HEDGEFUNDIE's excellent adventure Part II: The next journey

[Steve Reading]

I am seeing a 50% margin requirement for shorting FAZ. SQQQ has only a 13% margin requirement for me. But yes, margin calls are an issue. There are several ways to avoid this.

Umh, if I go to submit a sell order on 100 shares of FAZ, IBKR says the maintenance margin is $855. An order of 100 shares of FAZ is roughly $950 dollars short, hence, my claim of 90%. But it sounds like I'm mistaken, how do you determine the MM on FAZ? Thanks!

1) Keep position size small -- you will still crush long leveraged and long leveraged even with only a target of 15% of the portfolio exposed

What you say boils down to claiming that it is always better to leverage and increase exposure as a market declines. To the extent you aren't forced to liquidate (because the position is small to begin with) and to the extent markets will recover, then this always makes money. I don't disagree given those assumptions. I only disagree with the assumptions being a given.

2) Shorting both leveraged ETFs. I showed earlier how you can achieve exceptional returns with a delta neutral approach. You can even get excellent returns using a delta negative approach, if you increase the short size of TQQQ.

Are you referring to the PV graph? That's probably not delta-neutral, PV just thinks it because it uses monthly data. The only way to make money pair trading SQQQ and TQQQ is if you go delta positive after market declines (SQQQ short grows, TQQQ shrinks) and vice-versa. It's as though it was delta-neutral in a large time-scale but it really is just market-timing (increasing stock exposure when stocks drops and vice-versa).

3) Using options to define risk. I used to short SQQQ using call spreads, but I have switched to buying very short term call options, making the position more like a diagonal. These call options typically cost a few pennies but will completely protect me against a crash like we saw March 2020. In fact, I have structured my trades to actually profit if this happens.

I don't think I follow, do you have an example? Thanks.

By the way, you corrected me about the greeks. I was thinking about things a bit differently. What I was trying to suggest is that leveraged ETFs under-perform if realized volatility is high. For instance, if the SP500 is flat for an entire year, then SQQQ and TQQQ will be down. I believe this is a mathematically certainty (someone please correct me if I am wrong). The higher the volatility during this period, the more the leveraged ETFs will have fallen.

Yes, I understand what you meant but vega is the wrong term there. In options lingo, realized volatility is known as "gamma". You're right that long TQQQ does poorly with high realized volatility. Like I said already, it is like TQQQ is short gamma.

Shorting leveraged ETFs is better than going long leveraged ETFs. It is really that simple. I challenge you to find one case where going long would return more than shorting the inverse.

Since TQQQ is long vega and short SQQQ is short vega, then it's pretty easy to find examples where the former outperforms. You just have to find cases where markets trended (even with high realized volatility) and ended up far from their initial state.

I don't need to check but long TQQQ probably stomped short SQQQ since April 2020 for instance.

[fidream]

Karl Steiner came out with a blog post about the Hedgefundie strategy. tldr, doesn't seem good: https://www.mindfullyinvesting.com/why- ... the-lever/

[stockmaster]

Kark Steiner came out with a blog post about the Hedgefundie strategy. tldr, doesn't seem good: https://www.mindfullyinvesting.com/why- ... the-lever/

I personally agree with his criticisms. Got rid of my entire bond allocation a month ago.

[e5116]

Karl Steiner came out with a blog post about the Hedgefundie strategy. tldr, doesn't seem good: https://www.mindfullyinvesting.com/why- ... the-lever/

Thanks for the article. I mean this sincerely, who is Karl Steiner?

[Mother_McCrankel]

Didn't we already talk about this?

IBKR requires a 90% maintenance margin on a FAZ short. So if you start with 200% cash, -100% FAZ, a measly 5% rise in FAZ already triggers a margin call. Have you seen the graph of FAZ? Its a LETF, it gains 5% all the time. It tripled in March. It gained 50% in Dec 2018 and June 2020. You wouldn't have maintained exposure, the graphs above are all fairy tales. I suspect PV doesn't actually close a position until it reaches $0 dollars and I don't think it does intra-month (correct me if I'm wrong though).
I don't know for certain but I'll guess it's not much better with options.

But you know that already, your short LETF portfolios always carry protective puts for this very reason IIRC. I don't think you accounted for those in the graphs above.

Or maybe you do this in a tiny portion of your account (say <5%) to ensure you have overwhelming collateral. Obviously, that solves the issue. If you have effectively infinite collateral and know markets will recover (as they have thus far in the graphs above), then it's a no-brainer to just increase exposure as the market drops. It's free money at that point. But a bit misleading IMO.

