Latest strategy I’m trying: monetising vol-drag

I wrote before about why I love UVXY and other leveraged ETFs.  In a nutshell, they’re completely designed for day-trading; if you hold one longer than a day, you’ll likely be disappointed with the performance.

Away from the pretty straightforward UVXY trade I mentioned, I’m now trying a similar strategy with IWM & TZA.  Thesis is similar:

  • TZA is -3x the daily % return of IWM.  So if IWM goes up 1% in a day, TZA falls 3%.
  • Unlike volatility, I find no reason to believe IWM should mean-revert.  So I need to hedge the underlying exposure of TZA with IWM.
  • Over time, TZA has similar issues as UVXY: volatility drag due to Jensen’s inequality, as well as negative roll yield (being short IWM futures, which have pretty stable backwardation).
  • I am hedging just to start the trade – over time, the hedge will be less effective; however, I use long put options, which means gamma should work in my favour.
  • Overall, this looks to replicate a long variance-swap position on IWM.  I should be getting credit (i.e. decay) for IWM moving around prior to option expiration.  If IWM doesn’t move around enough to cause the decay in TZA, I’m out the option extrinsic value for both sides (ouch).

I’m interested to see how this moves over time.  Hopefully not walking into a quagmire.  Anyone have experience with this trade?  Let me know your lessons!


One thought on “Latest strategy I’m trying: monetising vol-drag

  1. Update here. Given the extreme moves in IWM over the past few days, this trade moved in my favour quite a bit. I took off early, as I’d rather pocket the gains than continue to eat the theta decay. The illiquidity of long-dated TZA options was particularly annoying, as well.

    I’m keeping this as a paper trade!


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