Back at work.
Markets have been quite volatile since the start of the new year. The dow has had several 200 +/- points days. Price discovery amidst all of the uncertainty. What effect does low oil have on the economy? What effect does an extremely strong dollar have? Will companies report lower earnings due to the lower euro? There is the potential greek exit, the potential QE from ECB on the 22nd. Just a boat load of uncertainty and markets hate uncertainty. Through out all of the swings from 208 to 198 my overall portfolio moves about 2% up or down. This is why I’ve constructed things the way I have. Most of the 2% movement comes from the on/off volatility in the options of the SPY/TLT pair trade. If the market moves slowly down my balance barely changes but if there is a quick jolt to the same place and VIX goes up drastically, I see the balance change due to heavy pricing of the spy options.
Update: 1:30pm GMT
Market isn’t even open yet and the volatility continues. A 41 handle swing as ES hits 2027 and falls to 1986 on the Swiss/EU unpegging bombshell. It’s now trading at 2010. That’s some large volatility for after-hours futures trading.
As for a review of the current portfolio and how it works:
We have what I call the protector portfolio which comes in two flavours (standard and alpha). This is a completely insured portfolio of equities that performs in all market types. It “may” slightly lag the market in prolonged bull markets in exchange for absolute protection and even very large profit in a bear market. It’s an all weather portfolio that has extremely low max draw downs. It’s the cornerstone of my portfolio.
Next we have is the momentum rotation portion which also has low drawdowns. It’s somewhat based off of the work of Meb Faber and closely mimics the Harvard and Yale endowments. We’re rotating between 15 ETFs based on relative strength and absolute strength. This provides some diversification as it is not very correlated to the market and can be hedge. This last month it’s been an extremely effective hedge. We’re in TLT, LQD and VNQ and all three are up very largely offsetting any down movements in SPY/TLT and our protector portfolio.
Next we have SPY/TLT pair trade. This is our monthly option trading strategy. It’s essentially OTM pair credit spreads. We expect about 15% a month from these. These can be volatile. It’s a small portion of the portfolio but provide large returns. Backtested 8 years shows very strong results (~12%-15% a month). But you can also have drawdowns in market declines as the credit for the TLT spread won’t offset the loss in the SPY spread. We do roll the TLT spreads to mitigate this. If the TLT spread becomes worthless, we roll to a higher strike. This can mitigate most of the downside effect on the SPY portion. We’ve only backtested without rolling so the returns should be higher though I don’t count on it. I also add some hedging if I feel it needs it. I have a signal to increase or decrease the ratio of SPY to TLT. This month we’re at 60/40. We’ve just had a market decline from 208 to 200 and the trade is handling it quite well mostly due to the fact that I’ve staggered my entries over a week, I’ve used a ratio of 60/40 TLT to SPY and I’ve added some hedges. If I hadn’t the trade would be down about 2.5% but instead it’s up around 10%.
Finally we have volatility trades related to earnings. This is a completely unrelated trading strategy based on the fact that volatility increases the closer you get to earnings. We use straddles and calendars to capture the increase.
That sums up our portfolio method for 2015.