IEF, the 10 year bond, pays about a 2% yield. Does this mean TYO , the 3x inverse 10 year bond etf, will decay 6% a year just from the dividends? Also SPXU (3x inverse S&P 500) ...if the SPY pays a 2% dividend, will this decay 6% a year just from dividends? Shorting inverse etfs in this manner may be easier than reinvesting dividends if this is so
Those are good questions, I had to do a little research but I think there are 2 issues to consider. First, the borrow cost on TYO is currently 4.87% at IB, so that kills all but 1.1% of any decay. Second, TYO and any 3X or inverse ETF is a daily balancing fund which means it returns the inverse or 3X the inverse of the index's return each day, not over time. As a result of this, it's very possible for the underlying to go down and the 3X inverse ETF to also go down over a period of a year, for example.
I plan to use deep in the money options or sell collar to get around the borrow fee My research (to answer my question) is 'yes' - it does decay. In 2012, IEF (the 1x 7-10yr bond) was up 2% and had a 2% yield. The 2x and x3 inverse versons fell 10% and 15% in 2012, suggesting multiple sources of decay including yeild
Clearly it's your money and you're free to do as you want with it. However I'd suggest that you may be seeing what you want to see and ignoring the contrary evidence. First, options have the borrow cost baked in. If they didn't you could simply risk free arbitrage the difference with the underlying, why bother with doing anything else? I'd also suggest you look at the bid/ask spread on TYO...if you can even find any. The options are thinly traded at best. It also appears that you don't understand the path dependency of daily rebalancing leveraged or inverse ETFs. Instead of picking 2012, let's pick the last 12 months (seems the most logical place to start, right?) where TYO fell 17.7% while IEF only went up by 3.1%. There isn't "decay" going on here, there's the path dependency of daily rebalancing which depending on the volatility of the underlying will give you very unexpected results. If you plan to hold a leveraged or inverse ETF longer than a day and don't understand this concept fully then you're simply randomly gambling. A couple of free tips, take them for what they're worth. 1. If your strategy depends on the professional investor on the other side of your trades being a complete and utter imbecile (selling a deep ITM option without taking into account the impact of interest on the underlying) and the rest of the market completely failing to recognize and arbitrage away a relatively obvious risk free arbitrage opportunity (taking advantage of a leveraged fund "decay"), then you may want to think through the strategy a little more carefully. 2. If you have to go back to several years to make your numbers line up the way you want to, you may be data mining.