A couple of weeks back I had shorted SPXU and UPRO at the same
time, trying to make use of the decay effect. (nothing big..
about $3K of each - just experimenting with the process).
After an initial maximum drawdown of under $100, the decay started
working in my favor. This morning, out of nowhere, TS had covered
my UPRO shares... Luckily I was watching and so I covered the
hedged shares of SPXU. I made about $50 in the process. So the
experiment did not cost me anything. But i guess, I too was the
victim of this unexpected short covering. One thing I must say
though, the decay effect works very much in your favor if you can
borrow the sahres to short without being called out, and if you can
withstand the possible initial drawdown...
After the market close today, I received an email from TS which
I reproduce below. Also when I had called them earlier today, they
simply said the shares were no longer available to boorw and so
they had to cover them at the market open.
The interesting thing is both these shares were on their
threshold list (hard to borrow stock), but they only covered one.
If I had not noticed this, I would have been in the market
unhedged, with a potential loss.
Anyway, here is the email I got from them:
------------------
Dear Valued
Client:
We were
required by SEC Rule 204T to cover your short position of 34 shares
of UPRO. Please remember that from time to time as the Rule
requires we will "buy-in" and close out your short sale
position(s), without further notifying you.
As a
reminder, any losses suffered or lost opportunities realized as a
result of any such buy-ins to close out your position to satisfy
the Rule will be solely your financial responsibility.
Should you
have any questions please contact the Trade Desk at (800)
871-3563.
Here is an example of a hypothetical index that starts at 1000
and goes up or down every day by 50 points. (1 day up, the next
down, the next up etc.)
And the decay effect shown if you short both 3X direct and
inverse in the amount of $10K each. As you can see, this is quite a
decay rate.
The problem is compunding is a two edged sort. If the market
trends for an extended period, it hurts considerably. As the second
table shows, if the same index goes up by 50 points a day for 20
days, then you are out of pocket by over 275% of your original
shorts, while the underlying index has only doubled.
3X ETF's work by moving 3X the move in the underlying index from
the previous day's close. When market trends for a few days in a
row, this is a compunding effect on the upside and inverse
compounding effect on the downside. If you enter the shorts at the
beginning of a trend, one of the ETF's will go up on a daily
compunded basis, while the other will go down in incrementally
smaller and smaller dollar value. This will cause an imbalance and
a drawdown. Once trend is reversed, and market is choppy, the decay
effect will erase any drawdown.
If you are lucky enough to time it so you enter the shorts at
the beginning of a non-trending market, then all you get is the
decay and will not have the inital drawdown.
BTW, in a strongly trending market, this drawdown can come into
play at any time, but its effect tends to be maximized in the
beginning because you have the most money in play.
Newsletter
Subscribe to our email list for regular free market updates
as well as a chance to get coupons!
Short covering
More on brokers calling in shorts
Posted by mamaduck on 17th of Jul 2009 at 04:21 pm
A couple of weeks back I had shorted SPXU and UPRO at the same time, trying to make use of the decay effect. (nothing big.. about $3K of each - just experimenting with the process). After an initial maximum drawdown of under $100, the decay started working in my favor. This morning, out of nowhere, TS had covered my UPRO shares... Luckily I was watching and so I covered the hedged shares of SPXU. I made about $50 in the process. So the experiment did not cost me anything. But i guess, I too was the victim of this unexpected short covering. One thing I must say though, the decay effect works very much in your favor if you can borrow the sahres to short without being called out, and if you can withstand the possible initial drawdown...
Short covering
Posted by mamaduck on 17th of Jul 2009 at 04:30 pm
After the market close today, I received an email from TS which I reproduce below. Also when I had called them earlier today, they simply said the shares were no longer available to boorw and so they had to cover them at the market open.
The interesting thing is both these shares were on their threshold list (hard to borrow stock), but they only covered one. If I had not noticed this, I would have been in the market unhedged, with a potential loss.
Anyway, here is the email I got from them:
------------------
Dear Valued Client:
We were required by SEC Rule 204T to cover your short position of 34 shares of UPRO. Please remember that from time to time as the Rule requires we will "buy-in" and close out your short sale position(s), without further notifying you.
As a reminder, any losses suffered or lost opportunities realized as a result of any such buy-ins to close out your position to satisfy the Rule will be solely your financial responsibility.
Should you have any questions please contact the Trade Desk at (800) 871-3563.
Initial drawdown
Posted by junkmaylbox on 17th of Jul 2009 at 04:47 pm
Could you please explain why or where it comes from?
Decay effect
Posted by mamaduck on 17th of Jul 2009 at 05:30 pm
Here is an example of a hypothetical index that starts at 1000 and goes up or down every day by 50 points. (1 day up, the next down, the next up etc.)
And the decay effect shown if you short both 3X direct and inverse in the amount of $10K each. As you can see, this is quite a decay rate.
The problem is compunding is a two edged sort. If the market trends for an extended period, it hurts considerably. As the second table shows, if the same index goes up by 50 points a day for 20 days, then you are out of pocket by over 275% of your original shorts, while the underlying index has only doubled.
Inital drawdown
Posted by mamaduck on 17th of Jul 2009 at 05:04 pm
3X ETF's work by moving 3X the move in the underlying index from the previous day's close. When market trends for a few days in a row, this is a compunding effect on the upside and inverse compounding effect on the downside. If you enter the shorts at the beginning of a trend, one of the ETF's will go up on a daily compunded basis, while the other will go down in incrementally smaller and smaller dollar value. This will cause an imbalance and a drawdown. Once trend is reversed, and market is choppy, the decay effect will erase any drawdown.
If you are lucky enough to time it so you enter the shorts at the beginning of a non-trending market, then all you get is the decay and will not have the inital drawdown.
BTW, in a strongly trending market, this drawdown can come into play at any time, but its effect tends to be maximized in the beginning because you have the most money in play.