By Brendan Conway

Trading the stock market has gotten sufficiently frustrating that BNP Paribas has been touting the benefits of shorting pairs of leveraged exchange-traded funds to beat major stock indexes or diversify ones portfolio.

The investment banks strategists  are out this month with a guide to what they call a double short for institutional investors. The idea is to turn the peculiar features of leveraged ETFs into an advantage when markets are trading erratically. Youve read about the inefficiency of leveraged ETFs when theyre held for periods longer than a day or so. It happens that these ETFs tend to exhibit relatively strong mean-reverting tendencies in volatile, back-and-forth markets. Simultaneously shorting a bull fund and a bear fund for, say, the emerging markets, or for large-cap stocks, has worked out well for investors who can find ways around the often substantial borrowing and transaction costs.

Bloomberg

For instance, an investor who borrowed and sold short the two leveraged gold ETFs at the start of the year would have snagged a 17% return through late June, not counting transaction or borrowing costs, BNPs researchers note. The leveraged gold-bull fund Direxion Daily Gold Miners Bull 3X Shares (NUGT ) fell about 44% through late June while bearish companion Direxion Daily Gold Miners Bear 3X Shares (DUST ) rose nearly 10%.

Another winner so far this year: A trade that takes advantage of Russian markets roller coaster. Shorting both the Direxion Daily Russia Bull 3X Shares (RUSL ) and the Direxion Daily Russia Bear 3X Shares  (RUSS ) this year would have yielded 22% before accounting for the cost of the trade. And those costs can often be substantial: Its generally more expensive to sell short leveraged ETFs. Smalltime investors may well be priced out because of the cost of executing this idea.

Will it continue to work? Thats hard to say, but we can be clear on one thing: If the stock market settles into a comfortably low-volatility rally, it probably wont. If we continue to see a headline-driven market and worsening crises in Europe, theres a decent chance that it will.

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