I am seeing a 50% margin requirement for shorting FAZ. SQQQ has only a 13% margin requirement for me. But yes, margin calls are an issue. There are several ways to avoid this.

1) Keep position size small -- you will still crush long leveraged and long leveraged even with only a target of 15% of the portfolio exposed

2) Shorting both leveraged ETFs. I showed earlier how you can achieve exceptional returns with a delta neutral approach. You can even get excellent returns using a delta negative approach, if you increase the short size of TQQQ.

3) Using options to define risk. I used to short SQQQ using call spreads, but I have switched to buying very short term call options, making the position more like a diagonal. These call options typically cost a few pennies but will completely protect me against a crash like we saw March 2020. In fact, I have structured my trades to actually profit if this happens.

By the way, you corrected me about the greeks. I was thinking about things a bit differently. What I was trying to suggest is that leveraged ETFs under-perform if realized volatility is high. For instance, if the SP500 is flat for an entire year, then SQQQ and TQQQ will be down. I believe this is a mathematically certainty (someone please correct me if I am wrong). The higher the volatility during this period, the more the leveraged ETFs will have fallen.

If realized volatility is low, then the market will almost certainly be higher than in the previous year, which means SQQQ will be down significantly.

The only scenario in which SQQQ would be up is if the market is down. However, markets almost always experience severe volatility when they crash, which means that SQQQ will still under-perform.

Portfolio Visualizer marks to market the portfolio every month, so you are correct that a lot of the strategies would have blown up. That's why a hedge is necessary if the target position size is 100%.

Are you trading on Portfolio Marigin (in IBKR)? I'm keen to explore this strategy.

If I short SQQQ and keep 100% of the purchase amount held in cash, so not utilising margin, what risks are there to me (margin call, etc)?

[typical.investor]

Didn't we already talk about this?

IBKR requires a 90% maintenance margin on a FAZ short. So if you start with 200% cash, -100% FAZ, a measly 5% rise in FAZ already triggers a margin call. Have you seen the graph of FAZ? Its a LETF, it gains 5% all the time. It tripled in March. It gained 50% in Dec 2018 and June 2020. You wouldn't have maintained exposure, the graphs above are all fairy tales. I suspect PV doesn't actually close a position until it reaches $0 dollars and I don't think it does intra-month (correct me if I'm wrong though).
I don't know for certain but I'll guess it's not much better with options.

But you know that already, your short LETF portfolios always carry protective puts for this very reason IIRC. I don't think you accounted for those in the graphs above.

Or maybe you do this in a tiny portion of your account (say <5%) to ensure you have overwhelming collateral. Obviously, that solves the issue. If you have effectively infinite collateral and know markets will recover (as they have thus far in the graphs above), then it's a no-brainer to just increase exposure as the market drops. It's free money at that point. But a bit misleading IMO.

I am seeing a 50% margin requirement for shorting FAZ. SQQQ has only a 13% margin requirement for me. But yes, margin calls are an issue. There are several ways to avoid this.

1) Keep position size small -- you will still crush long leveraged and long leveraged even with only a target of 15% of the portfolio exposed

2) Shorting both leveraged ETFs. I showed earlier how you can achieve exceptional returns with a delta neutral approach. You can even get excellent returns using a delta negative approach, if you increase the short size of TQQQ.

3) Using options to define risk. I used to short SQQQ using call spreads, but I have switched to buying very short term call options, making the position more like a diagonal. These call options typically cost a few pennies but will completely protect me against a crash like we saw March 2020. In fact, I have structured my trades to actually profit if this happens.

By the way, you corrected me about the greeks. I was thinking about things a bit differently. What I was trying to suggest is that leveraged ETFs under-perform if realized volatility is high. For instance, if the SP500 is flat for an entire year, then SQQQ and TQQQ will be down. I believe this is a mathematically certainty (someone please correct me if I am wrong). The higher the volatility during this period, the more the leveraged ETFs will have fallen.

If realized volatility is low, then the market will almost certainly be higher than in the previous year, which means SQQQ will be down significantly.

The only scenario in which SQQQ would be up is if the market is down. However, markets almost always experience severe volatility when they crash, which means that SQQQ will still under-perform.

Portfolio Visualizer marks to market the portfolio every month, so you are correct that a lot of the strategies would have blown up. That's why a hedge is necessary if the target position size is 100%.

Are you trading on Portfolio Marigin (in IBKR)? I'm keen to explore this strategy.

