Darwin’s Inverse Leveraged Short ETF Strategy – Incredible Results Outlined

by Darwin on January 26, 2010

The time has arrived to finally unveil Darwin’s Inverse Leveraged Short ETF Strategy.  If you’re wondering what it is and why it matters, in a nutshell, it has completely changed the face of trading for me – and it can for you too, if you have the access to the 2X or 3X Leveraged Funds required, if you enable margin trading, if you have the capital requirements and if you can monitor and sustain risk of loss.  It’s a long name, and it can be complex to follow so please read along.

What is Darwin’s Inverse Leveraged Short ETF Strategy?

I will start at the most basic level and delve into increasing levels of complexity as we go.  At it’s most basic level, you short opposing leveraged ETFs at the same time with equal funds.  The desired outcome is a market-neutral strategy whereby you can reap significant returns over time regardless of what equities at large are doing.  What wealthy investors pay a hedge fund manager 2% plus 20% of profits is now at your fingertips – with risks, that you must understand and manage.  Take a look at the chart below for an example from 2009.  I’ve charted the performance of the 3X short ETF, 3X Long ETF and the underlying sector ETF all related to the Financial Sector.


Note how the Blue Line (XLF – 1X Financials ETF) is up marginally over the period.  Meanwhile, FAS, the 3X Leveraged Financial ETF is down close to 50% while FAZ, the 3X Short Financials ETF is down over 90%. If you shorted both FAS and FAZ for calendar year 2009, you made 50% on FAS and 90%+ on FAZ for a normalized gain of 70%.  You made this 70% during one of the most tumultuous, volatile and desperate trading years in our generation.  And get this – you’re not really putting up the funds to earn that 70% (sort of).  You can be long in whatever you want (cash, stocks, bonds, whatever) and use your short capability to dedicate a portion of your portfolio to daul inverse short ETF positions as I outline below.

Wait, if one Leveraged ETF is up, the Inverse ETF must be down, right?

Nope – More often than not, they’re both down over long periods of time (just months, we’re not talking years here).  That’s the tragedy (for long investors) and the beauty (for shorts).  Due to daily rebalancing, which slowly erodes the value of these ETFs, everyone’s screaming from the rooftops that they’re bad buy and hold investments.  In fact, there are numerous lawsuits against Direxion and Proshares for selling these “instruments of mass destruction” to retail investors – and even professional money managers – who can’t grasp the concept.  Basically, if you’re going to take a number and go up 2%, down 2% bouncing back and forth, as long it’s not a steady march in one direction for weeks on end, both sides will decline over time.  Try it out yourself in a spreadsheet – you’ll see – it’s that simple.  Since they are such bad investments over time, rather than diving in head first and buying them; short them!

Darwin’s Actual Returns: Inverse Leveraged Short ETF Strategy

3x-leveraged-short-portfolioSo as to remove any doubt, I’ve included the actual screenshot of my trading account as of this weekend where Ameritrade clearly outlines my total gains and losses since opening the position.  In each of the pairs (ERX) (ERY) Energy, (FAS) (FAZ) Financials and (GLL) (UGL) Gold, I’m up.  Note how the NET gain for each pair is positive – that’s the key.  I’m up regardless of what happened to the underlying sectors. In order to understand what these returns would look like on an annualized basis, I’ve performed some nifty excel functions since I’ve only been in each position for a few months.  I also made sure to include the impact of short dividend sales and distributions that occurred late last year (which makes my return look worse, not better).

3x-leveraged-short-portfolio-excelDouble Digit Returns – Nice!

You might be saying “So what?  The S&P500 is up 65% since the bottom in March. And you’re wasting time making 37%?”  That would come from someone that’s totally missing the point.  The market will not be up 65% again in the foreseeable future.  The market will undergo corrections and lackluster years.  This model is blissfully indifferent to the whims of the overall market returns.  This model can also make 37% when the market is downIt can make 37% when the market is flat.  By using sectors that aren’t correlated closely (oil, gold, financials), and offsetting the time of entry, I’m even introducing diversification into the returns of each pair.

Remember Madoff? People Lost Their Life Savings Chasing 12% in Any Market.

Well, this is as transparent as it gets and you can capture double digit gains annually in any market – as long as you manage and understand your risks as outlined below.  I will continue to share my specific short trades and results here (Subscribe).

Sounds Too Good to be True – What’s the Catch?

There’s an important factor I didn’t share yet – and I want to highlight it prominently.  This model breaks down when the underlying sector takes off.  There are margin issues to consider.  There are several risks and considerations – please read the next section before trying this.

Risks and Considerations

I already have a disclaimer on my blog, but I want to reiterate that fact that I am not certified to provide financial advice.  I am an individual trader and not your adviser.  If you want to embark on a risky strategy that entails margin requirements, the ability to cover margin calls, the ability to sustain losses in the event of unforeseen market moves, and other risks that may not have been outlined here, you should consult your own adviser before doing so.  I think you get the point.  Aside from that, I want to highlight where this model breaks down and how I personally manage risk in my leveraged short portfolio:

  • Not Enough Shares to Short with Broker: I ran into this with my TMF/TMV Short Pair as evidenced in the performance snapshot.  Basically, Ameritrade called up one day and said I had to close out my short position because there weren’t enough shares to short.  This was a few months into the position and in looking back to 7/1/09, if I still held those shares short, I’d be up an impressive 19% on average since they each lost 19% over that ~6 month period coincidentally (see Short Treasury Pairs Chart Below).  That was one of those circumstances where each side of the trade lost a substantial amount of money over a brief period.  Anyway, there’s really nothing you can do to prevent this from happening other than going with a larger online broker and going with the more prominent pairs.  What I’ve found is that multiple pairs I’ve tried to short with multiple online brokers have not been available to short.  So, I’ve had to settle with the 3 pairs I have going now.
  • Margin Call – Given the recent more stringent margin requirements for leveraged ETFs (which really did nothing to address the lack of understanding of these instruments and only made it more expensive to trade), it’s entirely plausible that when one of the pairs may have gained by say, 50% (meaning you’re 50% in the hole in a short position), even though it’s inverse ETF pair may have lost, say, 70% (meaning you have a 70% gain there, for a net 20% positive position), the customer service rep likely won’t even understand the math involved and quote procedure and say that you’ve either gotta pony up more capital or close out your short position.  While this would still net you a gain overall in this hypothetical scenario, you may be margin called in a sub-optimal situation or have no extra cash to input.
  • Margin Costs – Depending on what sort of other capital and holdings you have in your portfolio, be careful that you’re not paying exorbitant margin fees to maintain this strategy.  While I’m not getting hit with margin expenses because these positions aren’t occupying a majority of my portfolio, if you have this strategy eating up the max margin window, you may be paying 10%+ in margin fees to maintain a strategy that may not even make 10% for you ex-expenses.
  • Runaway Market – This is pretty much your largest risk.  While I outlined how you can make money on both sides of the inverse leveraged ETF pairs in many situations, when an underlying index appreciates (or depreciates) so rapidly on a routine daily basis without a significant break in the trend, you can literally have runaway returns.  Remember how you can say, make 40% on one side and lose 32% on the other side and still come out ahead?  Well, what happens when a leveraged ETF returns over 100% in a given period?  You can’t make more than 100% by shorting anything – it’s mathematically impossible.  What would actually happen is your gain would be maxed out at around 90% while the runaway leveraged ETF could be up say, 200% (net loss of 110%).  Recall, when you short something, your losses are infinite.  See below on how I manage a Runaway Market.  To demonstrate an extremely bad situation, see below (Bad Chart) for what happened from the absolute pivot bottom in March until September in 2009.  FAS was up over 500% !  This would have killed an investor who stayed in short without taking evasive action.

