So, let's say I'm short a 3x levereged ETF or ETN, and want to cover...

[Saltynuts]

I am short several 3x ETFs, the inverse ones, so I am effectively long. But I don't want to buy those, as that will trigger tax on my gains. So instead I want to short their inverse, the 3x long counterparts, and have as absolutely as small net gain/loss on the positions going forward - I want the ups on one to as closely as possibly exactly offset the downs on the other and vice versa.

So let's say I am short $100 of SPXS. So to offset it I short $100 of SPXL.

Now let's say the market has a huge down day, S&P 500 down 3.33%. My SPXL drops 10%, to $90, while SPXS rises 10%, to 110. There is a $10 gain which exactly offsets my $10 loss.

So, if I didn't do any buying or selling, if the next day the S&P 500 had another huge down day, down 3.33% again, my SPXL drops 10% to $81, my SPXS rises 10%, to $121. So, I'm up $19 on my SPXL, but down $21 on my SPXS.

The reason I think this happens is because each day these levereged ETFs or ETNs rebalance their futures to try and make them 3x (or whatever their leverage ratio is) of whatever they track the next day. So I think if you don't rebalance along with them you will have a whipsaw where after long what you started with as almost perfectly offsetting positions become less and less offsetting the further the underlying moves in one direction over time.

So, how to fix this? I think this does NOT mean that one has to sit there each day buying and/or selling the securities to keep them in perfectly equal total balances. I think what it means is that, to stay as flat as possible, at 3:59 eastern each day one should buy/sell the two so that the short balances are perfectly equal.

Does everyone agree? Or would one have to do some crazy stuff in the aftermarket?

Thanks!

 

[bh_prop]

Why would you tie up your $$ like that trying to emulate an all cash position? Just to avoid paying 2019 capital gains? At some point the taxes on those need to be paid and you have to consider opportunity cost vs tax

 

[DaveV]

Why would you tie up your $$ like that trying to emulate an all cash position? Just to avoid paying 2019 capital gains? At some point the taxes on those need to be paid and you have to consider opportunity cost vs tax

Perhaps the OP is waiting for a short term capital gain to become long term, which could significantly reduce the tax owed.

 

[Saltynuts]

Perhaps the OP is waiting for a short term capital gain to become long term, which could significantly reduce the tax owed.

Yes indeed. Guys, I am not asking for opinions as to my goal, only how to get there as a technical matter. Thanks.

 

[Sig]

So, how to fix this? I think this does NOT mean that one has to sit there each day buying and/or selling the securities to keep them in perfectly equal total balances. I think what it means is that, to stay as flat as possible, at 3:59 eastern each day one should buy/sell the two so that the short balances are perfectly equal.

First off congratulations, you've figured out something that seems to confound 90% of the posters on this site with respect to leveraged and inverse ETFs. Which is that their returns are a multiple of the daily percentage change of the index and hence they would not be expected to be able to return 3X or -3X or -1X or whatever they are over more than a 1 day period if bought and held.
To your question, you're right, you definitely don't want to buy and sell throughout the day because the ETFs do a good job of tracking that daily return percentage and if you buy and sell during the day you won't be tracking that. You do need to rebalance every day that there is a significant move or periodically as they drift apart due to the effect you did a good job of explaining. I've done a bunch of back testing and found that doing the rebalancing in the last 5 minutes of the market (which exposes me to risk from last second moves at the close) get's better results than rebalancing in extended trading hours (which exposes me to wider spreads) if I'm trying to exactly offset one with the other. I haven't been in your situation and done it with actual trades, it was just a thought experiment, so YMMV when doing it for real. You might also consider just buying or selling 3X the underlying to hedge instead of the opposite ETF depending what the ETF is and how much you own. That would give you more fidelity in matching size and some leveraged ETFs have somewhat significant fees that you'd be paying double on if you held both sides.
Finally, from a tax perspective what you're tying to do is called "selling short against the box" and won't accomplish what you want it to. You're certainly free to buy an opposite position, but at the point you do the IRS treats it as if you've sold the original position for the purposes of determining short or long-term gains. So bottom line you can't risklessly extend your short-term gains to make them long-term in the manner you're advocating, or any other manner, assuming you're working under U.S. tax law.

 

[Saltynuts]

Sig, you are the MAN! Thanks so much for that clear and coherent response!!!

 

[kmiklas]

I am short several 3x ETFs, the inverse ones, so I am effectively long. But I don't want to buy those, as that will trigger tax on my gains. So instead I want to short their inverse, the 3x long counterparts, and have as absolutely as small net gain/loss on the positions going forward - I want the ups on one to as closely as possibly exactly offset the downs on the other and vice versa.

So let's say I am short $100 of SPXS. So to offset it I short $100 of SPXL.

Now let's say the market has a huge down day, S&P 500 down 3.33%. My SPXL drops 10%, to $90, while SPXS rises 10%, to 110. There is a $10 gain which exactly offsets my $10 loss.

