Decayed and Confused

There's an old saying in investing that more risk leads to more return. In theory that's the deal, if you are willing to experience more volatility you should get paid more over time. 

It doesn't always work that way.

What if I told you that two leveraged ETFs, one betting that an individual stock would go up and one betting that it will go down, both lost nearly their entire value since inception? Meanwhile the underlying stock, while negative, lost considerably less than either of them?

Strategy Inc. (Nasdaq: MSTR), formerly known as MicroStrategy, was founded in 1989 as a business intelligence software company. In 2020, under the leadership of co-founder Michael Saylor, it made a rather unconventional pivot: it adopted Bitcoin as its primary treasury reserve asset, using proceeds from equity and debt issuances to aggressively accumulate cryptocurrency on its balance sheet. Today the company describes itself as the world's first and largest Bitcoin Treasury Company, holding over 800,000 BTC as of early 2026.

The practical effect is that MSTR trades less like a software company and more like a leveraged, publicly-listed Bitcoin fund. Over the trailing five years, its annualized volatility has clocked in at approximately 108%, roughly double that of NVIDIA. Keep that high number in mind, because it's at the center of everything that follows.

In September 2024, Tuttle Capital Management & REX Shares launched through their T-REX ETF franchise (fittingly named after an extinct species) two leveraged ETFs tied to MSTR. 

MSTU offers 2x the daily return of Strategy stock (bullish), while MSTZ offers 2x the inverse daily return (bearish). Both funds offer investors a way to take a high-conviction directional bet on one of the market's most volatile stocks.

The results? Probably not what investors on both sides of the trade would have expected:

Since inception, MSTU and MSTZ have fallen 94% and 96%, respectively, albeit with very different return profile. Meanwhile the underlying stock, MSTR, has fallen only about 38%.

Calling the direction correctly didn't help. Being directionally correct and shorting a stock that fell 38% in less than two years and losing almost your entire investment demands an explanation.

That explanation is volatility decay.

It's common in investing to think in additive terms: if 100% exposure gives you a certain return, then 200% should give you twice as much. This is true for a single day in isolation. But real investing unfolds over the long-term, allowing returns to compound. The gap between the simple average of returns and the actual compounded result is called variance drain, and it grows quietly and relentlessly as volatility increases.

Funny enough, you don't even have to look toward the leveraged ETF market to witness this, just look at Strategy itself which is a leveraged play on Bitcoin. Since the inception of the T-REX ETFs, it has significantly lagged the actual performance of the "underlying" cryptocurrency:

Consider a stock that drops 10% on day one, then rallies 10% on day two. The arithmetic average is zero. The actual compounded result is not:

Volatility alone, with no net directional move, erodes wealth. Now apply 2x leverage to the same stock: the drop becomes −20%, the rally becomes +20%. The compounded result is now −4%. 

The drag has not doubled with the leverage: it has quadrupled. And it hits both the long and the short fund identically, because daily resets compound against volatile movement in either direction.

A stock moving twice as much each day doesn't produce twice the drag, it produces four times the drag. At MSTR's five-year annualized volatility of 108%, the structural headwind facing any daily-reset leveraged product is severe enough that no directional view can overcome it over time. The long fund and the short fund were always going to arrive at the same destination.

The only question was how quickly.

The chart above captures this phenomenon in it's simplest form, the purple line illustrating a security that alternates going up 10% and down 9.1% over 60 trading days. At the end it finishes exactly flat, whereas the hypothetical 2x leveraged (blue line) and 3x leveraged (orange line) ETFs on that security finish -42% and -89%, respectively. The added volatility alone did that damage, and it scaled with the amount of leverage.

So who actually benefits from these things?

In most investments, someone's loss is someone else's gain. With daily-reset leveraged ETFs on volatile individual stocks, that someone is rarely the investor holding the fund. There are two parties in this structure who get paid regardless of what the underlying does:

The ETF sponsor. Expense ratios are currently 1.05% on these ETFs, collected daily on every dollar of assets in up markets and down markets alike. 

The swap counterparty. To deliver 2x daily leverage, funds enter into swap agreements with financial institutions. The embedded financing cost on those swaps can run 5–6% annually, paid to the counterparty out of fund returns regardless of direction.

Together, fees and financing costs layer an additional 6–7% annual drag on top of the variance drain that volatility is already producing. 

It's also worth noting that this problem isn't universal to all leveraged strategies. In a smooth, sustained uptrend with relatively low underlying volatility, daily compounding can actually work in an investor's favor in what's called the "trend bonus." The problem is specific to high-volatility, choppy underlying assets like MSTR. You are essentially asking a daily-reset mechanism to perform well in an environment that is almost perfectly designed to destroy it.

Brent Coggins

Chief Investment Officer, Triad Wealth Partners