Just wanted to share a little fun strategy.

Premise: 3X leveraged ETFs always decay over time. For example, if you have an ETF that starts at 100%, goes up 25% to 125% and then goes back down 20% to 100% you are back at square one. But the 3X ETF will go up 75% and go down 60%, ending up at 70%.

So we know that shorting a 3X ETF will make money when it eventually decays, but if it spikes up suddenly we lose a lot of money. Hence we hedge by shorting both the 3X ETF and the inverse 3X ETF.

In this backtest we short 3 pairs of 3X ETFs ("JNUG", "JDST", "DUST", "NUGT","DGAZ","UGAZ”) in equal proportions and rebalance every 60 days.

Caveat: This strategy will lose money when the 3X ETFs go out of sync, which happens often in periods of high volatility (although this is a statistical arbitrage opportunity, which is a separate strategy in itself). IB’s margin maintenance for 3X ETFs is 90%, so a 10% drawdown is enough for a margin call. Hence don’t actually trade this strategy unless you add some protection for situations where the ETFs are going out of sync.

Returns are neutral of market direction. Lower during calm periods and higher when the ETFs move more, and hence decay more. CAGR 27% / Sharpe 0.942 in backtest period.

It’s not possible to model the carry cost of shorting in the backtest. But the stock should not be too hard to borrow, since people who want to short an ETF will just buy the inverse.