Leverage ETF short selling: why not hold short for long time

UVXY has an -95% annual return. 3X ETF like UWTI/DWTI has great daily rebalance decay. Shorting them looks more beneficial than inverse ETF. Why not short?

0. Summary

Most individual borrowers won't benefit from rebate but have to pay the negative rebate as a lending privilege. Do not hold the short position for an extended period: Leverage ETFs are all Hard-To-Borrow securities with high borrowing costs; they are not profitable as it looks; borrowing rate can soar anytime; brokers can recall short position anytime.

1. Collateral vs Margin

	Stock Price	Margin_A	Margin_B	Fee Rate	Rebate Rate	Total Rate	Days to cover
AAPL	150	30%	30%	0.25%	0.91%	-0.66%	1.1
GPRO	10	50%	50%	12.81%	-11.65%	24.46%	3.7
GPRO	1 day after	50%	50%	24.25%	-23.28%	47.53%	3.7
SPY	250	30%	30%	0.33%	0.83%	-0.50%	2.8
VXX	30	200%	125%	2.95%	-1.79%	4.74%	0.9
UVXY	20	400%	200%	9.43%	-8.27%	17.70%	0.2
NUGT	30	90%	300%	6.26%	-5.10%	11.36%	0.7
UWT	20	100%	300%	6.70%	-5.54%	12.24%	2.7

Data from two different brokers A & B. Approximate margin due to rounding, timing, etc.

The (cash) collateral is stated as "102% of the value" as "industry convention". It will first *102% then round up to the nearest dollar. For example, $147 stock round up to $150; $0.25 stock round up to $1 (resulting 800% collateral, usually with HTB rate. Most brokers restrict short selling below $5.)

Margin is very different from Collateral. Margin depends on your account country regulations and broker rules. So far as I tested, the US.Reg.T didn't work as 100%+50% for regular stocks, but just 50% the same as long stock. For leverage ETF, the margin requirement depends on broker rules.

AAPL only needs a 30% margin to borrow (Reg.T reduced margin, shorting 100 shares of $150 AAPL only needs $4500 margin, same as long 100 shares), but UVXY needs a 400% margin from Broker_A, 200% from Broker_B.

2. Fee rate

The fee paid to the lender. Calculated by collateral value at borrowing, annual rate, with 360 days a year.

Yes, pay interest during weekends. Any 5 days *5/360.

As the lender you will get only part of interest (usually 50%), the broker collects the other 50%. Additional restraints apply to lenders to earn the interest, such as a minimum $50,000 value shares hold.

3. Rebate rate

By definition, "The cash collateral is reinvested to generate income, and returned to the borrower." 

When it's positive, the borrower earns interest on the cash collateral (if the cash is not used in borrowing, but buy treasury bond, the borrower will earn interest), so the interest is returned to the borrower at the end of the loan period. Of course, brokers set rules to avoid borrowers get the rebate but hold the interest profits, such as a minimum $100,000 short position.

When it's negative, the borrower essentially pays the lender (broker) a rental fee for "the privilege of borrowing the scarce security". Usually for hard-to-borrow HTB stocks. All leverage ETFs fall into this category.

Many brokers use an all-in-one rate for short selling, they don't need to return interest to the borrower. Anyway individual borrowers hardly benefit from the rebate.

4. Example_UVXY

To borrow 100 shares of UVXY at $20 from Broker_A:

1. Put down approximately 400% margin of $8000 towards the broker. Part of the margin, $20*102% round up to $21*100=$2100 is used as collateral towards the lender. The lender cannot use the cash because he is required to put down 100% margin to long UVXY. The broker essentially catches all.

2. Pay 11.04% interest to lender+broker. Pay rebate fee 9.88% to broker.

3. If UVXY declines 95% a year, the borrower pays 20.92% interest, that's 74.08% annual return. But with a 400% margin, it's 18.5%. Do NOT hold short position Reason #1. Even you really could hold, it's not that profitable, especially compared to risk.

Well, Broker_B only requires a 200% margin for UVXY. To borrow 100 shares from Broker_B: Sorry, no share available./this is illegal in your country.

4. Real test: short 100 UVXY + short 100 VXX for $4500, one month. gain +$400, but paid interest $190. The same time long SVXY $4500 could gain $230.

5. From the table

1. The easy-to-borrow stock has a low borrowing rate. For AAPL the borrower owes dividends/can't benefit from rebate so it may appear negative.

2. The hard-to-borrow stock has a high rate with a negative rebate. Borrowers have to pay the privilege. Do NOT hold short position Reason #2: Leverage ETFs are always HTB with high borrowing rates.

3. Leverage ETF Days-to-cover is shorter than 1 day. The borrowing fee is minimal compared to volatility. Similarly, the fee difference between VXX and UVXY appears to be an arbitrage opportunity, but impossible to catch.

4. For example, GPRO near earning has increased fees from 24.46% to 47.53% in one day. Such borrowing fee was determined/settled daily, so it happened to borrow with a 10% rate but the next day you paid 50%. This was not unusual. Historically stock borrowing interest could soar up to 300% of a stock price. I saw 80%-120% a few times. Soaring rates could be predictable for earning reports.

5. The last sentence is past tense. Now the borrowing fee is determined hourly (even minute). It happens to borrow at 10% but later in the day paid 50%. Because rarely any trader will hold leverage ETF for a long time, the rate change quickly. This is unusual. But don't cry when cheated. The interest is still charged for 1-day for day trading (not confirmed). Do NOT hold short position Reason #3.

6. Brokers have the right to recall a short position at any time. Although usually not used, but short squeeze does happen, especially at an unfavourable time. Do NOT hold short position Reason #4: Force close position at max drawdown isn't fun.

In day trading, borrowing fee is minimum compared commission. But holding short leverage ETF isn't a good idea, even with rebalance decays.

Reference:
Securities lending: Still no free lunch, Karin Peterson LaBarge, Ph.D.,CFP®, Vanguard Research
https://personal.vanguard.com/pdf/icrsl.pdf
Data from: Interactive Brokers, Scott trade, TD Ameritrade.