The Hidden Risks of -3X Leveraged ETFs: How Volatility Drag Erodes Returns and Why Long-Term Holding is a Gamble

Investors seeking amplified exposure to market movements often turn to leveraged ETFs, but few understand the hidden risks embedded in these products. Among the most extreme examples is the ProShares UltraPro Short S&P 500 (FAS/SPXU), . While this structure appears straightforward, the reality for long-term holders is far more complex. Daily rebalancing, compounding effects, and volatility drag combine to erode returns, often producing outcomes that diverge sharply from expectations. This article unpacks these dynamics using FAS as a case study, illustrating why these instruments are inherently unsuited for extended holding periods.

The Mechanics of Daily Rebalancing and Volatility Drag

Leveraged ETFs like FAS maintain their target exposure through daily rebalancing, a process that adjusts holdings at the end of each trading day to preserve the -3X leverage ratio. According to a report by LeverageShares, this mechanism works effectively in trending markets but introduces significant risks in volatile or range-bound environments. For instance, if the S&P 500 fluctuates up and down by 2% daily, the compounding effects of FAS's -3X leverage amplify losses over time. A stock that oscillates between +2% and -2% daily would see FAS's value decline by 12% over two days, even if the underlying index returns to its original level. This phenomenon, known as volatility drag, is not a flaw in the product but a mathematical inevitability of daily compounding.

Case Study: FAS ETF Performance (2023–2025)

The ProShares UltraPro Short S&P 500 (FAS), also listed as SPXU, exemplifies these risks. From 2023 to 2025, FAS's net asset value (NAV) , . Over the same period, the S&P 500 itself posted a modest positive return, highlighting the stark divergence between the ETF's design and its long-term performance. This erosion is not unique to FAS but is magnified by its -3X inverse structure. As stated by ProShares, the fund's volatility is inherent to its use of derivatives and futures to amplify returns, which also exacerbate compounding losses during periods of high volatility.

The Dangers of Extended Holding Periods

Leveraged ETFs are explicitly designed for short-term tactical use, not long-term investing. Data from LeverageShares underscores that daily rebalancing benefits trend-following strategies but penalizes investors in choppy markets. For example, , . Over multiple cycles, this asymmetry compounds into a downward spiral. Holding FAS for three years, as demonstrated by its 2023–2025 performance, exposes investors to this erosion regardless of the underlying index's direction.

Conclusion: A Caution for Investors

The ProShares UltraPro Short S&P 500 (FAS) serves as a cautionary tale for investors underestimating the risks of leveraged products. While these ETFs can deliver outsized returns in aligned market conditions, their reliance on daily rebalancing and compounding makes them perilous for long-term portfolios. , despite a relatively stable S&P 500, underscores the importance of understanding volatility drag. Investors must treat these instruments as short-term tools, not long-term holdings, and recognize that their performance is dictated by daily market fluctuations rather than annual benchmarks.