How to React to a Runaway Leveraged Short ETF Situation

What do you do if you undertook the strategy when an underlying index takes off, delivering triple digit gains on one side of the coin?  There are a few options at your disposal, none of them being optimal.

First, you could run for cover and just close your positions.  You’d take a loss, which happens in trading.  I’d advise against just closing your losing position and letting the other one run since it’s no different than just opening a 1-sided short position now, which is more akin to just picking a direction and shorting it as opposed to the market-neutral returns the Inverse Leveraged Short ETF Strategy is supposed to deliver.

The next strategy, which is what I’ve modeled out and started to do for one position when it ran involves offsetting risk of further loss and seeking a new market-neutral overlay position with stock options.  It’s rather complex, and up front, one can’t possibly line out how every scenario must be confronted on a generic level.  Much depends on which underlying index you’re dealing with, what volatility looks like, how far out of whack the inverse ETFs are, etc.  This will be the subject of Part 2 (subscribe for free for future posts) of this series on Darwin’s Inverse Leveraged Short ETF Strategy.  In short, you reset the equation with options (either puts or calls, writing or buying [depends on the situation]) such that if the dual short ETF strategy runs away on you, your are compensated by the overlaid options position(s).  The bottom line is you’ve gotta be prepared for another run up or down because this runaway scenario can and does occur.

How Does This Strategy Fit Into My Portfolio?

As I alluded to earlier, there are now pretty rigid margin restrictions and lack of available shares to short out there, so you can’t go willy-nilly shorting all kinds of pairs without collateral to back it up.  In my case, these short positions occupy a portion of a broader trading portfolio that includes long stock positions, options, credit spreads, and other strategies.  As such, a failure of any one or two inverse short ETF pairs wouldn’t be devastating, nor would it trigger margin costs that I couldn’t readily rectify.  I just want to make it clear that you can’t go open a trading account funded with $2,000 and go short $2,000 in ETF pairs.  If you’re considering this, consider how it fits into your broader portfolio, if at all.

Why Am I Telling the World About This Strategy?

I’m not the only smart guy out there who’s figured it out.  And I’m not that smart – the traders at Goldman and the quant funds are smart.  There are probably crazy blocks of trades going on exploiting this stuff on a daily basis with all kinds of derivatives, options and futures supplementing these strategies.  Think of this as the poor man’s hedge fund.  As such, it’s only a matter of time before it’s out there, so why not be the first to publicize and share what I’m doing?  I wanted to allow several months of tested data to show that I was putting my money where my mouth is, and it’s looking good at this point.  Might wider adoption result in fewer shares to short, impacting my ability to continue to do this into the future?  Maybe, but there will likely be an ample supply of uninformed retail investors continuing to flood into long positions in leveraged ETFs despite my best attempts to highlight Leveraged ETF Risks of value decay over time.


Short Treasury Pairs Chart

This is what a good chart looks like – when both sides of the Leveraged ETF Pair lose value over a short period of time.  Just let it ride!


Here’s What a BAD Chart would Look Like:

When this happens, you can’t sit idly by and watch your margin short position take off. Back at the 50% up mark on FAS, I would have taken evasive action as outlined above.


Check out the tickers in the lists below, plot them side by side in Yahoo!Finance or Google Finance charts and move the slider around.  You’ll find some cases where this worked out beautifully and some where you could be caught with a losing position.  The trick is to find the right pairs and manage the position closely by checking at least once per week.

This post will surely result in some discussion and questions.


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1 JohnnyH January 26, 2010 at 9:59 am

An cool strategy, one I have considered myself… but like you said, with efficient movement the strategy really break down fast.

I tested this strategy for random entries and gauged results for multi-month periods… The short pair was usually a winner, but when it wasn’t -look out!

I wish I had a formula/spreadsheet that could predict profits with this strategy, but I wasn’t able to easily do it.

Congrats on the year and thanks for the post!

2 Kevin January 26, 2010 at 10:11 am

I have done this exact strategy with FAZ and FAS. And yes the net result was a 10% return or so. I’ve tried to repeat the trade, but its tough to find the shares to short.

Thanks for the thorough explanation.

3 pkamp3 January 26, 2010 at 11:29 am


Interesting strategy. I looked at taking half of a similar trade – shorting the short version of an S&P 500 ETF. In hindsight, my returns would have looked pretty good, but that’s always 20/20 anyway!

I wonder how long returns like this will last on the matched pairs. I feel if enough investors get in on it, it will crowd out the easier profits, or perhaps lower profits to a similar risk/return profile as the normal asset classes they are backing. I’m interested in your unscientific opinion on this one… any thoughts?


4 JoeTaxpayer January 26, 2010 at 12:26 pm

I wrote about the leveraged ETF issues in a brilliantly titled “ETFed”
Had I given it more thought, I might have stumbled on to this strategy. Excellent work.

5 FattyR January 26, 2010 at 12:49 pm

Very interesting article – still trying to wrap my head around this.

Essentially, isn’t this a play on volatility? As I understand it, the under-performance of leveraged ETFs comes primarily from the daily movements that the ETFs try to mimic – the bigger the daily swings, the bigger the deviation from the target return. So as long as you’ve got a market that’s regularly up-and-down, this should be profitable. Accordingly, the amount of leverage in these funds should increase the success of the strategy (this will be more successful with 3x funds, than 2x funds).

As you mentioned the downside risk is in market runs (either up or down). If the underlying index moves the same way in successive days, the leveraged etfs should performed as designed and this strategy would falter. But that risk is mititgated by the fact that successive runs are the outlier, not the norm.

My guess is that the biggest hurdle to this is the implementation (again as you mentioned): finding the shares to short and the margin costs.

Very, very interesting, tho.