If I short SQQQ and keep 100% of the purchase amount held in cash, so not utilising margin, what risks are there to me (margin call, etc)?

Assuming an SP500 one year loss of 30%, and yearly volatility between 10% and 25%, the ULTRAPRO SHORT QQQ prospectus states the fund is expected to gain between 100.4% (at 25% volatility) and 174.6% (at 10% volatility). Since you'd shorted it, I do see the possibility of a margin call. With 50% volatility though, the fund's expected -34.9% loss would be your (shorted) gain. Weird right?

Anyway, I disagree with the conclusion that shorting SQQQ is necessarily better than TQQQ. It all depends on returns and volatility and in any case, using either requires a rebalancing strategy.

I also question how cheap it would be to borrow SQQQ.

[Mother_McCrankel]

Didn't we already talk about this?

IBKR requires a 90% maintenance margin on a FAZ short. So if you start with 200% cash, -100% FAZ, a measly 5% rise in FAZ already triggers a margin call. Have you seen the graph of FAZ? Its a LETF, it gains 5% all the time. It tripled in March. It gained 50% in Dec 2018 and June 2020. You wouldn't have maintained exposure, the graphs above are all fairy tales. I suspect PV doesn't actually close a position until it reaches $0 dollars and I don't think it does intra-month (correct me if I'm wrong though).
I don't know for certain but I'll guess it's not much better with options.

But you know that already, your short LETF portfolios always carry protective puts for this very reason IIRC. I don't think you accounted for those in the graphs above.

Or maybe you do this in a tiny portion of your account (say <5%) to ensure you have overwhelming collateral. Obviously, that solves the issue. If you have effectively infinite collateral and know markets will recover (as they have thus far in the graphs above), then it's a no-brainer to just increase exposure as the market drops. It's free money at that point. But a bit misleading IMO.

I am seeing a 50% margin requirement for shorting FAZ. SQQQ has only a 13% margin requirement for me. But yes, margin calls are an issue. There are several ways to avoid this.

1) Keep position size small -- you will still crush long leveraged and long leveraged even with only a target of 15% of the portfolio exposed

2) Shorting both leveraged ETFs. I showed earlier how you can achieve exceptional returns with a delta neutral approach. You can even get excellent returns using a delta negative approach, if you increase the short size of TQQQ.

3) Using options to define risk. I used to short SQQQ using call spreads, but I have switched to buying very short term call options, making the position more like a diagonal. These call options typically cost a few pennies but will completely protect me against a crash like we saw March 2020. In fact, I have structured my trades to actually profit if this happens.

By the way, you corrected me about the greeks. I was thinking about things a bit differently. What I was trying to suggest is that leveraged ETFs under-perform if realized volatility is high. For instance, if the SP500 is flat for an entire year, then SQQQ and TQQQ will be down. I believe this is a mathematically certainty (someone please correct me if I am wrong). The higher the volatility during this period, the more the leveraged ETFs will have fallen.

If realized volatility is low, then the market will almost certainly be higher than in the previous year, which means SQQQ will be down significantly.

The only scenario in which SQQQ would be up is if the market is down. However, markets almost always experience severe volatility when they crash, which means that SQQQ will still under-perform.

Portfolio Visualizer marks to market the portfolio every month, so you are correct that a lot of the strategies would have blown up. That's why a hedge is necessary if the target position size is 100%.

Are you trading on Portfolio Marigin (in IBKR)? I'm keen to explore this strategy.

If I short SQQQ and keep 100% of the purchase amount held in cash, so not utilising margin, what risks are there to me (margin call, etc)?

Assuming an SP500 one year loss of 30%, and yearly volatility between 10% and 25%, the ULTRAPRO SHORT QQQ prospectus states the fund is expected to gain between 100.4% (at 25% volatility) and 174.6% (at 10% volatility). Since you'd shorted it, I do see the possibility of a margin call. With 50% volatility though, the fund's expected -34.9% loss would be your (shorted) gain. Weird right?

Anyway, I disagree with the conclusion that shorting SQQQ is necessarily better than TQQQ. It all depends on returns and volatility and in any case, using either requires a rebalancing strategy.

I also question how cheap it would be to borrow SQQQ.

I'm using IBKR, and just read up re margin requirements for leveraged ETFs, which carry a 90% maintenance margin (I'm on Reg-T margin account btw). My biggest concern re shorting SQQQ is the little wiggle room in the maintenance margin requirements. Small movements / volatility could easy cause a margin call, could it not??

