AJ Fabino, Senior Editor, Stock Trader Network

LCDL is dead.

We are holding a small wake today for the GraniteShares 2x Long LCID Daily ETF. It was a good little trading instrument. It is now resting in financial-product heaven alongside Ask Jeeves and other relics that disappeared much faster than their users expected.

The cause of death was not Lucid Group (LCID) going bankrupt. Lucid did not file for Chapter 11, and its stock did not go to zero. Instead, an unverified report about a possible bankruptcy or take-private transaction sent LCID shares down more than 50% intraday on July 14. Lucid later called the rumors “completely false” and said it had enough liquidity to operate well into next year. The company made that denial in an SEC filing.

That reversal saved LCID. It could not save LCDL.

GraniteShares said LCDL’s swap counterparty exercised its contractual right to close the fund’s position during the plunge. The loss pushed LCDL’s net asset value below zero, forcing GraniteShares to terminate the fund. Lucid shares subsequently rebounded above $7, but LCDL no longer had exposure to the recovery. GraniteShares said shareholders will receive nothing in the liquidation.

Any trader who has used, or considered using, a leveraged ETF should understand what happened. The same basic mathematics exists inside every leveraged product, although the precise danger point depends on the fund’s leverage, holdings and contractual terms.

How leveraged ETFs create leverage

LCDL sought to deliver 200% of LCID’s daily percentage move before fees and expenses. It created that exposure through financial derivatives, principally swap agreements. In a total-return swap, a financial institution provides the fund with the economic return of a specified amount of LCID exposure. The fund receives the gains when Lucid rises and owes the losses when it falls.

Suppose a 2X fund has $10 of NAV per share and $20 of exposure to its underlying stock. If the stock falls 10%, the fund loses roughly $2 and its NAV drops to about $8. But if the stock falls 51%, that $20 exposure loses $10.20, exceeding the fund’s original $10 of equity. Before accounting for other assets, liabilities or expenses, its NAV has fallen below zero.

For a 2X long fund, a decline of slightly more than 50% is therefore an extinction-level event. For a 3X long fund, the mathematical threshold is roughly 33.3%. Individual funds may have different intraday rebalancing, termination and counterparty provisions, so traders need to read the actual prospectus rather than relying on the multiple printed in the fund’s name.

GraniteShares’ prospectus was explicit, saying that if the underlying stock of a 2X long fund falls more than 50% during a trading day, investors could lose their entire investment. The prospectus also warns that a counterparty action can lock in losses even if the stock later reverses.

Why NAV matters more than the screen price

An ETF’s net asset value is the value of its assets minus its liabilities, divided by the number of shares outstanding. Its market price is the price at which traders are willing to buy or sell those shares.

Under normal conditions, market makers and authorized participants help keep those two numbers close together. During a violent move, particularly when the underlying stock and the ETF are being halted repeatedly, the market price can become stale or disconnected from the value of the fund’s actual portfolio.

GraniteShares calculated LCDL’s July 14 NAV at negative $0.016 a share. That does not mean LCDL shareholders owe GraniteShares 1.6 cents for every share they hold—it means the fund’s liabilities exceeded its assets and there was nothing left for shareholders.

That is what made LCDL shares trading around $0.28 so dangerous. A low market price can look like a lottery ticket, but once the swap had been closed and the fund’s NAV was negative, buyers were not purchasing inexpensive exposure to a Lucid rebound. 

They were purchasing shares in a fund with no remaining economic value.

Stock Trader Network’s Dennis Dick Has Repeatedly Warned Traders About This

“The problem is yesterday for that small period of time LCID was down 51%,” DDD said. “That means that LCDL, at that moment in time, becomes worthless.”

The underlying stock’s recovery did not reverse the damage because the leveraged position had already been closed.

“They do twice the daily performance of the underlying instrument,” DDD said. “So, when the underlying instrument falls 51% even for a moment on a bogus headline, the underlying double long is worthless.”

DDD also questioned why LCDL continued trading before Nasdaq imposed a news-pending halt at 2:35 p.m. eastern time. GraniteShares said it notified the exchange but had no authority to stop secondary-market trading. Nasdaq alone controls that decision, and Nasdaq’s records show the T1 halt.

“Granite didn’t do anything wrong here,” DDD said. “They didn’t do anything wrong in the case that this is in the prospectus.”

So, Lucid survived the rumor and its shares recovered, while the vehicle offering twice its daily return was permanently wiped out.

Leverage did precisely what it promised—that was the problem.