More info below regarding the ability to practically implement these arbitrage strategies because of them being consistently on the hard-to-borrow list, as well as the stock loan (interest rates) charged on the amount shorted (if in fact you do get the locate from a broker). An excellent write up on leveraged ETF strategies, as well as some of the many caveats to practically implementing them in real-live trading is presented here by the excellent research site CXO Advisory which has backtested and performed statistical significance testing on a multitude of strategies:
Another point, I would like to state is that leverage, volatility, and beta are 3 entirely different beasts. Similar, but different. Leverage is stable (in a leveraged ETF, per the daily rebalancing defined by the ETF provider), beta and volatility are not and suffer from quite instability and regime shifts over time.
As well, here is some of my personal experiences research the ability to put these strategies on in previous work prior to joining Quantopian:
Yes, I totally hear you about these great stat arb opportunities available in these leverage ETFs in order to take advantage of the decay. In practice however I've found these strategies to be difficult to put on in a couple ways: 1) as a retail investor its virtually impossible to get a locate on any stock to short of an leveraged ETF, and very difficult to get a locate on the pair of them to put the arbitrage on for full effect. 2) as an institutional investor, if you are able to locate the leveraged ETF's to short, the prime broker will often charge fairly high interest rates on the stock they locate for you to short.
Have you had some good experience putting these trades on in real-time in a retail brokerage account, or in size perhaps at the institutional level? I know over the years prior to joining Quantopian, as a retail investor I have never had any luck getting locates on these leveraged ETF's in order to short them. Recently I've started looking at the short availability list that IB posts here, and I consulted it when thinking about rules for the contest: https://www.interactivebrokers.com/en/?f=%2Fen%2Ftrading%2FSearchShortableStocks.php%3Fcntry%3Dusa%26amp%3Btag%3DUnited%2520States%26amp%3Bib_entity%3Dllc%26amp%3Bln%3D
I can usually only find a handful of leveraged ETF's available to short, and many in very small size. As well, if you do get some stock to short, the broker can "buy you in" whenever they want, without warning in which case you can be short term exposed on the other leg of the arbitrage.
So since many of these strategies have some issues with scalability is 1 reason why we are disallowing them. However I will say, if brokers do start having greater supply available and making them easier to get short without paying exorbitant rates, it might become easier for us to start allowing them. From an operational perspective, currently we don't have a way to integrate stock loan availability in our backtester, or in the paper trading simulator. As well, we don't have a way integrate the stock loan interest rates that often vary wildly for hard-to-borrow securities -- they even vary wildly across different brokers, and even change intra-day at the same broker if the stock is really hard-to-borrow. If/when our papertrading platform can handle these details so as to mimick a more "real life" trading environment we will surely enable such additional aspects in future contests.
Would definitely like to hear more from you if you've had a strongly positive, consistent experience first-hand getting a locate on these ETFs to short, and if the borrow rates weren't prohibitive. It would definitely shed some light on it for me. As well would love to hear if anyone has put these trades on and did not experience the "buy-in" risk I describe above about the broker calling in your short in the middle of a trade.
I believe our best decisions can be guided by both data and experiences, so I'm always willing to revisit previous made decisions as either new data or new experiences come in to direct my views.
Really appreciate all this feedback -- keep it coming :)