6 Marc January 26, 2010 at 1:20 pm

I have been shorting FAZ/FAS since late August and I’ve achieved about a 12% return on my investment to this point. My strategy was to ensure that both shares were available in equal dollar amounts before I pulled the trigger. It took me about a week to acquire all the shares I wanted, and its been smooth sailing since.
The one thing I would say is that there are times when there will be big drops followed by big gains in the value of your investment, so it not necessarily for the conservative investor who can’t stomach extreme volatility.

7 JohnnyH January 26, 2010 at 1:44 pm

LOL, this is fun -but the key still eludes me… I’m going to figure it out… It’s not really so much about volatility as it is efficiency of movement.

For example, if you initiated this strategy w/ $100k on 3/6/09 your investment would currently be worth a margin call of -$71,887, making for a -171.89% ROI!

Despite that March was incredibly volatile… This is far from risk free, I would understand the math and risks before you jump in.

8 Darwin January 26, 2010 at 9:49 pm

Hi Johnny, you’re right about starting in March. That was about pivot bottom for the worst decline and then rebound in our generation. That’s the chart I included in the “Bad Chart” example at the end. If you just left the positions open you’d get slaughtered. That’s where the active management comes in. Here’s how you would have made a fortune…Let’s say once FAS was up 50% and running more daily, you said to yourself, “I better take some action here and protect my position from further losses”. You guy and buy puts on FAZ. If FAS continues to run, your FAZ puts come into the money. If FAS falls, the puts will expire worthless, but the double short strategy comes way back into the money because of the early volatility the other way.

While it’s not perfect and you can’t predict what to do in advance, there are ways to offset, and even benefit from a runaway market – but yes, as I stated emphatically throughout, you’ve gotta realize the risks involved and manage the positions closely.

9 cole January 28, 2010 at 8:30 pm

I bought 200 shares of FAZ at 18.60. Hoping to sell off in April for $700 a shares. Sound like a good plan?

10 Jacob January 30, 2010 at 12:16 pm

Very interesting. Love the caveats! Clearly reasoned articles like this, with serious discussion of the risks, are a great service – we appreciate it out here.

11 Monevator January 30, 2010 at 3:04 pm

Hmm, I’m not quite clever enough to follow 100% what you’re doing after the two glasses of red I’ve drunk tonight, but I have a feeling this falls into the ‘picket up pennies in front of a steamroller’ category of investing – I have a hunch you’ll be hit by some outlier and wiped out. But as I say, I haven’t fully digested yet (these ETFs are available here in the UK).

12 Monevator January 30, 2010 at 3:06 pm

(Sorry, I mean “picking” up pennies)

13 Monevator January 30, 2010 at 3:15 pm

(Sorry, again, I mean ” those etfs AREN’T available here in the UK”. The motto? Don’t comment after drinking!)

14 Monevator January 30, 2010 at 5:48 pm

Excuse all these comments (feel free to edit first comment and delete the corrections). I’ve been mulling this over, so came back to read it and realised I’d missed out that whole section on a runaway market! Anyway, that was what I was getting at (your short not covering your long).

Good luck with it.

15 finance February 4, 2010 at 2:19 am

cool strategy you have there, and easy to apply. thanks for the great post

16 Johan February 8, 2010 at 4:37 am

When do you rebalance the short positions? If you don’t and there is a run on one side, you will not have a market-neutral position any more.

I think rebalancing will mitigate run-away risk also.

17 Johan February 8, 2010 at 6:21 am

Well, I did some testing with rebalancing and it kills the performance of the strategy (even without taking trading costs into account). If you short two leveraged ETF pairs, you express a belief that the market will be flat and volatile. Effectively, you will be swing trading since every run up in one direction will leave you with a position where you profit heavily from a move in the different direction. There are easier ways to do swing trading IMO.

18 Louis Paul February 11, 2010 at 11:30 am

Can the Inverse Leveraged Short ETF Strategy be done with option puts on opposing leveraged ETFs rather than shorting them ? Assuming the answer is yes, what would the advantages & disadvantages be compared to short selling the ETFs ?

Darwin Reply:

@Louis Paul, Actually yes, it can. Here are some problems though. The volatility of these instruments is priced in, so the puts are VERY expensive. Looking back historically at put premiums vs. the 40-8-% decline you see on some of these over a given time period, in some cases, you made a profit, in some cases you didn’t. So, there’s no easy win there. I’d say, perhaps a good time to try it would be ~now when volatility is low (if you expect it to increase), but it would be prohibitive to employ when volatility is high. Remember, you’ve gotta double your money on at least one of the puts to offset a potential total loss on the other, assuming only one comes into the money. If both came into the money, then great.

Finally, for many of these pairs, the one side ran while the other tanked, so you’d have one ETF at $100 per share and the other at like $5. Given the bid/ask spread and small dollar movement on $5 even with say, a 30% decline, you lose a lot of money on the spread and commissions depending on structure. In an ideal situation, they’d both be priced at like $40 or more the day you start a position.

So, short answer is, it works sometimes. But with the double short, you don’t lose any of your own money due to time decay like you do with options.

Finally, (again), you could actually buy a put on the correct side if you have a runaway situation to hedge further declines. I’ll write more on that in the future with a real-life example.

Louis Paul Reply:

@Darwin, THX – I am trading in retirement accounts which do not allow shorting of stocks/ETFs. But I can go long on option calls & puts.

19 Brendan February 12, 2010 at 5:21 pm

Great explanation. I also have been experimenting with an almost identical strategy with several ETFs since last fall. So far so good, but the thought of a runaway market still makes me worry sometimes. I’ve been thinking about buying some far-out-of-the money calls to protect myself.

One thing I’ve noticed that I would add is that for most leveraged ETF pairs, the bear one will tend to under-perform even more-so than the bull one. This is partly because the tracked indices tend to have positive nominal returns over the long term, but even if an index stays flat, it would still be true.

For example, say an index went up about 10% then dropped back to the original level (loss of 9.0909…%).

A double leveraged bull etf would return -1.82% (1.2 x 0.8181… = 0.981818…)
A double leveraged bear etf would return -5.45% (0.8 x 1.1818… = 0.945454…)
A triple leveraged bull etf would return -5.45% (1.3 x 0.72727… = 0.945454…)
A triple leveraged bear etf would return -10.91% (0.7 x 1.2727… = 0.890909…)

For this reason and because I’m a little more scared of a runaway bull market that a runaway bear market, I have in some cases initiated short positions only on the bear etfs, or made my bull positions smaller. This definitely makes things scarier day by day though since I don’t have as many losses and gains offsetting each other.

testing2 Reply:

@Brendan, if you did the opposite; i.e. market went down first, then up, you’d get the inverse. So, in effect, they’re mirror images and neither the bull nor bear presents an advantage over the other. They both stink to hold long term. And both are beautiful shorts.

