SQQQ provides 3x inverse 1-day returns of the Nasdaq 100 Index.

Levered ETFs provide positive convexity in the direction of the bet.

Daily rebalancing of exposure causes value decay, especially in volatile markets.

Investors who are afraid of market volatility often turn to inverse exchange-traded funds ("ETFs") such as the Proshares UltraPro Short QQQ ETF (NASDAQ:SQQQ) to protect their portfolios.

In my opinion, investors should consider reducing their long exposures instead of seeking inverse ETFs as a hedge, especially for holding periods of longer than a few days due to the volatility "decay" from daily rebalancings.

Fund Overview

As the name suggests, the Proshares UltraPro Short QQQ ETF seeks daily returns that is -3x the return of the Nasdaq-100 Index. The fund achieves the -3x daily return target by entering into total return swaps with large banks that are reset nightly.

Figure 1 - SQQQ holdings (proshares.com)

Levered ETFs Only Work On Short Time Horizons

Investors who are interested in the SQQQ are highly encouraged to read this disclaimer from the Proshares website:

Due to thecompoundingof daily returns, holding periods of greater than one day can result in returns that are significantly different than the target return, and ProShares' returns over periods other than one day will likely differ in amount and possibly direction from the target return for the same period. These effects may be more pronounced in funds with larger or inverse multiples and in funds with volatile benchmarks.

What this means in layman terms is that the SQQQ is only designed to provide 3x inverse returns for one day. For any holding period longer than 1 day, the returns expectations will differ.

For example, imagine you start off with $100 invested in SQQQ. If the Nasdaq-100 index returns -5% on day 1, your position will grow to $115 (3 times the 1-day return of 5%). If the Nasdaq-100 returns -5% again on day 2, your position will grow to $132.25. The 2 day total is more than 3 times the 2-day compounded return of 10.25% or $130.75, because the two moves are in the same direction.