Defiance ETFs plans fund that shorts two leveraged Strategy ETFs, aiming to profit from volatility decay

Defiance ETFs, founded in 2018 and known for pioneering innovative ETF products, recently filed for the Defiance MSTR Double Short Hedged ETF. The fund seeks to short two separate leveraged ETFs simultaneously: a leveraged 2x long fund and a leveraged 2x short fund, both tracking shares of the Bitcoin-focused company Strategy, previously known as MicroStrategy.

"The [Defiance MSTR Double Short Hedged ETF] is designed to benefit from the performance decay that may occur in these leveraged ETFs over time - particularly in volatile or range-bound markets where both the long and short leveraged ETFs may decline in value," the firm's filing states. The filing was first reported by Bloomberg analyst Henry Jim. 

Leveraged ETFs are generally designed for single-day holding periods. Because each day's leveraged returns reset based on the previous day's closing price, holding these ETFs over multiple days can lead to significant divergence from the expected cumulative return. This divergence, known as "volatility decay," occurs especially during periods of high volatility, typically causing leveraged ETFs to lose value even if the underlying asset’s overall movement is relatively stable. By shorting both leveraged long and short funds, Defiance's ETF hopes to profit from this decay. 

The filing doesn't disclose which leveraged funds the ETF will invest in; while Defiance offers its own leveraged long and short MSTR funds, the filing specifies that the funds will be "unaffiliated," indicating that it will invest in offerings from other fund managers. Defiance ETFs didn't immediately respond to a request for comment from The Block. 

Bloomberg Senior ETF Analyst Eric Balchunas called the filing "first ever of its kind, a new flavor of hot sauce," in a post on X. Balchunas linked the filing's strategy to a recent trade by Rob Arnott, who told Bloomberg he has been shorting both leveraged long and inverse ETFs in his personal account. “Not a brilliant strategy net of costs, but fun and low risk," Arnott said to Bloomberg. 

Balchunas said the strategy carries a significant tail risk if the market moves in one direction for an extended period of time. "[Probably] don't try this at home," he added.