I’ve been staying out of the market (except for USO), because I think the possibility of a pullback is fairly high. However, with two days to go on the SPY Weekly 6-August options (which are showing IVs in the 30s) things started looking attractive. I created an ITM covered call position, buying SPY at 112.45 and selling 111 strike calls at 1.84. I did sequential orders, with the SPY buy being a market order, and then a limit order to sell the calls. SPY did a nice little up move after I bought the stock, I was going to put in an order at 1.74, but after a few minutes I was able to get a fill at 1.84. Break even on this position is SPY at 110.61, best case profit is 0.39 per share (0.35%) which will occur if SPY closes at 111 or above tomorrow.
Six Figure Investing Blog
What kind of inverse fund is Barclays’ new XXV offering?
Sunday, August 1st, 2010We know that Barclays’ XXV is intended to be an inverse fund of VXX, but there is some confusion regarding what kind of inverse it will be. Will it be the equivalent of shorting VXX, or will it be an inverse percentage fund—trying to deliver the inverse percentage moves of VXX day to day? I’m hoping for the former, because the inverse percentage funds are inferior over the long term to the performance of a short style position, especially in choppy markets. I’m sure the Barclays’ strategy is correctly stated its EDGAR filing, but smarter people than I have looked at it and come up with different answers.
With a whopping 10 days of data it looks like the shorts probably have it. The percentage chart below has the sign inverted on the XVV results to make it easier to compare to the VXX moves. If XXV is trying to be an inverse percentage fund its performance on the 26th and 30th was pretty poor. On the other hand, it was pretty good performance in order to emulate a VXX short.
The second chart shows the difference in results between 100 shares of XVV bought on its first day of trading (19-July-2010) vs a simulated inverse VXX percentage style fund.
VXX vs XXV daily % moves, click to enlarge
Comparison of a true VXX short vs XXV, and inverse % style VXX approach, click to enlarge
Crossover
Thursday, July 29th, 2010For the first time since late May the 2010 price of SPY has risen above the 2004 price for the same day. Not much else to say except this latest rally does offer a little hope that we aren’t riding a bear trend into a double dip.
SPY 2003/2004 vs 2009/2010, click to enlarge
Predicting the future: 27-July-2010
Tuesday, July 27th, 2010I am an engineer by training. It is in my blood to try to engineer a investment solution that gives good upside performance while structurally limiting risk to reasonable levels (e.g., no greater than the upside opportunity). A few years ago I concluded that I had not figured out a way to do this, and that it is probably impossible.
For example highly rated bonds, usually not considered the riskiest of investments, are sensitive to prevailing interest rates. AGG, a bond ETF is currently yielding around 3.7% annualized interest. Its duration, a term that defines the average time until maturity for the bonds in the fund is around 4. The duration metric quantifies how sensitive a bond investment is to interest rate fluctuations. In general, the price of a bond will drop by the duration amount in percent if applicable interest rates (intermediate time frame in this example) go up by one percent. So, if interest rates go up by one percent, which is almost certain to happen, the bond fund like AGG will lose 4%. Interest rate increases of several interest points could easily happen. AGG’s 3.7% interest rate starts looking like an inadequate return given the risk. Of course you could start adding things like protective puts, but those add commissions and costs that reduce your upside, and are typically very expensive if you are trying to completely limit your risk.
Some investment advisors might promote their asset allocation approach as not requiring predictions about the future, but their strategies are full of predictions (e.g., long term growth of stocks, interest rates going down when equities go down, stocks in emerging markets growing faster than USA based stocks).
So realistically our only way to make better than CD level returns is to make good predictions about the future. If you think interest rates are going to stay low for the next year, then AGG is not a bad investment–especially when compared to CDs and the like. There are a quite a few things that can be predicted beyond just interest rates (e.g, short term stock direction, stock gains over 10 year periods, volatility, volatility skew, “black swan” events, earnings reports, commodity prices, inflation rates, correlation between stocks, correlations between stocks and their sectors).
I am certainly not saying that we should forget strategies that limit/manage risk–I’m quite fond of those. I’m just saying that managing risk is only part of the story, we also need to be right with our predictions most of the time.
So what are my predictions? In general I tend to be pretty good at the longer term predictions, usually not patient enough with the middle term predictions (e.g., 3 months), not bad at the week level, and no better than a coin toss intra-day.
My 12 month predictions:
- No double dip recession
- Bull market starting back up again in the fall
My 3 month prediction:
- Sideways market. S&P highs lows near 1020, highs near 1140
The remainder of this week:
- 20% chance upside breakout for S&P > 1120
- 50% chance sideways movement the rest of the week, closing in 1090 to 1120 range
- 30 % chance fallback into the 1070 range
Dealing with risk — diversified asset allocation
Sunday, July 25th, 2010Diversified asset allocation, the belief system that most investment advisors preach—has the “right” mix of stocks, bonds, real estate, commodities spread out over the entire world. This investor age dependent mix is rebalanced, typically quarterly, by reducing your investment in areas that have performed well and increasing your stake in areas that are now underweighted—presumably waiting their turn to perform.
I don’t think this is a bad strategy, but it does make the assumption that the future will be like the past (e.g., equities average around 10% growth per year over multi-decade periods, and that some assets classes like bonds and commodities tend to counterbalance trends in equities. For at least equities, the 2000 to 2010 time period has not been kind to this strategy—ignoring dividends the growth has been negative on the broad based markets. Another trend is the recent synching up of commodities, and lower quality bonds with the equity markets. This may be due to the rise of the ETF, which has made it much easier to get in, and out of things like gold, oil, and bonds. Instead of counter balancing each other, they are increasingly moving in tandem—which increases the potential gains and risks.
Summarizing, from a risk management standpoint this approach has a fair number of issues:
- I don’t think the past reliably predicts the future. There are underlying assumptions about asset correlation and long term growth that look increasingly suspect
- Although this is the probably the predominate investment strategy in the USA–because the vast majority of people just do what their broker recommends—it delivers truly gut wrenching poor performance during big bear markets. People have their entire life savings invested in alignment with this strategy, and they see many years of gains erased in a few months. The doomsayers come out in force, the press headlines the losses, and the conventional wisdom states that stocks are dead. The end result is that a significant number of people capitulate near the bottom—bailing out of their investments at the worst possible time.
One of things I do like about diversified asset allocation is that its disciplined periodic rebalancing takes profits on winners and reduces your exposure to the hot sector. While an anathema to the momentum player, taking some of your winnings off the table periodically reduces your exposure to speculative bubbles. The bursting of these bubbles is notoriously hard to predict, and they go south very quickly when they do.
Dealing with risk
Tuesday, July 20th, 2010I’ve been thinking about various strategies for dealing with limiting losses. Many investment strategies exhibit moderate upside potential, with large exposure to downside risk. For example, on average the broad equity markets have shown annualized gains in the range of 10% over the long term, but these gains are often punctuated with large downside risks (market panics) that are deep and fast. This asymmetric behavior has discouraged many investors over the years–when a quick sequence of losses overwhelms years of building slow profits. This post on self evident shows that other people are thinking about this, and that the CBOE is developing a product that will attempt to counter the “black swan” events that the Longs dread.
