How does the cost of borrowing and the implied volatility of DDOG and Astera Labs affect the ETF's tracking error?

Impact of borrowing costs and implied volatility on tracking error

The 2‑× leveraged single‑stock ETFs on Datadog (DDOG) and Astera Labs (ALAB) will be most sensitive to two “cost” components that drive the day‑to‑day tracking error: (1) the cost of borrowing the underlying shares to finance the levered exposure and (2) the implied volatility (IV) embedded in the option‑based replication strategy. Both factors are fed into the ETF’s “swing‑factor” (the daily leverage multiplier), and any deviation between the realised cost and the model‑assumed cost translates directly into tracking error.

• Borrowing cost – The ETF must obtain short‑term financing to hold a 200 % long position. For high‑beta, high‑demand AI names like DDOG and ALAB, securities‑lending rates can swing between 3 %–6 % annually, rising sharply during earnings windows or when short‑interest spikes. When the actual financing cost exceeds the ETF’s internal financing assumption (often set at a lower, “baseline” rate), the fund’s net asset value (NAV) will lag the underlying price, inflating tracking error. Conversely, if the market supply of shares increases (e.g., after a large block trade) and borrowing rates fall, the ETF may over‑track. Traders should monitor the daily securities‑lending quote (e.g., Bloomberg  “DDOG LEND”) and factor a 10‑15 bps “borrow‑premium” into any intraday profit‑and‑loss model for the leveraged ETF.

• Implied volatility – The levered ETF replicates its exposure via a dynamic mix of futures, swaps, and short‑dated options. Higher IV raises the cost of the option‑based “synthetic” exposure (higher premiums on out‑of‑the‑money call options used for leverage). In periods of elevated IV (often >30 % for DDOG and >45 % for ALAB during AI‑sector hype or earnings releases), the replication engine must spend more to maintain the 2‑X exposure, widening the “vol‑drag” component of tracking error. Conversely, when IV compresses, the ETF’s cost‑basis drops, but the fund’s rebalance schedule may still incur “rebalancing loss” if the IV swing is abrupt, creating a short‑term tracking gap.

Actionable insight: When IV spikes above the ETF’s volatility‑adjusted benchmark (e.g., DDOG IV >30 % or ALAB IV >45 % with a steep term‑structure), expect a negative tracking error (ETF under‑performance) due to higher borrowing and option‑premium costs. In such regimes, consider shorting the leveraged ETF or using a lower‑leverage (1X) version if available, or hedge the exposure with a direct long position in the stock plus a short‑term credit spread to capture the excess borrow premium. When the securities‑lending curve narrows (borrow cost <1 % annual) and IV contracts (post‑earnings calm), the tracking error narrows and the 2‑X ETF can be used for aggressive directional bets with a clearer expectation of near‑perfect tracking. Monitoring both the daily securities‑lending rate and real‑time IV surfaces is therefore essential to anticipate and manage the levered ETF’s tracking deviation.