[Perfect Uncertainty]

The approach with VIX hedge is very interesting. I am playing with thinkorswim papermoney and initiated some HFEA positions today without the hedge leaving some funds for VIX hedge. I am an options newbie and looking at the VIX options chain for the next 30 to 120 days. VIX is around 22 this week. What would be the euqivalent 10 delta VIX strick price given where it is now? Looking at your 11/2019 posts it seems about 3.5x times VIX. Is that how one would get there? Also when you intiate such hedge do you recommend only starting with one 0.3 allocation that is 120 days out and then adding one each month later on versus initiating 0.3 % for each of 30, 60, and 90 days of trenches?

TIA.

I have options through February, but volatility has crept higher and the VIX is expensive right now. Currently, the 10 deltas are at a 75 strike price for March 2021.

From that, I add three pieces of data:

1. The VIX went up to 75 for only 6 days in March 2020 and not too much higher.
2. We know that when the hedge really works is when we have backwardation (front months trade higher than back months).
3. We want a high number of options to benefit from the VIX hedge.

So for me, I haven't purchased March VIX options because I want the hedge to be effective. To be an effective hedge I don't want any strike price above 55. I will continue to monitor the hedge for 10 deltas to be below 55 preferably and then pick them up then. When I'm 30 to 45 DTE I'll buy 50 strike price or lower. If I cannot obtain 10 deltas below a 50 strike, I would rather lighten my equity position until such time as the VIX is more reasonably priced.

[Perfect Uncertainty]

How it follow from the bolded that XVZ doesn't offer much protection? It more than doubled between late-Feb and early-March. If anything, I would think the fact that it stabilized only 20% lower than its peak would be a point in its favor, since holding onto its gains like that limits the timing element of rebalancing.

My issues with XVZ are more the fact it's unlikely to perform well in a longer more gradual downturn like 2018 or the early 2000s, and as you said the low volume (only $30M AUM).

Your approach seems similar to the VIX tail hedge index (^VXTH), which did pretty well in both the GFC and pandemic, but I think this type of strategy is much more valuable in a leveraged portfolio, since SPX will recover from a downturn, but UPRO may not.

Here are the issues with holding an XVZ. Review the historical chart for XVZ: XVZ History

1. When do you buy it?
2. How much do you pay for it?
3. It is pretty illiquid with an average daily volume of only 21k shares.
3. Yes it doubled in Feb/March. But the VIX options were up over 6,900 %.

XVZ might be a slight offset in a decline. Very slight.

I would stay away from it.

[CanaBogle24]

Someone made a separate thread a while back where people participating in the Excellent Adventure could post their results, allocation, and when they entered into it. I can't seem to locate it. Help anyone?

Here you go: viewtopic.php?t=326588

[Ramjet]

Someone made a separate thread a while back where people participating in the Excellent Adventure could post their results, allocation, and when they entered into it. I can't seem to locate it. Help anyone?

Here you go: viewtopic.php?t=326588

Thanks

[socoolme]

I have options through February, but volatility has crept higher and the VIX is expensive right now. Currently, the 10 deltas are at a 75 strike price for March 2021.

From that, I add three pieces of data:

1. The VIX went up to 75 for only 6 days in March 2020 and not too much higher.
2. We know that when the hedge really works is when we have backwardation (front months trade higher than back months).
3. We want a high number of options to benefit from the VIX hedge.

So for me, I haven't purchased March VIX options because I want the hedge to be effective. To be an effective hedge I don't want any strike price above 55. I will continue to monitor the hedge for 10 deltas to be below 55 preferably and then pick them up then. When I'm 30 to 45 DTE I'll buy 50 strike price or lower. If I cannot obtain 10 deltas below a 50 strike, I would rather lighten my equity position until such time as the VIX is more reasonably priced.

Thank you, this is very helpful. I am finding that just like March 2020 Feb 2018 had 2 to 3 days where VIX options were in the money. Most noticebly around the Feb 5. Additionally 15 May 2018 VIX options with a strick price of 37 were priced higher than same expiry strike price of 30 which if right, does not make sense. Thinkorswim thinkback tells me so at the peak level of hedge that they offered.
Most of the times the options expired worthless, which is fine with insurance aspect. I am wondering if there is some rule of thumb where one would cash out and make a change to equity allocation when it happens. Now that would be timing the market, isn't it and we know it is hard if not impossible to accomplish. I believe March 2020 the options ended in the money however that was very volatile and I wounder how often one would see such a scenario. In general even at othe times when VIX was elevated the montly options expired worthless.

Coming back to the 10 deltas, if we cannot get a realstic VIX option at around stike of 50 would you consider getting smaller number of VIX options or tweaking equity allocation itself would be a better choice?

