Jane Street bets big on leveraged ETF swaps

Jane Street Group has begun providing swaps to a swelling cohort of leveraged ETFs, amping up the competition in a niche but lucrative corner of the derivatives market.

The trading giant entered the business earlier this year and furnished about $1.2 billion notional of swaps in the second quarter to roughly 75 leveraged and inverse single-stock exchange-traded funds listed in the US, according to quarterly filings data compiled by Asym Research. Focusing on single-stock ETFs, the firm now accounts for approximately 2% for the segment. Clear Street leads the way with about 21%, while Marex Group Ltd holds around 11%.

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US leveraged ETF assets peaked above $200 billion in the second quarter, fueled in part by the growth of single-stock products. That expansion has created fresh demand for swap dealers — which typically enter bespoke derivatives contracts with ETF issuers to provide the funds’ desired leverage — and greater risk as they take on exposure tied to some of the market’s most volatile stocks.

While Jane Street’s market share is so far modest, the move emphasizes the allure of the business, with non-bank dealers that have dominated the single-stock ETFs increasingly competing with Wall Street banks. It also highlights the broader encroachment of market makers into areas traditionally served by big banks.

Citigroup Inc., Goldman Sachs Group Inc. and Barclays Plc are the most active swap counterparties for index products, each accounting for at least 13% of the segment measured by total notional amount of the swaps. By contrast, Goldman and Nomura Holdings Inc. are the only banks with at least a 10% share of single-stock business.

The dominance of non-bank firms in providing leverage to single-stock ETFs partly reflects regulatory constraints on banks. Banks typically have strict risk-weighted asset rules and other requirements in place that are more onerous for positions linked to a single stock than an index.

“Newer counterparties likely see the growth of the levered space as well as the potential lucrative revenue,” said Todd Sohn, chief ETF strategist at brokerage firm Baird Strategas. “Pair that off with what may be restrictions from banks’ risk departments, and that is creating an entirely new cohort of counterparties for upstart levered ETF issuers to gain their swap exposure.”

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Clear Street started working with ETF managers several years ago and has grown to handle swaps on one-fifth of the single-stock segment. The firm chalks up its success in the area to its willingness to do business with unsung ETF issuers, before they became big.

“In 2022 and 2023 we directed our attention at some of the relatively new entrants into the ETF space who were below the radar of the big banks,” said John DiBacco, co-president and global head of markets at Clear Street. “We chose to target this group of customers and they had phenomenal business growth.”

So far, Jane Street has worked with issuers Defiance, Leverage Shares and T-Rex on swap arrangements for ETFs tied to stocks including Strategy Inc., Rocket Lab Corp. and IonQ Inc., according to data compiled by Asym from filings from June through August, which mainly reflect the ETFs’ second-quarter positions.

Jane Street declined to comment.

Jane Street is already one of the largest ETF market makers, providing day-to-day liquidity to issuers and investors. Becoming a swap counterparty takes that relationship a step further. The business also requires more balance sheet and comes with additional regulatory oversight.

“Entering longer-term positions means the two sides have to deal with credit risk,” said Asym founder Rocky Fishman.

Jane Street, which is on track for record trading revenue this year despite losing $15 billion in July amid a downturn in AI stocks, received regulatory approval to expand its equity swap dealing capabilities earlier this year. In May, Jane Street Derivatives Dealer LLC was included in the SEC’s list of security-based swap dealers and major security-backed swap participants.

Brokers like Clear Street and Marex, which typically don’t hold significant exposure to market moves, are already well set up to manage the risk from the ETFs.

While specific arrangements differ case by case, dealers offer swaps that provide an ETF its desired return on a daily basis, and then hedge the risk from the swap by trading the underlying stocks, futures or options.

“We use a combination of conventional listed options, sometimes flex, and sometimes over-the-counter options to protect the downside as well as the upside,” Clear Street’s DiBacco said.

In exchange for the swaps, ETFs pay dealers a financing fee, typically a spread above benchmark rates, and other contract fees. The ETF posts cash, Treasuries or similar liquid assets as collateral, and the swap is marked-to-market each day.

Financing costs can be substantially higher for single-stock products than index ones, especially when the underlying shares are highly volatile or have limited trading float. It also varies depending on the issuer.

T-Rex’s 2x Long MSTR ETF, for example, pays a swap spread of roughly 1,000 to 1,500 basis points above the benchmark rate, compared with about 300 points for its 2x Nvidia fund, according to data tracked by Baird’s Sohn. By comparison, the premium on a Direxion Daily Technology Bull 3X ETF is 60 points.

Those economics reflect, in part, the risks dealers take on when providing the leverage. As leveraged ETFs have grown, some firms turned to so-called crash puts — sometimes referred to as cliquets or stability notes — to transfer some of the tail risks created by the swap arrangements.

“For large market makers already entrenched within the ETF ecosystem, providing swap liquidity is a natural evolution given the attractive financing levels issuers are paying for leverage,” said Jordan Rosenfeld, portfolio manager at Calamos Investments.