November marks a year since Direxion introduced its Daily Financial Bull 3X Shares (FAS), Daily Financial Bear 3X Shares (FAZ), and a handful of other 3x and -3x friends. We don't mention these pups much anymore, partly because their defects are pretty well-publicized these days. And pretty well-litigated now, too, as everyone is now "shocked, SHOCKED" that they underperform over time.

Another reason they don't come up much is because this current market backdrop is the only one where a leveraged pup may hold its ground. High volatility, we know, will chop them up, but so will a relatively low volatility churn. But a low volatility move in one direction? They're not disasters to hold.

At least that's what we think. CXO Advisory ran some actual numbers last month.
 

To check, we examine the inception-to-date performance of paired short positions for Ultra S&P500 ProShares (SSO) / UltraShort S&P500 ProShares (SDS) and Ultra QQQ ProShares (QLD) / UltraShort QQQ ProShares (QID). Using daily adjusted closes for these 2X and -2X ETFs for the period July 13, 2006 (the first date prices for all four are available) through September 11, 2009, we find that...

First, we focus on the SSO-SDS pair. Over the entire sample period, while the S&P 500 Index declines by 16%, SSO (2X) and SDS (-2X) both underperform their leverage targets over the long term by falling 46% and 23%. The long-run performance of SDS seems especially out of kilter.

...The cumulative return is mostly negative during the first half of the sample period and mostly positive during the second half, with a large surge since March 2009. The terminal value of an initial $20,000 investment on July 13, 2006 ($10,000 in each of SSO and SDS) is $27,362. Again, this evolution assumes zero net cost for shorting.

The evolution for equal initial short positions in QLD and QID is generally similar, but it reaches lower values and is more volatile during the first half of the sample period. It is then less volatile during the second half of the sample period. The terminal value of an initial $20,000 investment on July 13, 2006 ($10,000 in each of QLD and QID) is $27,366.

Kind of what we expected. But of course, CXO goes further, and looks for some timing clues for the short pair.
 

The final chart shows the average net daily return for the shorted SSO-SDS pair by quintile of same-day VIX over the entire sample period. Results suggest that the shorted pair tends to produce positive returns when volatility is high. The standard deviation of daily returns is extremely high for the top quintile.

Results for the shorted QLD-QID pair are similar, but the average daily net return for quintile two is markedly more negative and the standard deviation of daily net returns is much less pronounced for the highest quintile.

We tested relationships between daily changes in VIX and VXN and net daily returns for the associated shorted ETF pairs, but got inconsistent results.

And in conclusion:
 

Overall impressions are:

1. The sample period is not long enough for reliable inferences that might guide a strategy of shorting leveraged ETF pairs; and

2. The interval from late 2008 through early 2009 is very disruptive to inferences about such a strategy.

In summary, shorting pairs of 2X and -2X leveraged ETFs may pay off over long periods as rebalancing effects grind on fund values, but data for guiding inference is skimpy and somewhat "wild."

My takeaway? Kind of as expected. There's so much path dependency involved that it will likely never lead to firm conclusions. I'd say just keep the guiding principal that these pups are here for trading, and not holding for long periods.

Now, before you try shorting both at home, I always like to warn that it's a tougher trade in practice than in a lab. The CXO study here doesn't rebalance, which is fine. But if you hold that position in real life, you'll get very exposed to short-term one-directional moves.

Consider if you shorted equal dollar amounts of FAS and FAZ a few month's ago, you'd be wildly short now.

The math will presumably work for you over time, but your account may go broke first.