3X ETF Short Hedge Algorithm

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.

Update Backtest

Impressive! Are there any indications on IB for the cost of borroow on these? Also, have you tried different rebalancing periods, out of interest? I'm thinking a lower rebalance period would potentially yield more stable results, but I'm not sure.


IB's borrow cost starts at 0.25%, their statistics say the average is 0.3% but can go up to 30% during a short squeeze. They don't have statistics for individual stocks but I don't worry too much about it, and I'm short more often than long.

The 3X ETF short strategy is somewhat sensitive to starting and rebalancing periods. If you happen to rebalance when the ETF pair is out of sync (and you are at a loss), when they eventually sync again you will lose even more. But if you hold the pair throughout the correction you'll get your money back and more.

I would be wary of tuning the rebalancing frequency as it's literally the only parameter of the strategy and you'll likely introduce a lot of overfitting bias into the backtest.


Update Backtest


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