Preying on Leveraged ETFs

Yinhong Zhao

Papers from arXiv.org

Abstract: We argue that arbitrageurs preying on the closing rebalances of leveraged exchange-traded funds (LETFs) contributed to the Korean market's extreme volatility in 2026. An LETF's mandated daily rebalance is sized by the day's return, which generates an upward-sloping demand at market close. In response, rational arbitrageurs pre-position, enlarge the fund's order, and liquidate into the demand they have induced. Consistent with this mechanism, Korean stocks tracked by LETFs reverse about 75% of their first-day response to pre-open U.S. news by the next close and oscillate for several days thereafter, a pattern absent in every control group. Our quantification implies that self-reinforcing rebalance raised SK Hynix's annualized volatility from 84.8% to 136.7% over nine weeks and transferred 19% of terminal wealth from the products' predominantly retail holders. Dispersing the rebalance across the trading day may backfire, whereas a flexible leverage multiple could help.

Date: 2026-08, Revised 2026-08
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