Leveraged ETFs, or trader crack, are the causative agents of panic attacks, late night vomiting, and brief moments of sheer ecstasy. Use of these products will often lead to marked declines in account value and frequent head-to-keyboard motions followed by obscenities. Leveraged ETFs undergo decay over time and volatility meaning that eventually the value of any leveraged ETF will, with high probability, approach zero. I won’t bother to write what others have explained well elsewhere but I will outline a trading strategy that utilizes this value decay to profit without risk.
First, take a look at a few charts of 3X ETFs, both the long and the inverse shown paired up for relative performance:
FINANCIAL 3X ETF PAIR
SMALL CAP 3X ETF PAIR
ENERGY 3X ETF PAIR
What you will note is that the gains in both the long ETF and its inverse ETF do not cancel each other out as they should if you were short and long the same stock. This is the effect of the decay.
By using a hedged position of being short (in equal $ amounts) both long and inverse ETFs (ie short the same dollar amount of FAS and FAZ), the position will profit from the net return (decay). You will see that over a volatile 3 month period average gains would be around 10-30%. Not a bad return on an annualized basis. The trouble will be finding shares to short. The big boys knew about this strategy a long time ago.