So, if I didn't do any buying or selling, if the next day the S&P 500 had another huge down day, down 3.33% again, my SPXL drops 10% to $81, my SPXS rises 10%, to $121. So, I'm up $19 on my SPXL, but down $21 on my SPXS.

The reason I think this happens is because each day these levereged ETFs or ETNs rebalance their futures to try and make them 3x (or whatever their leverage ratio is) of whatever they track the next day. So I think if you don't rebalance along with them you will have a whipsaw where after long what you started with as almost perfectly offsetting positions become less and less offsetting the further the underlying moves in one direction over time.

So, how to fix this? I think this does NOT mean that one has to sit there each day buying and/or selling the securities to keep them in perfectly equal total balances. I think what it means is that, to stay as flat as possible, at 3:59 eastern each day one should buy/sell the two so that the short balances are perfectly equal.

Does everyone agree? Or would one have to do some crazy stuff in the aftermarket?

Thanks!

Yeah this is some variant of a hedge. I hedge a lot to isolate risk; and deal with this constantly: one goes down, another goes up, and things get out of whack. It’s a pain; I just got margin called the other day because I was rebalancing and forgot about my SMA. Effing Reg-T.

(NOTE: Taxes on short positions are always paid at your income bracket. The 1-year capital gains timer begins when you cover/buy/close, NOT when you open the short position. Yeah it makes no sense; they want to discourage shorting)

That being said, I use these tactics:

1. Strive to keep the balance in a range from 5-10%. Pick the side that you believe in more, and go a little heavier there. If it gets out of range, rebalance. If you balance every day at 3:59 the fees will kill you, and you’ll also drive yourself crazy.

In your example, if you have a bias towards the S&P going down, then short SPXL with $103 and short SPXS with $97. A little heavier on the bearish side.

2. Another way is to calculate the total cost of rebalancing in blocks of 10. Example: if the SPXS is at 17 and SPXL is at 54, and you’re a little light on SPXL, you can to sell about 310 shares of S and 100 shares of L to stay in range at a total cost of $10,670.
- Note the bias towards the SPXL short @ $5,400 vs $5,270 short SPXS.

- Here we also add to our investment to rebalance the position, so we don’t touch our existing investment.

3. Yet another tactic is to diversify your sides, so there’s less volatility and things tend to stay in balance. Example: work Gold into the mix, and short DUST and NUGT. You get the idea; diversify the sides to gain more stability... but get ready for more math!!! You’ll have to balance weighted averages on each side, and you may have additional biases within your diversification!

4. Some fund managers simply rebalance every month, to keep things simple. A little dull... these must be managing teachers pensions :/

It’s a lot like baking: a little salt, a pinch of nutmeg, a cup of sugar, a 3/2 cup of flour, a handful of nuts... balance, and PROFIT!

A balanced hedge is a thing of beauty.

5. Beware of the 4+% annual fees on short positions. This can eat into your gains.

Hope this helps.

—Miklas

 

[quant1]

I am short several 3x ETFs, the inverse ones, so I am effectively long. But I don't want to buy those, as that will trigger tax on my gains. So instead I want to short their inverse, the 3x long counterparts, and have as absolutely as small net gain/loss on the positions going forward - I want the ups on one to as closely as possibly exactly offset the downs on the other and vice versa.

So let's say I am short $100 of SPXS. So to offset it I short $100 of SPXL.

Now let's say the market has a huge down day, S&P 500 down 3.33%. My SPXL drops 10%, to $90, while SPXS rises 10%, to 110. There is a $10 gain which exactly offsets my $10 loss.

So, if I didn't do any buying or selling, if the next day the S&P 500 had another huge down day, down 3.33% again, my SPXL drops 10% to $81, my SPXS rises 10%, to $121. So, I'm up $19 on my SPXL, but down $21 on my SPXS.

The reason I think this happens is because each day these levereged ETFs or ETNs rebalance their futures to try and make them 3x (or whatever their leverage ratio is) of whatever they track the next day. So I think if you don't rebalance along with them you will have a whipsaw where after long what you started with as almost perfectly offsetting positions become less and less offsetting the further the underlying moves in one direction over time.

So, how to fix this? I think this does NOT mean that one has to sit there each day buying and/or selling the securities to keep them in perfectly equal total balances. I think what it means is that, to stay as flat as possible, at 3:59 eastern each day one should buy/sell the two so that the short balances are perfectly equal.

Does everyone agree? Or would one have to do some crazy stuff in the aftermarket?

Thanks!

Yea you can rebalance them daily at the market close (or rather when they are rebalanced as per the prospectus).

As a side note, emulating a long position via selling an inverse levered ETF potentially has alpha due to "beta decay". Is this why you did this?

 

[Saltynuts]

Yea you can rebalance them daily at the market close (or rather when they are rebalanced as per the prospectus).

As a side note, emulating a long position via selling an inverse levered ETF potentially has alpha due to "beta decay". Is this why you did this?

Yes, among other reasons...