15 Responses to “Finally, time to short the long bond (for a trade).”

1. hcrosby
   December 23rd, 2008 at 1:57 pm

   

   My plan is to add a little bit of TBT each and every month going forward…..I don’t see how it doesn’t ultimately work out in a BIG way.

2. Mike
   December 23rd, 2008 at 2:42 pm

   

   Well, buying and holding or accumulating can be problematic with short ETFs. The way the math of daily compounding works out, volatility eats away at your position if the market doesn’t move your way in a relatively straight line. It’s best to trade each move as if it is the last. Just look at SRS — the real estate index that it tracks (IYR is the long ETF) is down 50% in 12 months, but this 2X short ETF is flat, and it has performed exactly as advertised, delivering -2x each DAY’s percentage move.

   For accumulating in anticipation of a real crash, 2011 TLT puts may be best, though these are still somewhat expensive (meaning that not ALL bears have given up).

   For a good trader, futures are a very clean way to play, using stops and taking profits when shown.

3. Bjorn
   December 24th, 2008 at 12:08 am

   

   Hi Mike,

   I’ve been watching some of the ETF perfomances and have been shocked.

   SRS is at about 57 and its 52 week high has been at 295.

   You note that the index it tracks is down 50%; yet, SRS performance is flat (at best).

   Can you see SRS being able to recapture some of its loses off its 52 week high. Or, can the volatility simply kill it even though the index it tracks continues to drop in the New Year? In other words, can SRS theoretically recover?

   I also noticed that DXD (DOW ultrashort) lost points today even though the DOW dropped 100 points. That seems extreme. Is that volatility at work too?

   Thanks

4. Mike
   December 24th, 2008 at 2:23 am

   

   Hi Bjorn.

   Yesterday’s Proshares action was from capital gains distributions:

   http://biz.yahoo.com/bw/081222/20081222005859.html?.v=1

   Best not to think about these things as stocks, but more like trading tools. Their performance depends entirely on how the market moves, not where it moves.

   If the market goes down a steady percentage each day, short etfs will go up by the corresponding percentage, and the daily compounding works like magic, as in SRS’s run to 300 in the crash. If the movement gets choppy, as of late, these things are crushed.

   This, along with counterparty risk, is why I got out of my short ETFs early in the crash, around Oct 1, and have just used LEAPs puts since.

5. Bjorn
   December 24th, 2008 at 3:29 am

   

   Mike,

   May I seek to clarify this ETF volatility for myself a bit more?

   So, for example, if Apple stock drops, as it has, I could hold it indefinitely in the hopes it could again rise. If it did rise, it would not matter how choppy that rise was. However, with an inverse ETF like SRS, if the underlying Index declines, but does so in a very choppy manner, I could still take a loss, even if the Index happened to reach the hoped for level. In other words, with the inverse ETF, simply holding and waiting could get me killed, even if the underlying Index eventually did reach my target level. It is not merely a matter making less profit due to volatility, but one could actually take a huge loss.

   I’m probably restating the obvious, but am I getting this right?

   I’m not in these right now, but I was still thinking about them for down the road when things finally turn around. I had not taken the volatility to heart. It was the counter-party risk that had spooked me.

   Thanks so much

6. Mike
   December 24th, 2008 at 3:41 am

   

   You’ve got it. I went over the math in this old post:

   http://sovereignspeculator.com/2008/08/08/inverse-etfs-vs-leaps-puts/

   You can run any scenario through in your head if you remember that the inverse ETFs deliver an inverse of each DAY’s return in the index.

   To use them successfully, you need to time the market just right on a relatively short-term basis — you need to own them only when the market is moving your way on a steady streak. Since this is very tough, I greatly prefer options.

7. Mike
   December 24th, 2008 at 4:06 am

   

   From the August post:

   “Brutal math

   The main problem with short ETFs is that as the underlying indexes get lower, small dollar moves become large percentages, especially in 2X funds. This math works against you as the market exhibits volatility on its way down. A dollar of loss in an index wins you a smaller gain in your short fund than a dollar of gain in the index from that lower level gives you a loss in your fund. Here’s an illustration:

   Imagine if XLF (a financial index ETF) goes from 20 to 19 one day, and SKF (SKF’s 2X inverse) goes from 100 to 110.

   $1 out of $20 is 5%, so SKF goes up 10%

   $1 down = $10 up

   The next day XLF goes from 19 to 20, so SKF goes to $98.42 . $1 out of $19 is 5.26%, so SKF goes down $11.58.

   XLF is back where it started, but SKF is down 1.42%.

   As many have learned in the bounce from the July 15 lows, this math can be brutal with larger percentage swings, and these moves will only get wilder as the market goes lower.”

8. Bjorn
   December 24th, 2008 at 10:40 am

   

   Mike,

   Thanks for including the ETF math example again. It’s kind of unnerving to watch this volatility play out with these inverse ETF’s. Your initial warning about them was timely.

   Does volatility work against you when you are going long with an ETF in the same way it does with the inverse ETF’s?

   Also, when you are using a LEAPS put option, on say IYR, is the potential volatility of IYR a concern at all (other than delaying the move toward your strike price)? Or, are you now “out of your own way,” as you once put it?

9. Mike
   December 24th, 2008 at 12:09 pm

   

   “Does volatility work against you when you are going long with an ETF in the same way it does with the inverse ETF’s?”

   No. Long ETFs are just typically just baskets of stocks like index funds, though there may be some unusual ones that aim to track things like oil futures that behave in strange manners. IYR and XLF and SPY and GLD and such just own securities or metal and move with the prices of those assets.

   With options, volatility increases the premium, so when the VIX is high, it is harder to buy puts cheaply. Ideally, you want to buy when the VIX is low (like Spring 07) and sell when it is high (like Oct-Nov 08).

10. Graphite
    December 24th, 2008 at 1:40 pm

    

    Hey Mike, any new thoughts on holding cash inside the US? (Aside from “don’t do it” heheh)? Now that T-Bill yields are down to zilch, safes and safe deposit boxes seem like the least bad options.

11. Mike
    December 24th, 2008 at 1:50 pm

    

    Yes, hold some folding (or stacking!) money, but not in a SDB — the point is to avoid the risks of keeping all your money in banks.

12. MikeC
    December 24th, 2008 at 8:52 pm

    

    I really enjoy following this site. Back to the main subject: shorting long bonds. “Never bet against the Fed” is supposed to be one of the basic tenents of trading. Let’s assume you are right, however. It seems the Fed has the ability to keep rates down for months and months. So why the rush? Is it because 2011 TLT LEAPs give one plenty of horizon to work with, i.e., better buy now than miss out?

13. Mike
    December 25th, 2008 at 4:49 am

    

    This is just a short-term trade I’m making because I think the bond is overbought. I think it will come back after any correction.

    It is nowhere near ready to crash yet, because there are still too many guy like us ready to short it. We all need to give up first.

    Look at the charts in this old post that show how long yields stayed ridiculously low while inflation raged in the 1940s:

    http://sovereignspeculator.com/2008/08/08/that-crazy-crazy-bond-market-a-call-for-sub-3-long-bonds/

14. lyle
    December 29th, 2008 at 2:37 am

    

    Hello Mike…what’s the problem with a straight short? will TLT go up even if the rates are steady?

15. Mike
    December 29th, 2008 at 6:35 am

    

    No, TLT pretty much does what the long bond does, so there is no problem with a straight short. I just never short that way, since it requires a margin account, lots of cash, and very good timing. I’ve always preferred options, but to each his own.