Forget 1:1 Returns: The Double-Leveraged Secret to Outperforming the S&P Financials

There are times when your conviction in an investment is higher than your available capital. These are those times when simply matching the returns of a stock market sector would seem like leaving money on the table.

For example, suppose you're unabashedly bullish that financial stocks will soar as the Federal Reserve cuts rates more than currently anticipated at its next meeting. Instead of buying an exchange-traded fund that can deliver one-to-one returns with financial stocks, you want one with a little more juice. Enter the ProShares Ultra Financials (NYSEMKT: UYG). It's the only ETF that offers twice the daily performance of the S&P Financial Select Sector Index.

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Doubling up on financial stocks

The ProShares Ultra Financials enables traders to target magnified returns on the financial sector. The bank ETF investment aims to deliver double the daily returns of the S&P Financial Select Sector Index, before fees and expenses. That index tracks 76 financial stocks, led by Berkshire Hathaway, JPMorgan Chase, and Visa. It allows you to gain this leveraged exposure without needing to buy financial stocks with margin in your brokerage account.

Here's how the fund works. If the S&P Financial Select Sector Index rises 1%, an ETF tracking that index on a one-to-one basis, such as the State Street Financial Select Sector SPDR ETF (NYSEMKT: XLF), would also rise 1%. However, by using leverage to gain twice the daily exposure, this ETF would rise 2%.

This ETF offers a leverage lite way to invest in financial stocks compared to the Direxion Daily Financial Bull 3X ETF (NYSEMKT: FAS). That ETF aims to deliver 300% of the daily returns of the Financial Select Sector index before fees and expenses. While it offers higher daily return potential, the fund's additional leverage can drag on its returns over the long term.

Leverage works both ways

The ProShares Ultra Financials fund is ideal for investors seeking to make a short-term leveraged bet on financial stocks without taking on quite as much risk as the Direxion Daily Financials Bull 3X ETF. For example, financial stocks rallied late last year. The State Street Financial Select Sector SPDR ETF rallied 5.8% from Nov. 1 through Dec. 23. Meanwhile, the ProShares Ultra Financials more than doubled that return at 12%. This ETF outperformed the Direxion Daily Financial Bull 3X ETF, as leverage and expenses reduced its return to 9%.

However, the fund's leverage works against investors when financial stocks fall. For example, if financial stocks fall 2% in a day, the fund would lose 4% of its value. These losses can add up over the long term. Over the last six months, financial stocks have declined by about 1%. Meanwhile, this ETF has lost nearly 14% of its value during that period due to fees, expenses, and leveraged losses on down days.

Best for a short-term financial stock bet

The ProShares Ultra Financials fund enables you to make a leveraged bet that financial stocks will rise sharply over the short term. However, that leverage can work against you if financial stocks don't rally, especially the longer you hold the fund. Given this dynamic, you should only consider this ETF if you have a very high conviction that financial stocks will rally sharply in the very near term.

JPMorgan Chase is an advertising partner of Motley Fool Money. Matt DiLallo has positions in Berkshire Hathaway, JPMorgan Chase, and Visa. The Motley Fool has positions in and recommends Berkshire Hathaway, JPMorgan Chase, and Visa. The Motley Fool has a disclosure policy.