A small mutual fund has returned 42% so far this year with an investment strategy involving exchange-traded funds that have been criticized in past years as a “minefield” for individual investors.

David Miller, senior portfolio manager of the $141 million Catalyst Macro Strategy Fund, isn’t saying that these particular ETFs—which make leveraged bets on various indexes going up or down—are a great investment for individuals. Indeed, many leveraged index ETFs and inverse leveraged ETFs “have done terribly over time," he says.

But Mr. Miller says he has found an opportunity to profit through trading options on these ETFs or related exchange-traded notes.

While the approach of the Catalyst fund is unusual, the fund is joined by many other “alternative” mutual funds and ETFs in using complex strategies and financial instruments. The aim is usually to deliver decent returns over time without moving in lock step with mainstream stocks and bonds. …

…Using options, Mr. Miller says Catalyst Macro Strategy has often bet on both a leveraged fund and the companion inverse leveraged fund to fall over time.

Catalyst has created its own models to value such options. Mr. Miller says they are often traded at surprisingly cheap prices in the marketplace, creating additional opportunities to profit.

The paired trades on options on leveraged ETFs are only part of what Catalyst Macro Strategy does. The fund can also take long or short positions in stocks, bonds and other financial instruments. “It has the ability to do just about anything,” says Todd Rosenbluth, director of ETF and mutual-fund research at S&P Capital IQ.

Mr. Rosenbluth says he is impressed that the fund has gained not only in the most recent selloff, when the performance of many such flexible funds improved, but throughout the year. “They were doing quite well when there wasn’t volatility,” he says. …

…David Kudla, founder and chief executive of advisory firm Mainstay Capital Management LLC in Grand Blanc, Mich., had held Catalyst Macro Strategy since early this year, and says he wasn’t troubled by this week’s volatility, citing the fund’s strong returns over the year. Mr. Kudla said he figured he needed to look beyond plain-vanilla investments in stocks and bonds to generate good returns this year. …


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