According to the firm’s filing, the Defiance MSTR Double Short Hedged ETF is designed to capitalize on the potential performance decay of these leveraged ETFs over time. This is especially likely in volatile or range-bound markets where both the long and short leveraged ETFs can depreciate in value. This revelation was first brought to light by Bloomberg analyst Henry Jim.

Leveraged ETFs are typically intended for single-day holding periods. Due to the reset of leveraged returns every day based on the previous day’s closing price, holding these ETFs over multiple days can result in a significant divergence from the anticipated cumulative return. This divergence, referred to as “volatility decay,” is particularly prevalent during high volatility periods, often causing leveraged ETFs to lose value, regardless of the underlying asset’s overall stability. By shorting both long and short leveraged funds, the Defiance ETF aims to profit from this decay.

The filing does not reveal which leveraged funds the ETF will invest in. Although Defiance provides its own leveraged long and short MSTR funds, the filing indicates that the funds will not be affiliated, implying that it will invest in funds managed by other firms. Defiance ETFs did not immediately respond to The Block’s request for comments.

Eric Balchunas, Senior ETF Analyst at Bloomberg, described the filing as “the first of its kind, a new flavor of hot sauce”. He linked the filing’s strategy to a recent trade by Rob Arnott, who confessed to Bloomberg that he has been shorting both long and inverse leveraged ETFs in his personal account. “It’s not a brilliant strategy after costs, but it’s fun and carries low risk,” Arnott said to Bloomberg. Balchunas warned that the strategy carries a significant tail risk if the market consistently moves in one direction for an extended period of time.

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