Shorting Leveraged ETF Pairs

Abstract

We study the strategy of shorting a pair of leveraged ETF and inverse leveraged ETF of the same index. The profitability of this strategy does not depend on the direction of the underlying benchmark. We derive an approximation formula to show that the expected return is high when the weighted sum of various orders of autocorrelations is negative and the volatility of underlying index is high. We then study the trading strategy in six markets and show that it can generate mean monthly returns of over 1% in four markets. The returns can be further enhanced if we exploit the persistence of the volatility and start the shorting pair strategy when the observed volatility is high.

Keywords: Leveraged ETFs, Dynamic Trading

JEL Classification: G1