Leverage is the Death Star of the Financial World

We have warned for years that leverage is the “Death Star” of the financial world — though unlike the fictional Star Wars super weapon, leverage poses a real and looming threat to investors. Leverage can make a relatively conservative strategy risky and it can turn a risky strategy into pure speculation.. Recently, we have focused our research and investigative resources on the impact of leverage in the world of options and futures. Some thoughts on the risks of leverage in the options/futures world are set out below.

Many option and futures strategies may appear viable because they are functioning well in a certain type of market. For example, some of these strategies have thrived in low volatility markets only to explode with the rise of the VIX.

Short volatility ETFs are an example of a product that has suffered from volatility due to leverage. One Reuters article aptly described what these funds attempt to accomplish as follows: “Short volatility strategies bet on future stock market swings being more muted than current expectations would suggest. In essence, these strategies pocket the ‘risk premium’ from selling insurance to cautious investors.”

Breaking down a leveraged option strategy to its most basic components, options and futures are essentially a way to leverage a small amount of money as a down payment on a bet relating to a future potential outcome. As a result, when you begin to discuss the use of leverage in connection with option trading strategies, you are really saying that you take a leverage-based strategy (options and futures) and borrow money to make these bets. This is leveraging the leverage, sometimes referred to as double leverage. This can result in outsized returns, but can also quickly collapse an entire fund or an entire portfolio when the bets don’t work out or the market moves in an unexpected direction.

At Vernon Litigation, we have been devoting research and investigative time to one particular group of funds operated by LJM Partners Ltd, which is already the subject of several class actions. Our focus has been on the limited partners who made significant individual investments as opposed to the mutual fund investors. LJM funds lost nearly all of their value in just two days earlier this year in February. These losses are being attributed to LJM’s inappropriate use of excessive leverage in an effort to juice returns. Without this excessive leverage, LJM would likely have not been significantly hurt by the surge in the VIX earlier this year. If you have any information that you believe would assist us with our investigation, please contact us to discuss.

Vernon Litigation Group is a team of financial litigators that represent clients in courtroom litigation, arbitration, and negotiations throughout the United States. Our lawyers have collectively represented hundreds of investors in FINRA and other securities arbitration and litigation claims nationwide and recovered millions of dollars from financial institutions. For more information, visit our website at www.vernonlitigation.com or contact Vernon Litigation Group by phone at 1-877-649-5394 or by e-mail at info@vernonlitigation.com.