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fooletfs (74.05)

3x ETFs shorting both pairs or going long both pairs. CAPs community service message.

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November 07, 2009 – Comments (4) | RELATED TICKERS: FAZ , EDC , TNA

Hello Fools,

Please help out if you have information to add to this subject.  To skip my babble, you can simply read the two sentences that are in bold below & respond to that. 

I had initially thought one could profit over time by shorting both tickers in a pair of leveraged 3x ETFs. 

 

For example going short both TNA and TZA. 

In simple percentage terms, the sum of these two would be in your favor.

HOWEVER, shorting does not work in simple percentage terms. 

If one of these were to fall & fall & compound & compoundingly fall, your winning short position on this (& any) security has a CAP on the gain; your max return on this winning ticker of the pair will always be less than 100%. 

On the flip side, the losing ticker may always run the risk of loss of more than 100% (if the underlying moves with major trends). 

 

Even without major trends, more scenarios result in a loss if you either go short on both TNA & TZA or go long on both. 

I've brought up historical numbers on yahoo finance for TNA & TZA & computed through different time periods. 

 

I went steps further & went back to 2007 & using 2x leveraged pair, SDS/SSO, looked at computing returns (long or short pairs) through different periods (short term 1-3month, to 6mos-1yr, to ~2yrs) at different volatility levels (rising volatility, lowering volatility, coming back to around same volatility):

Results were the same, in most cases, you will lose whether you go long or short on both tickers in a pair of leveraged ETFs.

If you short both, you have to be lucky & hope the underlying gyrates up and down, up & down, without major trend directions in either way. 

No easy, surefire way to make money here. 

These are instruments for either very short term trading or calls on major direction trends.

 

Any thoughts or arguements?

4 Comments – Post Your Own

#1) On November 08, 2009 at 1:17 AM, walt373 (34.38) wrote:

It is true that the two positions will not perfectly hedge each other because one will become larger than the other. All you have to do is rebalance them so they stay within range of each other. You can rebalance more or less depending on how much you are trading. You want to find a balance - rebalance too often and your transaction costs will eat away your profit, rebalance too rarely and you take on too much risk.

I have been doing this strategy since May, and it is up about 7% including transaction costs. It's actually given me a nice tax loss for the year too and no capital gains, because I only covered some of the losing position when I reblanced. Here's my blog about the strategy that I wrote when I just started.

 

 

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#2) On November 08, 2009 at 8:34 PM, fooletfs (74.05) wrote:

walt373

THANK YOU!

The helpful blog here by walt373

You are right!  Rebalancing the two within a certain ratio range makes a WORLD of a difference!! Wow!!

Running the numbers again, using hypothetical scenarios, actual 3x #s from '09, and 2x funds from periods mentioned above:

Worst case scenario, this strategy loses in a year: (5%)

Best case scenarios in a year: 10%+

Should expect most returns in a year: 3-7%

 

So in fact, IT IS a good idea to short both, rebalance when ratio hits 1.7 either way, and pray for two things: 1) Hope your short shares don't get called back by broker & 2) if in rebalancing you wish to increase position, hope you can short more.

This strategy may be a good play to allocate comparable to the fixed income/bond allocation of portfolio or completely replace that bond allocation with this.  

I would say maximum amount you sell each position is 23% of face value of account.  IE a $10,000 acct, short sell a maximum $2,300 worth of each ETF.

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#3) On November 08, 2009 at 10:07 PM, fooletfs (74.05) wrote:

Great article on this very discussion:

TRIPLE LEVERED ARBITRAGE from stocksandoptionsguru.com

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#4) On November 13, 2009 at 6:50 PM, walt373 (34.38) wrote:

I've come to the same conclusions - it's not actually as risky as you'd think: anything worse than a 10% loss in a year would probably be unusual. If volatility picks up enough, it can be very profitable, like it was in late 2008 to early 2009, so it's actually got a nice negative correlation with the market. Also, 23% sounds like an alright allocation, though I would lean toward a more conservative one like 5-10%.

One really nice thing about this strategy that may be overlooked is that shorting stocks actually requires no outlay in cash, though you probably want to have a "buffer", otherwise if your position goes negative you'll be borrowing on margin to fund your short reserve. But I only havelike 1/3 of my short position as a buffer, so like if I am shorting $3000 worth of FAZ/FAS, I actually only keep $1000 in my account (not including the $3000 proceeds from shorting). Taking this into account, the returns are actually like... a lot better, heh. Also, like I said earlier, you can play around with your rebalancing to get a tax loss without incurring capital gains, which is pretty nice.

Cool article too, thanks!

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