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VOLATILIT Y DECAY STRATEGY Description An alternative investment strategy that takes advantage of price decay in certain exchange traded funds and exchange traded notes due to their structural design. This strategy is not available for IRAs or Roth IRAs. Objectives Dramatically enhance risk / return characteristic of investor ’s entire portfolio Provide attractive average annual returns in excess of 10% with low correlation to equity markets. Earn especially attractive returns during volatile and declining equity markets, thus providing a potential hedge against market declines. Limit worst case drawdowns to 15%. Investment Resources / Research Used Portfolio123.com – Portfolio Management Software used to Rank securities (stocks and ETFs) based upon fundamental and technical criteria Develop, test, and implement a quantitative investment strategy that systematically buys and sells securities based upon strict trading rules. HOW IT WORKS A margin brokerage account at Interac tive Broker (IB) is used that permits short selling. IRAs or Roth IRAs not eligible. Investment strategy consists of multiple (3) sub strategies which are implemented using exchange traded notes and exchange traded funds. 40% Leveraged Small Cap Volatility Decay Strategy Short Leveraged ETF Pairs (3x Small Cap Bull ETF and 3x Small Cap Bear ETF) 40% Leveraged Emerging Market Volatility Decay Strategy Short Leveraged ETF Pairs (3x Emerg Mkt Bull ETF and 3x Emerg Mkt Bear ETF) 20% Volatility Linked Decay Strategy While margin is not typically used, there are borrowing costs associated with shorting securities. The estimated annual borrowing cost for this strategy is 2 -4%. VOLATILIT Y DECAY DUE TO DAILY REBALANCING Daily rebalancing in leveraged ETFs create a long term downward bias that is accelerated in period of sideways market volatility. Example: Day Index Value Index Daily Return Index Cumulative Return Index Cumulative Return 3x 3x Fund Daily Expected Return 100 Leveraged ETF NAV Actual Cumulative Leveraged ETF Return* 100.00 1 95 -5.00% -5.00% -15.00% -15.00% 85.00 -15.00% 2 100 5.26% 0.00% 0.00% 15.78% 98.40 -1.60% 3 105 5.00% 5.00% 15.00% 15.00% 113.15 13.15% 4 100 -4.76% 0.00% 0.00% 14.28% 97.00 -3.00% 5 95 -5.00% -5.00% -15.00% 15.00% 82.45 -17.55% 6 100 5.26% 0.00% 0.00% 15.78% 95.50 -4.50% 1 YEAR CHART OF 3X AND -3X LEVERAGED EMERGING MARKET ETFS 3x Leveraged Emerging Market ETF in Blue -3x (Inverse) Emerging Market ETF in Green Leveraged Small Cap Volatility Decay Strategy Market Neutral Small Cap Decay Strategy (40% allocation ) If small cap stocks are not overbought or oversold, this strategy initially places equal dollar weighted short pair trades in leveraged market index ETFs as follows: 20% short position in TNA (Direxion Daily Small Cap Bull 3x Shares) 20% short position in TZA (Direxion Daily Small Cap Bear 3x Shares ) When the pair become substantially out of balance or small cap stocks become overbought or oversold, the short pair trade may be rebalanced to equal weight or both positions may be exited until the overbought over oversold condition no longer exists. The pair trade, if held, will be rebalanced to equal weight at the end of the calendar year. Leveraged Emerging Market Volatility Decay Strategy Market Neutral Emerging Mkt Decay Strategy (40% allocation ) If emerging market stocks are not overbought or oversold, this strategy initially places equal dollar weighted short pair trades in leveraged market index ETFs as follows: 20% short position in EDC (Direxion Daily Emerg Mkt Bull 3x Shares) 20% short position in EDZ (Direxion Daily Emerg Mkt Bear 3x Shares) When the pair become substantially out of balance or emerging market stocks become overbought or oversold, the short pair trade may be rebalanced to equal weight or both positions may be exited until the overbought over oversold condition no longer exists. The pair trade, if held, will be rebalanced to equal weight at the end of the calendar year. VOLATILIT Y PRICE DECAY DUE TO ROLLING CONTRACTS How Volatility ETN (VXX) Works and Why Price Decay Normally Occurs VXX does not have a near term expiration but invests in futures contracts that do have near term expirations. VXX invests in both the front month and second month futures contracts on the VIX spot index. Since, the VXX fund is managed to maintain a balance of front -month and second-month contracts, VXX is always about 30 days out on the curve (similar to a futures contract expiring in 1 month.) Normally, investors expect volatility to be greater in 2 months than in 1 month and so forth. This creates an ongoing premium that must be paid to continually sell front month futures contracts and replace them with second month futures contracts (which, themselves become front month contracts in a few weeks’ time). This is referred to as roll cost. 2 YEAR CHART OF ACTUAL VIX AND TRADABLE VXX Non-Tradable Volatility Index (VIX) in Blue Tradable Volatility Based Exchange Traded Note (VXX) in Green Volatility Linked Decay Strategy Volatility Linked Decay Strategy (20 % allocation) Rules for Entering VXX Short Position: VXX in down-trend Todays 15 day exponential moving average (EMA) less than yesterdays 15 day EMA VXX at attractive short price (i.e., not too late to short) Closing price within 3% of 5 day EMA VXX not overbought or oversold 14 day Relative Strength Index (RSI) of VXX > 25 and < 50 S&P 500 not overbought or oversold 14 day Relative Strength Index (RSI) of S&P500 > 35 and < 65 Rules for Exiting VXX Short Position: VXX declines by 4% from its previous high closing price SIMULATED PERFORMANCE (1/2009-9/2012) Simulated Investment Performance (1/2009 -9/2012 ) Compound Annual Return: 42.5% Standard Deviation: 19.3% (S&P 500 Standard Deviation of 22.6) Maximum Drawdown: 14.4% Sharpe Ratio: 1.83% (S&P 500 Sharp Ratio of .42%) Correlation to S&P 500: -.57% Beta: .42 Monthly and Annual Simulated Returns (Gross of Fees and Expenses ) Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec Annual 2009 6.50% -2.40% 16.40% 6.20% 0.80% 3.90% 1.90% 0.60% 3.20% 0.30% 5.40% 5.10% 58.40% 2010 1.30% 2.40% 4.00% 2.80% 3.70% -1.50% 10.00% -2.00% 9.20% 6.30% -2.80% 2.50% 41.50% 2011 1.00% 1.70% 2.50% 4.10% 2.80% 2.30% -1.00% -2.20% 4.60% 7.80% 2.20% 4.50% 34.50% Model 4.10% 2.40% 6.60% 0.90% -3.60% 7.50% 2.10% 2.60% 1.30% 26.10% SUMMARY Combines multiple strategies with an objective of earning 10% or more per year¹ with maximum drawdowns of 15% or less. Takes advantage of market volatility and can improve diversification and risk / return of investor overall portfolio. Sources of investment returns (expect 10 -18% annual returns¹) 2-4% from Price Decay in Leveraged (3x and -3x) Small Cap ETF Pairs 2-4% from Price Decay in Leveraged (3x and -3x) Emerg Mkt ETF Pairs 6-10% from Price Decay in VXX ¹ B a s e d u p o n a p e r i od o f 5 ye a r s o r m o r e , n e t o f b o r r o wi n g c o s t s f o r s h o r t positions, and trading costs