Brendan Reply:

@testing2, It doesn’t matter which happens first because multiplication is commutative (1.1 x 0.909 = 0.909 x 1.1). If a stock moves around over the course of 2 days and ends up where it started, the move up will always be a greater percentage than the move down.

The only reason it might matter which happens first is that you could be forced to liquidate if you lose too much before you win.

20 Chris February 12, 2010 at 8:10 pm

Sweet to find this. Amazing actually. I mean I knew there were people out there evaluating these paired variations but this is great, great stuff.

I began testing a long variant of (more or less) this strategy with a covered call element for a couple months with FAS/FAZ . The initial idea was to go long on both a long & inverse set (dollar equal on each side – well, as close as you can get anyway) then sell calls on each side that are 10% or so out of the money.

With the built in decay of these vehicles I’d obviously prefer a put based strategy. Trouble is I have Louis Paul’s problem – this is an IRA I trade in. So I can only sell covered calls. Meaning I have to own 100 sh. lots of the underlying.

The goal was also to implement this in a way that minimizes market exposure time while still netting high enough premiums from the call sales to make a profit.

My arbitrary exposure time was 10-15 trading days prior to the option expiration date – Time decay seems to significantly accelerate after this.

The ratioanale for selling the calls at a certain % out of the money – 10% was kind of an arbitrary number – I’ve just started playing with this – was to be able to buy out the option (buy to close) on the losing side at maybe 20% (or significantly less depending on time decay) of what I sold it for with the hope that the 10% gain on the winning side would offset the 10% loss on the losing side and I get to keep the premiums. (minus the 20% or so buyback on the losing side’s call)

Long story short: it can work – which is to say it did turn roughly a 5% profit per trade (set) for the VERY small data set I have so far (2 expiration dates). Any serious volatility can kill it if you don’t buy to close the call and dump the underlying shares of the losing side fast.

I’d go into the math and what I’m starting to realize about when to sell the options to maximize premiums (options pricing on leveraged vehicles can be pretty inefficient and you can take advantage of this I think) and some other variables but my girlfriend is staring at me to go out to the pub. haha.

VERY interested on anyones thoughts on the approach I just described (or rather typed semi-coherently to appease said girlfriend).

Awesome Blog.

Darwin Reply:

@Chris, Glad you like. Hope your girl understands how excited guys get over annualized double-digit returns. If only they understood (LOL). I know ladies, you’re traders too – but take a look at the proportion of male commentors here…

Chris Reply:

@Darwin, Haha. Yeah she’s never understand my fascination with the market. There ARE some badass female traders out there though.

21 tim1198 February 19, 2010 at 7:05 am

Hi Chris:
Good Article; and good job explaining the risks with the runaway market. I wonder if you’ve considered a similar trade with USO. My personal experience with USO was buying USO when a barrel of oil was $40, and suffered a loss even when oil recovered to over $55 a barrel. It was frustrating to lose money when my thesis was correct. USO suffers the same deterioration fate since they roll over every month (Contango degrades, backwardation enhances). I just seem to find a good proxy for the price of oil to balance out the USO short. Your thoughts?

Darwin Reply:

@tim1198, The USO issue’s a bit different. That’s a tracking error (percieved, not real) due to rolling futures contracts when oil is in contango (which it is frequently). This is different than losing value over time. Also, there’s no inverse to short with it. Good thinking though in pointing out that futures-driven ETFs have been losing track of their underlying commodities.

22 Chris February 19, 2010 at 12:25 pm

This is actually Darwin’s article and his explanation.

I just added some thoughts on my little variant of market-neutral ETF strategies. I also don’t understand your question. Sorry – what is your strategy with USO?

tim1198 Reply:

Hi: My question with USO was: Is there a strategy opportunity, given that the ETF doesn’t track its underlying commodity. I was looking for a strategy, or an oil proxy so that I can buy the proxy and short USO. But as Darwin pointed out above, there’s no inverse to short with.

I hope this clarifies my question better.

Chris Reply:

@tim1198, Gotcha. I still don’t understand contango – although I haven’t really tried to – which is probably why I didn’t get what you were asking. Sorry. Commodities ETF’s seem to be different animals to me as far as how they move (they seem to trend harder, faster and longer). And I haven’t considered them for these types of strategies. Although with the right strategy those traits could present an opportunity.

Silver is particularly interesting to me. I would love it if someone could explain to me how the silver market is rigged so I could front-run the big boys. I know their are silver traders out there who have a good idea how and when it’s being manipulated. Anyone here? Anyone? Bueller?

tim1198 Reply:

Hi Chris:
I learned about USO Contango about the same way I learned how to play Poker; by putting money in and losing it 🙁

There’s a short article that does a good job explaining this condition. I hope this helps.

Chris Reply:

@Chris, Tim – thanks for the link. I did execute a buy-write on a silver 3X without doing my homework. Let’s just say I paid a similiar “trader’s tuition” for a lesson on how fast and hard those markets can move if you’re only on one side. I felt like that quote from “Rounders” : “If you look around the table and can’t spot the sucker, You are the sucker”.

23 Maxi February 21, 2010 at 10:29 am

I just read your article and sounds quite a good strategy, all your bias about what could happen with the market is absent.
However I don’t understand why it’s impossible to make more than 100% by shorting any particular instrument. Let’s say a short FAZ at 10 and then a year latter it goes down to 0.1, wouldn’t I have done %100+ on that one?

thanks for sharing your thoughts

Darwin Reply:

@Maxi, An investment can never go past 0 (into negative territory when long), so the most you could make on say, $10, would be $10 – for a 100% gain.

24 Chris February 24, 2010 at 2:46 pm

Hi Darwin,

Hey what graphing tools are you using in the above examples. I’m looking for a way to visualize this better rather than just a series of cells in Excel.

And when are you putting up part II ? C’mon man this is good stuff!! I’m curious to see what else you’ve researched.


Darwin Reply:

@Chris, Chris, glad you enjoy. For charting, I simply used Google Finance and copied/pasted screenshots.

For an update, did one tonight! Check out post from 2/25 – new shorts revealed and a YTD hypothetical portfolio shows more double digit returns if starting in 2010.

Chris Reply:

@Darwin, Sweeet.

25 Andrew March 11, 2010 at 8:04 pm

I have been looking at this strategy and think there is a lot of promise to it. However, what worries me most is the change in the ratio of nominal prices between the opposing ETFs. Part of the beauty of the opposing ETFs is that they are a hedge for one another. However, you have to have equal positions of each to be truly hedged. If the market moves significantly (even if not a “run away” as you put it), you could end up with double exposure to one side or the other and the value of your position would be much more closely tied to that particular ETF. It seems like you would have to keep an eye on the trade and rebalance when necessary. Have you thought about rebalancing either periodically or when the ratio of the nominal values of the ETFs changes beyond a certain degree?

