What is a single-stock ETF?

That's right – there is a new type of ETF in town. The single-stock ETF allows for leveraged or inverse trading of a single stock, and that's what all the hoopla is all about. It's designed to give investors like you more options for dealing with unpredictable markets by removing the need to sell short individual equities. Although, you should note that single-stock ETFs involve more risk than regular ETFs and may not be suited for long-term investors due to their structure and usage of leverage.

History of single-stock ETF

When did this new ETF hit the markets? Back in 2018, that's when the leveraged single-stock ETFs first debuted on European exchanges. And then, in 2022, financial services provider AXS Investments introduced eight such products to the US market for the first time. Ready to learn more? Let's dive a little deeper. 

What is a single-stock ETF?

The important thing is to remember that the daily performance of single-stock ETFs is correlated with the daily performance of a single stock, which makes them leveraged ETFs. There are a few distinct types of single-stock ETFs:

• Leveraged long single-stock ETFs: these ETFs aim to multiply their stock price. For instance, the AXS 2X NKE Bull Daily ETF (NKEL) seeks to achieve two times the daily return of Nike stock. Thus, if Nike's stock price increases by 4% on a particular day, the ETF should increase by 8%.
• Short single-stock ETFS: these are funds that "short" stocks. A short single-stock ETF, Direxion Daily TSLA Bear 1X Shares ETF (TSLS) mirrors the inverse of Tesla's daily performance. To put it another way, if Tesla stock drops 10% on a particular day, the ETF should gain the same amount.
• Leveraged short single-stock ETFs: these ETFs use leverage to short the company's aim for a negative multiple of their stock. The AXS 2X PFE Bear Daily ETF (PFES) is an exchange-traded fund that aims to provide two times the daily return opposite of Pfizer. Accordingly, a daily drop of 2% in Pfizer's stock price would lead to an increase of 4% in the ETF's value.
• Hedged single-stock ETFs seek to minimize the impact of daily price fluctuations in their underlying stock. For instance, the Innovator Hedged TSLA Strategy ETF (TSLH) aims to replicate Tesla's daily return while being limited to a range between -9.29% and -10.01%.

Single-stock ETF issuers, like those of other leveraged ETFs, sometimes rely on trading derivatives, which are sophisticated financial products, to achieve their desired rates of return.

According to Malcolm Ethridge, a certified financial planner and vice president of CIC Wealth located in Rockville, Maryland, single-stock ETFs might be used by traders to double down on short-term wagers on businesses like Apple.

Ethridge, however, warns that investing in a single stock ETF is not a long-term strategy.

"Their approach is to take things day by day and ticker by ticker. If you buy them on a Monday and want to keep them until Friday, you're making a mistake, "he explains

In 2018, leveraged single-stock ETFs debuted on European exchanges. In 2022, financial services provider AXS Investments introduced eight such products to the US market for the first time.

Is it better to buy a single stock or ETF?

There are two scenarios where ETFs perform better than equities. To begin, an ETF may be the ideal option when the standard deviation of the sector's stock returns is small relative to the mean. Second, an ETF is the way to go if you don't know enough about the firm to give you a leg up.

What is the advantage of a single-stock ETF?

The potential for new single-stock ETFs is immense, as there are more than 4,000 stocks in the US equity market. 

All stocks, in theory, could have a corresponding leveraged or inverse exchange-traded fund. The downside is that there will likely be intense rivalry because this method is so simple to grasp and copy. It's possible that small and medium-sized ETF investors will be incentivized to introduce a series of single-stock ETFs for widely held companies, despite the fact that large ETF investors may be hesitant to enter the market. 

Each stock has a significant early mover advantage, but there are many stocks from which to choose. Considering the competitive nature of the market and the scarcity of accessible funds, actively traded equities may potentially be a target.

Do single stock futures still exist?

Because the US Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) could not agree in the 1980s on who would be responsible for regulating SSFs, the practice was outlawed at the time.

But in 2000, President Bill Clinton passed the Commodity Futures Modernization Act (CFMA). Then the SEC and the CFMA collaborated on a jurisdiction-sharing scheme, and single-stock ETF trading began on November 8, 2002, per the new law.

Bottom line

Generally speaking, trading and investing advisors are cautious about promoting single-stock ETFs due to the high degree of volatility they carry. According to them, single-stock ETFs have numerous drawbacks. The major one is that the fees charged by the funds will likely erode any positive returns due to the leverage involved. In fact, they say things can go downhill pretty quickly.

In the US, regulators at the SEC have expressed similar worries. Investors have been warned that the complex inner workings of such ETFs can cause their returns to deviate over time from their targets.

According to SEC Commissioner Caroline Crenshaw's July 2022 statement on the SEC website, "the daily rebalancing and effects of compounding may cause returns to diverge quite substantially from the performance of the, in this case, one underlying stock," especially if these products are held for multiple days or more.

Most investors are better off sticking to tried-and-true methods of wealth creation rather than speculating with single-stock ETFs.

Instead of gambling on the stock market, "take the plodding and boring road" of sustained profits over time, most advisors say. If you want to learn more about ETFs, check out our blog on ETFs explained.