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As the US government continues to issue record levels of debt, I don't think it can continue to sell that debt at 2 - 3% interest. It will face the simple supply/demand law of economics - the more supply of an item, the less valuable each item is and thus the price of the item goes down. Or, in other words, the US government will have to raise interest rates on debt in order to attract new customers.

Yields on the USTs may go a little lower but not much more. During the crisis they dropped as low as 2.08% and are now at 2.5% (on 10 yrs). Therefore, I think shorting USTs sometime in the next year is a fairly safe bet.

My guess is that in the April/May time frame the rates on USTs will start to rise as the government must find new customers and the FED will hopefully have stopped buying government debt thus slowing down their money printing (this is not a sure thing, however).

So I was researching an ETF that shorted USTs and found PST. It is supposed to return 2X the inverse of 10 year UST prices. I started charting it out and saw something strange. Take a look at the chart below: alt text

PST goes down when yields go down but it does not proportionally go back up when yields go back up. Strange.

So then I looked at an ETF that tracked 10 year USTs prices (a bull ETF - not a short). I looked at IEF - an EFT that tracks prices on 10 year USTs. See the chart below: alt text

IEF does a much better job of tracking the 10 year UST prices. I still don't understand why PST does such a poor job of shorting USTs. It seems like I'm better off shorting IEF instead of buying PST.

Is there a better way to short treasuries? Does anyone know why the short ETFs do such a poor job?

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3 Answers 3

up vote 17 down vote accepted

Leveraged ETFs are prone to volatility decay, also known as leverage decay: http://blog.quantumfading.com/2009/07/12/measuring-leveraged-etf-decay/

You can increase your chances by using a non-leveraged short ETF like TBF or simply shorting the long ETF. Beware: shorting bonds ETFs will result in you having the pay the dividends, which can be substantial.

Edit: SBND has recently appeared on the market. It is leveraged 3x monthly. In theory, monthly leverage should be less destructive than daily leverage.

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Thanks for the link. Good explanation of the decay. I have to check out TBF. I have never shorted a security and did not realize that I would have to cover the dividend. Is this because I borrowed the security and the loaner of the security as well as the person I sold the borrowed security to would both expect the dividend payment? –  Muro Aug 21 '10 at 15:23
    
Yes, the dividend will be automatically deducted from your account balance. –  James Roth Aug 21 '10 at 17:07

PST, or any of the Ultra Short/Long funds aren't actually holding any traditional securities -- just swaps that are betting on the underlying asset. They also don't track the value of the underlying security over time -- just for one day. (And they're not even guaranteed to do that!)

IEF is an actual treasury bond fund that holds real-life treasury securities, not swaps. Shorting a fund like IEF is one option, another is to buy options on a fund like IEF.

Be very careful investing with ETFs, and don't buy any until you fully read and understand the prospectus. I got burned by an Ultra Long ETF because I didn't do my homework.

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3  
Leveraged ETFs are extra trouble in general. –  fennec Oct 2 '10 at 6:03

This ehow article provides some answers to the question "How to short US Treasury bonds?":

Open a futures account and short the government 10 year treasury bond contract. There is no accrued interest to be paid. Margin on bond futures is less than 10 percent of market value. In addition, there will be no need to cover the account short with a specific bond. Simply buy back the contract in the open futures market.

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