a shorter time frame, we see that on a one-month basis, none of these funds have performed as well as the overall market, as represented by a broad-market ETF like the SPY. Straight away, you can see that investing in the broad market would have been better over the past month. Relative to its peer ETFs, however, NVDU hasn’t done that badly, only trailing NVDL by about 32 basis points.

That being said, when you’re looking at a much longer time frame, it’s important to understand that an ETF like NVDU or even NVDX or NVDL should only be used to boost the return on your core NVDA holding, but it can also give you downside protection to a degree. In an ideal scenario, investing carefully in a leveraged ETF when the underlying stock’s momentum is positive – and you see a string of ‘up’ days, as explained in my NVDX article linked above – should help offset the ‘down’ days on the core holding.

To explain that further, assume you’ve been holding a stock that’s given you a 6M return of 50%, that return will have been boosted because you invested cleverly in a single-stock ETF that gave you a bonus return on top of that 50%. Assume that’s another 10%; in that situation, you can then afford to absorb a 1/6th future drop in your combined holding (the stock plus the ETF) and still come out with a 50% return. Here’s a simplistic calculation:

Gain on Stock Price = 50%

Gain on ETF (assuming a holding equivalent to your stock holding) = 10%

Total Return = 60%

Future Loss = 1/6th of 60% or 10% of your overall return (assuming zero return on the stock)

Final Gain = 50%

Essentially, you’d end up where you started. On the other hand, without that leveraged ETF play, you would have lost 10% from your 50% return, ending up with 40%. In that sense, your ETF’s return has fully protected your core gains on the stock itself. In reality, this would depend on the size of these two holdings, but you get the general idea.

Therefore, using a leveraged ETF play not only boosts your investment but also safeguards it (to the extent of your investment mix) against future losses. In toto, your core NVDA holding is better off with such a pairing than without. Not a technical hedge, but it plays out that way.

NVDU vs. NVDL – The Better Buy

Both these leveraged ETFs have performed very similarly over the time frames that we’ve seen, but NVDL does seem to have a bit of an edge. Despite it having the highest expense ratio of the three leveraged ETFs showcased here today, the return has been superior in an overall up market as well as the more recent down market. Admittedly, doing a leveraged ETF play during a down market could wipe out any additional return you might enjoy during a previous up market, so that’s something you need to be careful about. Still, that would apply to any leveraged ETF, so that’s not really a factor you’d want to consider as a differentiator.

What’s important to understand is that such single-stock ETFs can play a major role in your portfolio, and they’re becoming more popular because of the performance they’ve delivered during bull markets. These outsized returns, as it were, can help control your losses when the market is down – again, as long as you don’t touch them during bearish periods. And that’s the other major risk you need to be aware of as well. At the risk of being repetitive, I’ll say it again – please do not engage with leveraged ETFs when the momentum is against you.

Driving that home with an example, over the past month, NVDA lost about 5.5%. Even though it might seem like there were opportunities for leveraged ETF plays over that period, only seasoned investors are advised to consider doing it. For more casual investors or those with less experience, it’s better to wait for much clearer bullish signals, and these are usually times when key catalysts reveal themselves. One major catalyst is next month’s earnings, and all signs point to investors as well as analysts expecting another blowout quarter:

• 36 of 36 analysts with an earnings estimate for Q1-25 have revised their estimates upwards. I dare say none have dared to revise downward, but that’s a whole other topic with respect to sell-side analysts.

• Both the broader market as well as NVDA have shown greater positive momentum over the past week. I would suggest watching the stock as we approach earnings on May 22 and investing in NVDA either now or during the run-up to earnings, and then leveraging that with NVDL when you see that momentum sustain itself for at least a few days. This is risky for several reasons I’ve already covered, but watching your investment closely and pulling out at the right time makes all the difference.

• NVDA’s RSI shows that it’s nowhere near overbought right now; pointedly, over the past year, the stock has hit the 70 level several times, even going far into overbought territory. As such, another bull run on the stock could technically sustain itself until it hits 70+, so that’s a positive if you’re considering an investment in NVDA and a leveraged ETF combo.

Overall, I might be comfortable assigning a Buy to NVDU, but on a comparative basis, I think NVDL is the better play here considering its much larger size and greater liquidity in case you’re thinking of entering (and, more importantly, exiting) a relatively large position. For that reason alone, I recommend not using NVDU as your preferred leverage tool to maximize or protect your NVDA gains. Use NVDL instead.

As always, these are my opinions alone, and I urge investors to do their own DD before investing in anything. I hope you’ve enjoyed reading my work. Please feel free to leave your comments on whether you agree, disagree, or have an alternative view. Thank you.