Download Flexible “Trend Following” Strategies

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