Saturday, April 14, 2018

Friday Update

I finally exited Leucadia National after they announced they are converting into an investment bank and will sell some of their private equity assets and change their name to Jefferies. It has been one of my worst investments losing just under USD 4k (there have been some far worse ones though...). I got in too late just as the financial crisis was getting underway and the company never recovered. Previously, it had an excellent track record and was referred to as a mini Berkshire Hathaway. I bought some more shares in 3i instead, which has been a good investment.

I have been doing more work on improving my trading model and more on trying to trade it. The options I am willing to buy - i.e. the maximum loss is bearable - have too much time decay and so the market can go up and I end up not making money. I about broke even over the week due to this and various stupid things I continued to do. I stayed up last night trading the market, though that is not something I should do. The market was beginning to go up after initially falling and I decided for some reason that shorting put options on expiration day would be a good idea. I shorted a 2650 Friday 13th S&P put and bought a 2625 Friday 13th S&P put. This exposed me to a maximum USD 1300 loss. Of course, the market immediately turned around and started going down. As it reached 2650 I sold short a futures contract as a delta hedge. Then the market bounced and hit the stop I had subsequently put in place at 2650. And then it went back down again... In the end, I actually ended up about USD 20 on the trade :) But it was quite nerve-wracking. I don't know how ERN sells lots of put options all the time without trying to determine market direction or "buy reinsurance" to make it an options spread.

Next week I am thinking to experiment with futures contracts with options collars to limit both the upside and downside. Using options you can have a much tighter effective stop and not worry about the market coming down, hitting the stop, and then going up again. The downside is that the upside has to be limited or the cost of the put option (or call if short the futures) is too much. So, you sell a call (or a put) to defray the cost. I think for a reasonable net cost it's possible to have a little more upside than downside, though as the model does have an edge it's not strictly necessary to have more potential upside than downside. I am thinking of buying a put 10 points (E-Mini S&P) below the entry price into the futures contract and selling a call 20 points above. The maximum downside is then something like 13 points (USD 650) and the maximum upside 17 points (USD 850). Another downside is that if the market is flat, you lose 3 points (USD 150).

The only issue is if both options are out of the money at expiration I will have a naked futures position without a stop at the end of that day's session. I guess if the market hasn't moved in a decisive manner up to that point then maybe it won't suddenly, but I need to be up in time to put on a new options position.

The model is neutral for Monday. The different predictors point in different directions.

Another idea I had is that it is easy to adjust the ASX200 index for franking credits. S&P have a franking credit adjusted index but it only goes back to 2011 and has some weird features, like only reinvesting the dividends once a year. If you get the monthly values of the total return or accumulation index - which includes dividends but not franking credits and the price index which is without dividends, you can calculate the monthly dividend yield. The dividend yield can then be grossed up for franking - this will exaggerate franking a bit as some companies pay unfranked dividends. The return including franking credits matches the MSCI World Index gross total return since the financial crisis in 2009 very well:

My performance is also given pre-tax includes estimated franking credits. A major reason why I am lagging the index is presumably management fees.... You can see though that my returns about match the ASX in the last five years, despite the drag of management fees. This is by investing more in funds that do generate alpha. The black line is a simulation for the "target portfolio".

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