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The problem with shorting leveraged etfs

Tuesday, October 25, 2016 6:24
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As I’ve described in my previous post, inverse etfs decay relative to each other. After looking at their charts it is not difficult to imagine earning ‘easy mony’ by shorting a pair of leveraged etfs. Max Dama has done this and there are more people doing this according to Google, but I think this type of strategy is pretty risky.

Here is an example of ‘easy money’. I’ve simulated a random walk (upper chart in blue) that has 50/50% chance of going up or down every day. And it always moves exactly by 3% (log, so it should be flat over the long run ). From this reference I’ve created two leveraged trackers, with +2x and -2x leverage, I’ll call them ‘up’ and ‘down’.


Suppose we start a 100 day period with a pair  consisting of equal amounts of capital in ‘up’ and ‘down’, both equal to 100$. So the pair value on day 1 is $200. Pair value is plotted in the lower chart.  Without a trend in the reference, the pair value decays at a constant rate exp(0.5log(leverage*(1+daily_delta))+0.5log(leverage*(1-daily_delta))).  If we short both ‘up’ and ‘down’ the lower chart will flip upside down, producing pretty good looking pnl.
But before you short sell  every available leveraged etf out there, take a look at the next chart:


All the parameters here are the same, only the underlying has two brief periods of consecutive wins or losses. This results in two heavy spikes in the pair value. If we would have shorted both ‘up’ and ‘down’ the result would be a pretty heavy drawdown. No easy money here…


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