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Seems that the answer to the first part should be yes, but haven't seen any references or examples. E.g. suppose I want to hedge XLF position with FAZ. Do people use close to current returns, or just recent? What's the risk / cost of intraday rebalance?

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1 Answer 1

Yes.

First, XLF and FAZ do not track the same underlying benchmark.
-> XLF tracks the S&P Financials Select Sector Index
-> FAZ tracks the Russell 1000 Financial Services Index
I'll ignore that for this sake, because their baskets are likely still very similar.

Pretending their benchmarks were the same, you would theoretically have a dead on (3x) hedge intraday. However, at the close of each day, you would be out of hedge. As soon as the market closes you would need to sell a bit of FAZ if the market is up, and buy a bit of FAZ if the market is down.

It's important to understand the underlying process of leveraged ETF's, and their need to rehedge at the end of the day. There's many good articles on the subject, a quick look found one: http://math.nyu.edu/faculty/avellane/LETFRISKPROF.pdf

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Thanks, I am aware of the issues around the close / overnight rebalance. But I think it's not that easy even if you want to hedge, say, till 2pm. –  LazyCat Sep 16 at 14:37

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