Trade Idea: Short bear call spreads on paired 3x leveraged & “inverse” 3x leveraged ETFs (ETN, ETP) to benefit from decay of underlying and options
Some preliminary thoughts of a trade idea before diving into more detailed research.
A. Core Rationales
1. Underlying: Beta slippage of leveraged ETFs
2. Underlying: Decay from futures roll yield
3. Negative correlation of ETFs (neutral underlying neutral exposure)
4. Options: Theta decay
5. Options: Implied Volatility premium
B. Risks
1. Sustained multi-day runs that amplify leverage of ETFs
2. Exercise of options for underlying
3. “Missing out” on strong directional trend on either side
C. Mitigation
1. Option spreads
2. Can convert exercised options to short underlying (potentially with long options for hedge)
3. Small position size: 3%-10% of portfolio
4. Rebalancing: after X% rise in underlying, exit and reset
D. Considerations
1. How anti-correlated are the underlyings?
2. Need small enough position for (almost) inevitable win, but not small enough WRT transaction costs
3. Wider options spread widths to limit number of spreads (lower transaction costs & bid-ask cross)
4. Short option strike closer to ATM to maximize short extrinsic value
E. Further Research
1. Liquidity(!): Create ranked list of most liquid underlyings and most liquid options chains
2. Average Beta slippage for each pair
3. Average Decay for each pair
4. Intraday and multiday spikes and runs: get worst, average, and median
5. Simulation/Backtest: Daily % & dollar moves of underlying
F. Initial Candidates
1. Gold: $NUGT / $DUST
2. Natural Gas: $UGAZ / $DGAZ
3. Energy: $ERX / $ERY
4. Small Cap: $TNA / $TZA
5. NASDAQ: $TQQQ / $SQQQ
6. SP500: $UPRO / $SPXU
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