Leverage is a Double-Edged Sword

Proprietary futures brokerage data allow us to analyze how the embedded leverage in derivatives affects portfolio returns and volatility across traders. Performance is persistent: Some skilled traders earn supernormal profits and some unskilled ones reliably underperform, in and out of sample. Implicit derivatives leverage enhances the performance of the former but has the reverse effect on the latter. Institutions are neither particularly skilled or unskilled, and do not benefit or suffer from leverage. Unskilled investors' levered positions amplify losses stemming from gambling proclivity, and margin calls account for the bulk of the underperformance. Skilled benefit from derivatives leverage via {\it de facto} market making and arbitraging the spot-futures basis; these traders on average earn a 19.3 bps daily return per leverage unit.