Final update on FAS FAZ short

It’s been quite a while since I last updated this blog. I’ve been busy programming BlackBerry applications for a personal project. I think the FAS and FAZ short strategy I explained a few months ago is due for a final update.

As expected, with lower volatility, the profit potential of this strategy decreased to almost nothing. for the past 6 months, the strategy performed a meagre 4.8% annualized. It’s time to put this one to sleep.

I intend to update this blog more often for the time to come. If you’re interested in specific subjects, let me know and I will look into writing an article about it.

Update: Shorting both FAS and FAZ

It’s been a month since I posted my article about shorting both FAS and FAZ. I received many interesting comments and e-mails. The strategy has been working nicely but not as good as it has in the past. The short availability has been a problem in the morning: most of the time, my broker will not let me short either one of them. Waiting until noon usually shows enough shares available to short. Overall, the last 30 days produced a 3.6% gain including commissions.

Direxion to offer monthly 3x leveraged ETFs

This is a follow up on my previous post about a trading strategy with FAS and FAZ, the Direxion Financial 300% ETFs. These two funds are tracking their index on a daily basis. This means a 10% drop today followed by a 10% rally tomorrow will NOT bring back the ETF to where it was. For example, if the fund started at $100, the 10% drop would bring it at $90. The next day, the 10% rally would bring it to $99, not $100 because 10% of $90 is only $9. In a volatile environment, this “eats” the fund’s value in a short time. But the value doesn’t really disappear… Direxion rebalances the funds everyday to make sure its value reflects the market, at 300% during the day.

To help longer term investors, Direxion will now offer similar funds with 2x and 3x leverage but tracking the index on a monthly basis. During the reference month, the value may drift away from the index value but should match the 200% or 300% return at the end of the month. In other words, this doesn’t replace the daily funds, it complements them. When more details are available about these new funds, I’ll see if I can find a strategy to trade the dailies with the monthlies.

Shorting both FAS and FAZ

I’ve been playing around with ETFs for a while and thought about a way to generate a considerable profit from them. Option traders are familiar with time decay but it also applies to leveraged ETFs. This ETF time decay is a result of the fund management fees, leverage financing interests and other expenses. Since November 2008, there are 2 interesting funds for this strategy: The Direxion Financial 3X ETFs. FAS is long the financial market and FAZ is short the financial market, both using 300% leverage. These ETFs are very popular and are traded in the tens of millions shares a day which make them good candidates for short selling.

While I was looking around for information on this strategy, some people rightfully said “they cannot go both to 0”. This may be true but that’s not the object of this strategy. Here, we want to re-hedge the positions daily to balance the dollar amount on FAS and FAZ. This way, we profit from the downward bias on both funds and we are hedged against the market since the net delta of this position is near 0 and readjusted to 0 every day.

The strategy is: everyday, at close time, balance the positions on FAS and FAZ to have the same short dollar amount resulting in a net delta of 0. A quick backtest starting with a short position of $5000 on each ETF shows:

Start amount	$ 10,000.00
Gross profit	$ 2,975.22
Fees ($0.005/share)	$ 376.31
Days	125
Annual return %	87%
Annual return	$ 8,687.64
Average win $	$ 107.06
Average loss $	$ (60.10)
Wins	48
Losses	36
Win %	57%

These are some interesting results! Excluding slippage, and margin requirements, this would yield a compounded annual 87% return. If your broker allows it, you can put the money for the margin requirement in a T-bill for a small return on that unused amount. This clearly shows that holding FAS or FAZ long for more than a few days is a very bad idea: it will eat through your cash.

Note: I haven’t tested this strategy. If you are aware of any reason why it would not work, please let me know. As of this writing, the short availability for FAS and FAZ is around 400,000 shares each with my broker.

Update: I fixed the annual return percentage and amount calculations. The 126% figure was wrong. It actually is 87%.

Update 2: As pointed out by AJG, watch out for dividends. As a reminder, when you are short, you have to pay the dividend. Usually the stock will drop by the same amount as the dividend so this isn’t a big problem.