Saturday, February 21, 2009
More On ETF Decay
First, visit - ETF Daily Compounding.
Lately, more than a few traders have reconsidered *ETF decay* and its effect on their trading strategies. If all of these daily-compounding, leveraged ETFs spiral downward with back-and-forth volatility, over time, then why not short them AND short the underlying?
Even better would be to short two decay-ers against each other! Consider two relatively new ETFs - Direxion's Financial Bull 3X Shares and Financial Bear 3X Shares. They've only been around since the end of November.
Since, theoretically, they should track oppositely, why not short them both?
So on one hand, you are *triple long* and on the other you are *triple short*.
If you're still perplexed, remember that -(-1), "negative, negative one", is also equal to just "1".
Say that a savvy trader shorted $100,000 of each at the beginning of our time period.
It's not too clear, but it looks like FAS started at 14.62 and FAZ started at 165. (I've truncated the first day of trading and started with the second day's close.)
So our spread began by shorting 6,840 shares of FAS and shorting 606 shares of FAZ.
FAZ closed at 72.50 yesterday and FAS closed at 4.90. Therefore, our P&L looks like this:
FAZ profit = $56,065
FAS profit = $66,484
Total profit = $122,549 !!!
And that's from shorting 200k worth of equity, a margin commitment of roughly only 100k....and in only 3 months time!
It seems that *decay* is greater for these ETFs when volatility and leverage are both high - the latter meaning that a *triple* ETF will erode more rapidly than a *double*. Forget *seems*, it's very simple to mathematically verify.
So where's the risk in this spread?
Maybe these ETFs are too hard to borrow - for the little guy trader at least.
I'm going to have to contemplate it some more.
And I'm definitely going to have to alter my strategies with SRS, SKF, TBT, and DXO.
Why should I trouble myself betting on *direction* when there's free decay, free theta, to collect in low risk arb spreads?