Darwin Reply:

@Andrew, It’s a tough balance. On one hand, if you keep rebalancing every time the pairs get a little out of whack you end up negating the benefit of each side dropping each time the underlying see-saws. Conversely, if you have like 90% loss on one side and 40% gain on the other, if that 40% side keeps moving in the wrong direction, the 90% loss side contributes an ever decreasing amount back to hedge so you lose money (as the “runaway market” scenario evolves).

That’s where you’ve gotta get creative and each situation’s different so I can’t outline EXACTLY what to do, but some thoughts (that I’ve used) – you can just buy the underlying index itself if it ran away long. Why? The underlying index is a straight 1X. It doesn’t lose value over time. If the index stays flat, both pairs continue to gain for you. If the index falls, you lose value on your 1X but make it back on that runaway side coming back to earth. If the index continues to run, you make money on the 1X while losing on the pair. It’s not a great solution because you may be “treading water” for weeks or months and you’ve gotta calculate what the right amount is to buy. However, it keeps you in check. Eventually the trend will break. They always do. That’s when you make huge gains back. The same concept can be applied with options but now you’re adding even more complexity due to volatility and time premiums. But I’ve used them too. I’ll continue to post what I’m doing with my particular positions in real time – stay tuned!

26 JLC March 31, 2010 at 11:03 am

If this hedge position held long term, seems there would be tax advantages. If the short half of the position that had lost money was covered before the end of the tax year, and the winning position held, then there would be a cap gains loss that could be used against other gains in that year.

To avoid one side exposure on the other held (winning) short position, one could buy the same position long to hold for the 30 day tax sale wash period, then sell the long after 30 days, and replace the covered short position in the side that had lost a month ago.

That way the cap loss would be realized, and the cap gain continued.
Does this sound right?

27 BKL May 17, 2010 at 12:46 pm

A quick question on rebalancing. How often do you reset your positions to balance one another. Say one position is up 20% and the other is down 5%. Would you rebalance? Thanks for the strategy btw? It is very interesting. BKL

28 clive collins July 4, 2010 at 6:55 pm

Hi All, How about this? Buy furthest out and deepest ITM put and call on two opposing 3X funds. (This would cost minimum time value loss. Replace when new further outs become available.) Using long calls for stock substitute and long puts to nullify any fund price movement, sell calls three months out and three dollars OTM. (ala covered calls) When one short call falls, say fifty cents, buy back and sell again at three dollars above current fund price and three months out. Gains result from rolling down calls and time decay on both short calls. Possible loss from sustained move in either direction. If advancing fund gets ITM, then, if short call is exercised, long call on that fund would be exercised by broker, stock bought at current price and delivered to short call buyer at his strike price, resulting in a loss. This would have to be managed. Purpose of long calls and puts being three months out and three dollars OTM is provide time and space for volatility to work favorably and also to minimize likelihood of advancing fund getting ITM and being exercised. Clive

clive collins Reply:

Where I said “Possible loss from sustained move in either direction” should have said “from a sustained move up by either fund”. Moves down are fine. Clive

29 Ajdedo July 6, 2010 at 6:27 am

I’m so glad I found this site. I’ve been thinking about this concept for a year, but never heard anyone else talk about it before. Thanks!

I understand the basic concept, but I’m a bit uncertain about the math regarding balancing the ETFs. Especially when I could not buy them on the same day.

For example:

Let’s say I shorted 100 shares of SRS @ $29. It is now @30 and I’m down -$100.
Finally some URE is available to short, and it is trading at $34. How may shares of URE do I need to short to balance the 2 pairs of ETFs?

Would it be 88?


Jan Reply:


That would be:
sell 100 of the lower priced stock and low price divided by high price times 100 of the higher priced stock

In your case:
100 SRS and
30/34*100= 88 of URE indeed…

30 Michael Maurice July 15, 2010 at 5:29 pm

Are you still tracking this strategy? I haven’t seen an update in a while.

31 Harry July 20, 2010 at 12:23 am

Looks like this will win most of the time, also I would suggest that we use calls to protect against massive in one direction. Example if FAS is at 20.11 when you begin to short buy a cheap call at say $ 28 or 27. This way even if the ETF goes 35% in one direction the max loss is capped off. Ideally I would suggest that short the ETF pair and buy a way out of the money call and a put. This way you are completly protected against any massive moves in the market like Mar 09 or Sep 08.
Also I think we may have to reset the position every month not sure if that is a good idea. By reset I mean get rid of the ETF pair, take profit/ loss and start over again with options. rvharry79 at yahoo.com

I am not a expert please evaluate your own risk before shorting because shorting can lead to infinite loss.

Ajdedo Reply:

Could you not do the same with just placing an order to cover the short position if it goes up?

For example: I bought 200 shares of SRS at $28, now it’s at $22. I have a cover order for $27. Is that not safe? Should I try a put/call instead?

Harry Reply:


I dont think I understand your question, please let me know the details if you are still interested.
mail id rvharry79@ yahoo dot com

32 Agus August 23, 2010 at 3:32 am

Hm.. it’s a very interesting topic. I had done research myself and then finally found out this topic.

I think this strategy will still work, but the key is to have the exact number of lot when shorting both positions. This will overcome the runaway market condition like on the Bad Chart mentioned by Darwin.

For example, based on the historical data from Yahoo Finance. The close price
On Mar 6, 2009. FAZ = 104.7 FAS=2.64. Total Combined Price: 107.34
On Sept 1, 2009. FAZ= 26.39 FAS=68.1. Total Combined Price: 94.49

During this time, the runaway scenario is definitely happens. But because we put the same number of lots when shorting, we’ll still end up with profit.

Let’s say we’re shorting 100 lots for each FAS and FAZ.
The profit/loss for from Mar 6, 2009 – Sept 1, 2009 will be:
FAZ = 100 * (104.7 – 26.39) = 8131 (Profit)
FAS = 100 * (2.64 – 68.1) = – 6546 (loss)
Total = 8131 – 6546 = 1585 (Profit)

In this scenario, we’re making a percentage profit of (107.34-94.49)/107.34 = 11.97% within 6 months period during a runaway market.

That’s why I think this strategy will work regardless on a runaway or swing market condition.

What do you think guys?

33 Ajdedo September 1, 2010 at 10:43 pm

What happens if a stock reverse splits?

For example:

I shorted 200 SRS @ 28 = $5600. I know from history that when the price gets too low it will reverse split. What will happen to my shares and money when SRS reaches $5 and then 1:10 splits to $50?


