Bear Spreads on Leveraged ETF Pairs?

A reader wondered: “After reading ‘Shorting Leveraged ETF Pairs’, I’m wondering whether there is any other way to play a leveraged ETF pair — perhaps writing bear spreads on both funds simultaneously.”

With the hypothesis that leveraged ETF rebalancing costs eat into fund assets and therefore grind the net value of a balanced matched pair downward, iterative bear spreads on both funds might be a way to exploit the grind in a way that is roughly self-financing and close to market neutral.

However, this logic assumes that the options market maker (or other options trade counterparty) is ignoring or underestimating the impact of the grind when pricing the options.

CXOadvisory.com does not have the data to test the hypothesis empirically. Even with an assumption of a very tame return distribution, there probably is not enough history on candidate funds and options for reliable inference. Any backtesting would be messy with respect to picking strike prices and handling bid-ask spreads.

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• Performance of Leveraged ETFs over Extended Holding Periods
• Multi-year Performance of Leveraged ETFs