The Double Short
The only investment I have at the moment is a double short of 2 leveraged gold funds T-HGU and T-HGD. My brilliant brother Howard Joe put me in touch with this interesting trade (and others which I have yet to master).
HGU is levered to replicate twice the movement of gold; if gold goes up $1, the fund goes up $2. If gold goes down $1, the fund goes down $2. HGD is the opposite i.e. if gold goes up $1, the fund goes down $2 and if gold goes down $1, the fund goes up $2. These funds are designed to replicate the daily movement in the price of gold.
The basic premise behind the double short is that if the security (i.e. in this case gold) is highly volatile on a daily basis but relatively stable over a longer term, one can make money with a passive buy and hold strategy. If you held a long position in both HGD and HGU, the “up” funds gains/losses would be canceled out by the “down” funds offsetting gains/losses. Since the funds charge a management fee, over time this long strategy would lose out due to the fees. Taking a short position in the funds allows you to make money off the management fees as the more fees are taken, the lower the price of the funds. Being short both positions, you want the fees to be as high as possible. Also, since both these funds are levered, the fund has to incur additional costs e.g. interest charges to maintain the levered position or option charges if the position is being maintained with calls or puts. The more charges the fund incurs in maintaining the position, the lower the price of the fund and the better the short position becomes.
There’s additional volatility caused by beta slippage which I’ll address at a later date.
Proof: to back test this trading strategy, graph both HGD and HGU on the same graph and see what the imperfectly offsetting returns look like over 6months…over longer periods the returns are even better. Note that the more negative the combined returns, the better it is for the short positions. A 1 year return has HGU returning 20% and HGD at negative 50%. If you were short both these positions, your combined returned would be positive 30% for the entire position. Since you have to fund both positions, your return is half of 30% i.e. 15%. A 3 year chart shows both funds returns are negative with the corresponding short HGU having a positive 25% return and the HGD having a 3 year return of close to positive 95%.
I’ve held the above position for about 3 months and prior to the record price of gold this week, my return was 1.6% for the period. Once gold spiked, my position went briefly negative and is now back to slightly positive. The amount of volatility from the combined position is amazingly low; it’s much lower than the volatility of owning a stock. I’m hoping that gold continues to trade in a volatile fashion on a daily basis, but on a relatively stable basis long term. More on this in coming blogs.
Arnold Joe