34 Vinvestor September 8, 2010 at 6:15 am

Guys, this is simply the effect of compounding 3x daily returns. You can simulate the returns of these ETFs by going long(/short) 3x your capital of the end of the last day every new trading day.

I.e.: I have 100, I go long 300 with my 100 3x leveraged. Market does -1%, then my position goes 297, so my capital at the end of day is 97. Next day I go long 291 (=97 x 3) because I only have 97 capital.
This way you have 3x the daily returns. When you look at these ETF’s returns, it’s quite close to that strategy (same for the short ones but other way around).
Now the effect is that if there are big movements that are reversed in the underlying, this will indeed make the ETFs lose money. If there is a clear trend without big mean-reverting moves, you’ll not be seeing that effect.

What you guys are doing is basically speculating on mean reversion of some market. This is quite dangerous when you consider the secular bull/bear moves that markets can make for long times. Never forget Keynes: market will stay irrational longer than you stay solvent.

Ajdedo Reply:


Um, I don’t think that’s the same thing. I think the difference is that we’re playing with the built in decay of every ETF.

For example. If the stocks the ETF is tracking goes up 5%, then the ETF itself will only go up 4.9%, and if the stocks the ETF is tracking goes down 5%, then the ETF itself will go down 5.1%.

Meaning the ETF will always perform slightly worse then the stock it is based on. And by shorting the ETF over time, you can capitalize on this decay.

Vinvestor Reply:

@Ajdedo, No, it’s because you compound 3x daily returns, look:

Underlying does : 3%, 5%, -2%, -3%. Total over 4 days : 2.8%

ETF does : 9%, 15%, -6%, -9%. Total over 4 days : 7.2%, while you’d expect it to do 3*2.8% = 8.4%.

This is the “decay” you guys talk about, but it’s just a mathematical property of compounding. Now look at what happens in a “secular bull” market:

Underlying does : 3%, 5%, 2%, 3%, so : 13.6%
ETF does : 9%,15%, 6%, 9%, so : 44.8%.

This is MORE that 3*13.6% = 40.8%!!! Over long periods of time this effect is huge of course, so beware, if you start this strat at some wrong point, you’ll be killed by margin calls on your short of the trending fund that gains huge amounts in that sort of environment.

This strategy is of course not to be dismissed, but you must understand that you’re actually speculating on mean reversion. This can be rational of course, because if you know some volatile market that cannot trend off too far from some fundamental value, you can do this, but make sure you can survive some move until the correction comes that will make you’re positions profitable. Anyway there is more risk in this strategy than you think.

35 Ajdedo September 11, 2010 at 2:04 am

Okay, so what would you do?

I shorted SRS @ 26.94 and it is now at 21.91. That’s a 22.5% gain. I have a $5 VTSO just in case the price spikes.

Would you ->
1) Stay the course with SRS only… keeping the VTSO
2) Short some URE to balance it off… dropping the VTSO
3) Do something else….

Thanks. 🙂

36 Vinvestor September 11, 2010 at 6:23 am

Yeah well depends what you want to do… I don’t know anything about the US real estate market/companies that SRS tracks… Basically you’re long real estate 3x more or less now, while being short this “decay” if there’s a mean reverting market, but also short this amplifying effect if there’s a major down move in real estate stocks. Now this no problem because you got this stop order that will stop you out whenever real estate drops.

To me this strategy seems ok if you’re bullish/neutral on real estate and not expecting rapid down moves in real estate so that you can profit from mean reversion over the long time without being stopped out. The problem I think is that you will tend to be stopped out, and that’s very expensive, because if theres a correction after the move, you would have made a lot of money on the reversion, but you got stopped out…

37 Global 34 September 28, 2010 at 4:24 am

Thanks for the interesting article and trading concept. I’m a fan of the 3x ETFs, but there must be a more efficient way to play the degradation in share price. It almost seems you could just use a covered call and accomplish the same.
I am currently working on a speculative trading strategy that only trades 3x Leveraged ETFs for smaller account appreciation. If anyone is interested you can check it out at my website.

Global 34

38 Jim September 29, 2010 at 3:13 am

Good article, but investors really need to consider the costs involved. The SEC mandates that when triple-leveraged ETFs are sold short, an investor has to keep 90% of the cost to cover the short position in cash in a margin account. If the investor already has enough cash in his account to meet this 90% value, then this isn’t going to be much of an issue. However, if the investor does not have sufficient cash, the investor’s brokerage will borrow the shortfall on the margin, and those margin rates could be 8 or 9% or higher, depending on the amount borrowed and the particular brokerage.

Instead of shorting both the bull and the bear leveraged ETFs, why not simply short the bear leveraged ETF? I have done this myself and found that this strategy works best with leveraged ETFs that track indexes having a high beta relative to the overall market. For example, a triple leveraged bear ETF that tracks a volatile index such as an emerging markets index or even a small cap index.

One important observation I have made is that for practically every major equity index, there are more days on which the index rises than there are days on which the index falls. I also noticed that magnitude of the drop on negative days tends to be larger than the magnitude of the rise on positive days. So even in a bear market where the overall index is dropping over time, there may be more up days than down days. The inverse, of course, is necessarily true for triple leveraged bear ETFs.

This observation is relevant because triple leveraged ETFs appear to decay much more quickly when there are more negative days than positive days. I cannot really explain why this is the case, but even if a market that is relatively flat for a long period of time, the bear triple leveraged ETFs seem to decay more quickly than the bull triple leveraged ETFs because there are more down than up days for the bear triple leveraged ETFs even if the underlying index finishes at the same level as where it started.

One caveat of only shorting the triple leveraged bear ETFs is that during short periods of time, the ETF can quickly move against you, although over sufficiently long periods of time, the ETF will revert to its long-term downward trend. Investors also need to make sure than they won’t be forced to buy to cover a short position at an inopportune time – so investors should consider the total number of shares outstanding and the current number of shares sold short prior to implementing a shorting strategy themselves.

39 Ludo September 29, 2010 at 10:34 am

I follow the basic tenet of this post, but nothing is quite as certain as it appears, in life. As noted previously, the key issue is one of reversion from the mean and of compounding of either positive or negative returns, to produce most of the times yields that are lower than the corresponding index yield.
One point about the FAZ vs. XLF plot during the period March 2009 onwards. First, the index corresponding to FAZ is the Russell 1000 Financial Services (RGS) Index ($RIFIN.X). Comparing FAZ to XLF is not strictly correct.
The sharp decay during the April and May month corresponds to a sharp drop in volatility – as rightly said – determined by a change in accounting rules (i.e., mark to market vs. mark to fantasy) – a historical, one of a kind event.
Conversely, to a rise in volatility should correspond a higher risk that the underlying index would decrease, with higher expected prices for FAZ. It all depends on the magnitude and intensity of the change in volatility and of the corresponding market drop.
I firmly believe that, should a rise in volatility reoccur, with herding behavior on the selling side of the index, instruments like the FAZ would have a sudden, certainly temporary but however extremely significant upward jolt in price.

