Abstract
Using new SEC data, we study how funds use derivatives and how derivatives contribute to performance. Despite small portfolio weights, derivatives significantly impact funds' leverage and contribute largely to returns. Contrary to prior research concluding derivatives are used for hedging, we find most derivative users buy index derivatives to amplify market exposure. Surprisingly, they underperform nonusers yet receive more flows. Using COVID-19 pandemic as a shock to evaluate explanations, we find they suffered a double whammy: failed to outperform nonusers by suffering losses from long derivative positions during the crash and from newly opened short positions when markets unexpectedly rebounded.
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