I have not looked at this idea in over two years when I was running numbers on some of the trades that could be done with the contango with the oil ETFs. I would guess the quants have this figured out to the hundredth or less of a penny but couldn't options be used with this concept to further the time decay as well as protect from having your short called away? I would guess there is some sweet spot with a month and in the money option pair that may get you there.
I was thinking something similar. Like perhaps selling one ITM call, and buying three 10 delta calls, rather than sell the etf outright. I just took a look at the SKF may 17/22 call 1/3. You can sell the 17 calls for 1.28 and buy the 22 calls for .16. This will leave you with 80 cents of premium with 74 or so cents in intrinsic value in the spread. Therefore, to collect the 80 cents of premium, the etf needs to go down. If, the etf pins to the 22 strike you'd lose $4.2, and start to break even by 23.4. As the market drops, and SKF goes up, the volatility would absolutely pop. Therefore, there should be a way to trade out of your position for far less of a loss than $4.2, due to being long volatility as SKF rises. Also, if the stars do align properly than this trade would absolutely kill it to the upside.
So essentially you're doing a Bear Call Spread, with the purchase of 2 OTM calls as a hedge I really like this play. Its a very cheap hedge with some nice sized potential rewards.
Yeah, but you know what...I was thinking about the OP's strategy. If he wants to get short deltas in both the triple long and triple short etf's, he could simply sell the call bear spread in both. I would choose one strike below and one strike above the ATM. That way it is more of a pure directional move, with a limited downside (and limited upside, of course). I tried to find specific strikes for an $11 FAZ paired with a $110 FAS. It's not easy balancing the risk. It would have to be the 10/12 cs in FAZ 10 times, with the 100/120 cs in FAS one time. This would be a bet I could support, as opposed to simply shorting the underlying etf's naked.
I did a simple test in Wealth-Lab, just shorting all 6 on 9/8/2006 and holding. Just commish at 0.01/share and $10K positions. Not sure how availability and margin/borrowing costs would affect results. Looks about the same as yours: Total Net Profit: $22,619 By Year: 2006: ($1,103) 2007: ($-611) 2008: $16,673 2009: $8458 2010: ($797) Highest DD: (12,899) 3/9/2009 Doubt it is something I'd do, but still is interesting... Good trading to all.
Your approach is well thought out. I was thinking a different angle though. I was thinking if one was to sell ITM calls on both the long and the short 3x ETF. Selling an ITM call is near a sytheic short and while not as good as a short in some respects (like limits on gains) it has some advantages over a pure shorting both the long and short 3X ETFs. 1. you wont get your short shares called away at the worst possible time 2. each day that goes by your gaining from not only the ETF decay but also the option decay 3. money can be made in a flat market These are just ideas that I have not tested at all.
This is an immense improvement from simply shorting both ETF's. However, I would still leave in fairly tight etf limit orders, to cover if the market starts to go through another Oct '08 type of drop. Regarding your #1, if the etf does start to take off AND carry rate goes negative AND clearing firms start calling in short positions, you would most likely be assigned on your ITM calls (now deeply ITM calls). The last thing you need is your clearing firm covering your short stock positions for you and handing you whatever opening print they can find. You can actually go to the CBOE website, and peruse the many arbitration cases where traders are calling foul play on the horrendous fills (sometimes $10 through any reasonable market price) given to the trader during forced liquidations.
This is exactly why I would suggest doing this via call spreads or even using 1 by 3's. The whole unlimited potential loss from one strategy doesn't work as a part of my overall business plan.
Like I said I have not tested this and I must say a lot of good points are being made. I could have quoted a could of posts that are very good but I picked this one because I think its the most important to think about the reply. ALL and I mean all except option buying has a potential loss of your entire funds unless your long and the risk is less than your total working capital. Anything else and I mean anything else you face unlimited loss. Even spreads don't "HAVE" to go as they should. selling an in the money call and buying a deep out of the money for potential of a black swan should take care of the issue. It will of course lower the return but provide a level of protection and the decay will be faster in real dollars for the in the money or perhaps a calendar spread would be a better idea. Of course a calender spread makes positioning harder but this may be overcome possibly with several entries. For example dividing up the capital allocation into four or five and with one per week and then rolling over each week which may (or may not) smooth out the variance of the calender.
When these things launched they were priced at $60 each. If you were to outright short the pair you would need to short them in even amounts 4:1 if prices are $80/$20 5:1 if $100/$20, etc. In theory you could just short the pairs in even amounts (4 shares at $20 for one share at $80) and walk away - but that's not going to give you a perfect even hedge either. As these things decay one will fall faster than the other forcing the need to rebalance. With stocks you would cover at a profit and then reshort or just short more of the lesser value to maintain your hedge. With options you would need to factor this in as well - also factor in expiration and the premium that will be built into future dated months (the market makers know about the decay too). Front months will have lower premium but you will get killed at ex while back months will be great because you have the time to decay - but there is quite a bit of premium built into the options to factor both the 3x etf decay + the options decay. Just my .02...