The compounding works in two ways – it erodes returns when volatility drops, but it enhances returns when volatility increases – making the current market price relative to volatility attractive.

Nobody can rightfully predict the upward movement should such an event occur, since it is more an issue of mass psychology and herding than anything else. I would however expect that FAZ would move in an exponential fashion (caused by the herding phenomenon) to upwards of several hundreds USD – albeit for the relatively short amount of time of the fear outbreak.

40 Jim September 30, 2010 at 3:34 am

Ludo, I would short a bear leveraged ETF tracking a broad index, not some niche sector. I read somewhere that a lot of people couldn’t short FAZ because there were insufficient shares available for shorting. FAZ had an incredibly large volume of shares trading hands every day – the number of shares traded on a daily basis was much larger than the total number of shares outstanding (because day traders were trading the same shares over and over in a day).

Look at how other triple leveraged bear ETFs have decayed, such as EDZ, TZA, and BGZ. I suspect that over the next ten years, as we have a longer track record for daily movements of theses leveraged ETFs, we will see that some of the leveraged bear ETFs may gain 200% or more during bad bear markets, but they quickly lose those gains and revert to their downward trend over time.

41 Phil December 8, 2010 at 7:36 pm

Has anyone been shorting these long term and holding? I am looking for the most stable, most reliable broker, once that will not subject me to buy-in’s. I have been with IB and they have forced me to buy in numerous times.

42 Andrew December 8, 2010 at 8:14 pm

Yes. I’ve held a short position of SRS with Questrade for about 5 months now. I periodically add to (short) my position several times within that time. I have never been asked to cover. Probably because the position has always been in the black.

43 Harry December 8, 2010 at 10:03 pm

Hi, The same problem with buy in with IB.
I had sold a in the money call and one day I saw that I was shorting the stock.

44 Adam December 22, 2010 at 2:41 pm

Is there a list of leveraged ETF’s that are ‘shortable’? I have tried many times and every time I hear ‘not enough shares available to lend’.

45 Andrew December 22, 2010 at 2:56 pm

I get ‘not enough shares available to lend’ with SRS 19 out of 20 times. I just keep trying day after day after day. Eventually about 1 day a month the order with go through. On that day I just pile up as much as I can afford regardless of the price.

46 Johnny905 February 22, 2011 at 1:20 pm

I have been thinking about this strategy for a couple of years now, but everytime i try to test it out i can’t get the shares to borrow. I definitely think you need to rebalance ocassionally based on pre-set rules. I ran some regressions and have the rules all set, I just can’t seem to get the shares to short…

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48 Rick June 25, 2011 at 3:15 pm


Any updates?

49 Ian Stack December 21, 2011 at 11:45 pm

thank you for this article. i have been thinking about the double short on these, though never followed through (had the time to make money day trading them). you did a remarkable job putting together an article with charts for an idea many people have been thinking for some time. this is a almost two years since you published your work, and in that time it has become increasingly easier to short these etf’s (due to far larger volume) thanks again. easy way to pay my mortgage, every month, gaurenteed. anyone who doesn’t understand it, or is too scared because of volitile markets need to wake up. if you got 20k like me. you will on average make 7-8k with little work. thanks again buddy! way to spot something few see.

Truman Waldrup Reply:

@Ian Stack, what time frame do you use to day trade etf and do you have a favorite etf and technical indicator you like? Thanks Truman

Ian Stack Reply:

Re: A few months in to the double etf strategy, and I have picked up on a few etf pairs that seem safer than others. Right now the market has been on a complete roar and I can see how a runaway market could be a huge risk with etf’s that strongly correlate with the broader market. I would stick with multiple pairs of commodity 3x etf’s. To answer your question, I havent day traded many etf’s this year. When i do, my time frame is a few days at most. technical indications seem to have eroded lately due to the large volume of computer trading as well as low fed interest rates. if you use this strategy, go with gold or energy etf’s. I like Dust-Nugt, Erx-Ery. Good luck

50 John July 27, 2012 at 3:07 am

Can’ t you just buy a put option instead so your losses are limited to the premium paid for it or am I missing something?

51 Mark Uzick January 4, 2015 at 7:33 am

I don’t see why a runaway market should be a risk if you continually rebalanced the long and short ETFs.

Another way to mitigate risk without the trouble of rebalancing would be to go short a 3x ETF and go long 3 times that amount of a similar, but un-levered, ETF.

Am I failing to understand something?

Brendan Reply:

@Mark Uzick, continuously rebalancing would mitigate the runaway market risk but also counteract the decay that is the source of returns for this stategy.

Buying 3x an unleveraged etf would not work forever as a hedge because once things start to run away from you, your position in the unlevered ETF will no longer be the right size compared to the leveraged ETF. And if you kept rebalancing to make it so, you would destroy your source of returns just like in the earlier case.

Mark Uzick Reply:

I understand that you’d eventually have to rebalance a 3 times 1x long to a 3x short, but only if they move in a bearish direction for an extended amount or when there’s enough decay in the 3x (I.e., profits.) to put them out of balance.
What I don’t understand about your reply is why you believe that your individual actions in your own account would have any effect on the continuous decay of leveraged etfs – their overall, combined value would continue to shrink, but without the risk of the runaway effect. Think about it: you must eventually take your profit and establish a new position – that’s no different from rebalancing, except that you are taking more frequent, smaller profits and don’t allow your losing side to get big enough to overpower your winning side. It also has the benefit of allowing the continuous reinvestment of profits, so that your position scales up, allowing your gains to increase instead of diminishing.

Brendan Reply:

@Mark Uzick, I think an example would best illustrate what I mean. I’ll using pretty extreme swings with a single rebalancing to illustrate the point, but it also remains true with more realistic scenarios of smaller swings and longer time frames…

Say you short 100 shares of both FAZ and FAS when they are both $100. You collect a total of $20,000 cash and are short $20,000 ETF value.

Say the 1x financial index XLF drops 10% per day for 3 straight days (30% moves for the ETFs), then rises 11% per day for 3 straight days (33% moves for the ETFs):

Day 1: XLF $90, FAS $70, FAZ $130
Portfolio value: 100 x $70 +100 x $130 = $20,000
Day 2: XLF $81, FAS $49, FAZ $169
Portfolio value: 100 x $49 + 100 x $169 = $21,800
Day 3: XLF, $72.9, FAS $34.3, FAZ $219.7
Portfolio value: 100 x $34.3 + 100 x $219.7 = $25,400

If you don’t rebalance, your portfolio will benefit from the decay that occurs when financial stocks recover:

Day 4: XLF $80.92, FAS $45.62, FAZ $147.20
Portfolio: 100 x $45.62 +100 x $147.20 = $19,282
Day 5: XLF $89.82, FAS $60.67, FAZ $98.62
Portfolio: 100 X $60.67 + 100 x $98.62 = $15,929
Day 6: XLF $99.70, FAS $80.70, FAZ $66.08
Portfolio: 100 x $80.70 + 100 x $66.08 = $14,678

In 6 days, the portfolio gained 26.61% ($5322) by capturing the decay. However, if you had rebalanced the $25400 equally after day 3, your results would look like this:

End of Day 3: Switch to 370.24 shares FAS ($12699.23), and 57.81 shares FAZ ($12700.86):
Day 4: XLF $80.92, FAS $45.62, FAZ $147.20
Portfolio: 370.24 x $45.62 +57.81 x $147.20 = $25,399.98
Day 5: XLF $89.82, FAS $60.67, FAZ $98.62
Portfolio: 370.24 X $60.67 + 57.81 x $98.62 = $28,163.68
Day 6: XLF $99.70, FAS $80.70, FAZ $66.08
Portfolio: 370.24 x $80.70 + 57.81 x $66.08 = $33,698.45

In this case, rebalancing after day 3 causes the worst possible result. If you run the same scenario rebalancing every single day, you end up just sitting at $20,000 the whole time (minus transaction costs). There’s no scheme that gets you a risk-free gain.

52 Mark Uzick January 5, 2015 at 7:21 pm

You are only showing the runaway effect – NOT DECAY. Your examples are using a perfect conversion of 10% to 30%, but with decay it will actually be greater than 30% to the downside and less than 30% to the upside.
What you’ve shown is that the runaway effect cause losses in a one way market, but ends up with gains in the case of a retracment – you don’t need a pair of levered etfs for this effect; a pair of 1x etfs will do the same thing, but slower.
Playing the runaway effect is a gamble; rebalancing eliminates this risk, and would seem – though hard to believe – to make profit a certainty.

Brendan Reply:

>You are only showing the runaway effect – NOT DECAY. Your examples are
> using a perfect conversion of 10% to 30%, but with decay it will actually be
> greater than 30% to the downside and less than 30% to the upside.

I’m not sure where exactly you think the decay comes from. The daily 2x or 3x behavior of these fund may not translate perfectly, but it is close enough to not be a major source of decay (perhaps 1 or 2% per year at most). The daily reset / rebalancing done behind the scenes in these funds IS THE SOURCE of what people called “leveraged decay.” If you do your own rebalancing, you work against the cause of that decay. Try any example yourself and you will see. You can put the up and down days in any order.

53 Mark Uzick January 6, 2015 at 5:59 pm

What you are calling “decay” is actually just the effect on a portfolio that is simultaneously holding both bullish and bearish etfs of the same underlying equities. As you have skillfully illustrated, the path of the underlying is what determines profit or loss – this is just an effect of math, not the decay caused by leverage; proof of this is shown by the fact that the path dependent effect you have illustrated will happen in non-levered etfs. Any levered product will undergo time decay – you can think of a levered etf as something not so different from an option; and the time decay of an option is far greater than the 1 or 2% that you cite – it’s of an order of magnitude comparable to the decay of levered etfs; and that makes perfect sense – there is simply no way to evade time decay in a levered product. That the etf must rebalance to maintain it leverage ratio or whether you rebalance your portfolio to neutralize the effect of price path will do nothing at all to affect the time decay that’s inherent to all leveraged products.

Brendan Reply:

OK, I guess we are just referring to different types of “decay”. I am using it the way many articles on 2x and 3x ETFs do when illustrating the ways losses occur.

I agree I appear to be low on the 1%-2% estimate – I just checked the last 3 months of daily FAS/FAZ moves and the daily leveraged decay of the pair (as you use the term) seems to be more like 6% annualized. How much of this is due to the time decay of options/futures, and how much is due to the transaction costs of rebalancing, I couldn’t say.

One thing to watch for though is that if you use a margin account to short the ETFs and rebalance frequently, you may incur your own set of margin and transaction costs that eat into that (6%?) return pretty heavily. Maybe to the point where just holding a bond or CD would be just as good depending on interest rates.

Mark Uzick Reply:

@Brendan, Can the annual decay of a 3x levered etf really be so low? That would mean that it would be easy money to simply sell yearly puts of a strike that gives 3x leverage against the underlying, hedged by the reverse levered 3x etf. The puts, while they may not consist of 100% time value, would have an overall time decay of far greater than 6%, as their time value portion would have a decay of 100% annually.

Also: in your “pairs strategy portfolio” your examples would tend to support the notion of time decay as something far greater than 6%.

Mark Uzick Reply:

@Mark Uzick, BTW: to say this in a way that might be more clear: the 1 – 2% of decay caused by rebalancing is a management and transaction expense that’s ubiquitous to all portfolios – it has nothing to do with leverage. While the rebalancing that you do in your account will negate the advantage of shorting to capture the rebalancing expenses of an etf, it’s the inherent time decay of all levered products (Probably between 20% and 60% anually.) that’s the real issue here.

54 RetailTrader February 8, 2015 at 10:05 am

Hi Darwin and all

I have been trading this strategy using FAS and FAZ since 2010/11 with some variations, including letting the ratio between the leveraged ETF pairs run somewhat and hence introducing an element of directional trading, in addition to profiting from the leveraged decay which was the original point of this strategy. I have been documenting my progress since late last year at my site so you are all welcome to check it out.

Roland Reply:

@RetailTrader, It would be very interesting for me to have a Look to your Resultat. Unfotunately there is no functioning link behind your Name “realtrader”.

55 VT July 13, 2015 at 2:42 pm

What about just using standard PUT options rather than shorting?

I’m trying this now with an equal value of PUT options on both FAS and FAZ that are 6 months out and about 15% in the money. This brought the delta of each option to around .50. The volatility is a bit different at around 50 on FAS and 60 on FAZ.

Decay on the options should be minimal since they’re 6 months out (January ’16).

Does anyone have any thoughts on this strategy?



56 Jacob Sznajdman October 8, 2016 at 7:44 am

Apart from fees and differences in when rebalancing, shorting a short etf should be equivalent to being long on a long etf.
Thus does this strategy exploit “collecting” fees instead of paying them as you are shorting?

An interesting thing to note is that long term negative effects of leveraged etfs is a myth. See this brilliant paper: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1664823

The point of the paper is that although volatility drag is a short term downside, having a high leverage is still worth it due to long term rising market trend, which is precisely what is the risk in your strategy. So over the long term the “black swans” will according to this paper outweigh the short term benefits of shorting the volatility drag.

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