One more question, the 0.3 % a month is about 4% a year assuming none of the VIX options expire in the money. So underperformance is a insurance that you pay for keeping HFEA and sleep better at night. Is that the right way to look at it?

[000]

Karl Steiner came out with a blog post about the Hedgefundie strategy. tldr, doesn't seem good: https://www.mindfullyinvesting.com/why- ... the-lever/

thanks for the link

[000]

Kark Steiner came out with a blog post about the Hedgefundie strategy. tldr, doesn't seem good: https://www.mindfullyinvesting.com/why- ... the-lever/

I personally agree with his criticisms. Got rid of my entire bond allocation a month ago.

So you're just 100% UPRO now?

[stormcrow]

Kark Steiner came out with a blog post about the Hedgefundie strategy. tldr, doesn't seem good: https://www.mindfullyinvesting.com/why- ... the-lever/

I personally agree with his criticisms. Got rid of my entire bond allocation a month ago.

So you're just 100% UPRO now?

Man, any significant pullback is going to be brutal isn't it?

[perfectuncertainty]

Thank you, this is very helpful. I am finding that just like March 2020 Feb 2018 had 2 to 3 days where VIX options were in the money. Most noticebly around the Feb 5. Additionally 15 May 2018 VIX options with a strick price of 37 were priced higher than same expiry strike price of 30 which if right, does not make sense. Thinkorswim thinkback tells me so at the peak level of hedge that they offered.
Most of the times the options expired worthless, which is fine with insurance aspect. I am wondering if there is some rule of thumb where one would cash out and make a change to equity allocation when it happens. Now that would be timing the market, isn't it and we know it is hard if not impossible to accomplish. I believe March 2020 the options ended in the money however that was very volatile and I wounder how often one would see such a scenario. In general even at othe times when VIX was elevated the montly options expired worthless.

Coming back to the 10 deltas, if we cannot get a realstic VIX option at around stike of 50 would you consider getting smaller number of VIX options or tweaking equity allocation itself would be a better choice?

One more question, the 0.3 % a month is about 4% a year assuming none of the VIX options expire in the money. So underperformance is a insurance that you pay for keeping HFEA and sleep better at night. Is that the right way to look at it?

We want the VIX options to expire worthles. Just like car insurance - we don't want to use it.

Yes, with a strategy like HFEA we are chasing high returns and expect to at least double the market return (else it's not worth the risk). So I'm content giving up the 3.6% return for the insurance. I know without any doubt that the VIX hedge will hit. I don't know when. But I do know it will more than cover the losses during a black swan since it is inversely correlated (VIX is based on the SP500 and so is UPRO).

[willthrill81]

Karl Steiner came out with a blog post about the Hedgefundie strategy. tldr, doesn't seem good: https://www.mindfullyinvesting.com/why- ... the-lever/

Based on my quick read, he seems to be basically concluding that it's too risky. That's a reasonable assumption, and Hedgefundie himself concluded that the risk of the strategy was high enough that the majority of his portfolio was still invested in unleveraged index funds. My own version of the strategy is only taking up about 6% of my portfolio, so even if it completely implodes, my retirement plans won't be impacted that much.

[Ramjet]

Karl Steiner came out with a blog post about the Hedgefundie strategy. tldr, doesn't seem good: https://www.mindfullyinvesting.com/why- ... the-lever/

Based on my quick read, he seems to be basically concluding that it's too risky. That's a reasonable assumption, and Hedgefundie himself concluded that the risk of the strategy was high enough that the majority of his portfolio was still invested in unleveraged index funds. My own version of the strategy is only taking up about 6% of my portfolio, so even if it completely implodes, my retirement plans won't be impacted that much.

It's a reasonable write up, but I think the possibility of interest rates staying low or flattish for a very long period of time has been discounted too much. Lots of mention of time periods with rising or falling rates but not flat

[willthrill81]

Karl Steiner came out with a blog post about the Hedgefundie strategy. tldr, doesn't seem good: https://www.mindfullyinvesting.com/why- ... the-lever/

Based on my quick read, he seems to be basically concluding that it's too risky. That's a reasonable assumption, and Hedgefundie himself concluded that the risk of the strategy was high enough that the majority of his portfolio was still invested in unleveraged index funds. My own version of the strategy is only taking up about 6% of my portfolio, so even if it completely implodes, my retirement plans won't be impacted that much.

It's a reasonable write up, but I think the possibility of interest rates staying low or flattish for a very long period of time has been discounted too much. Lots of mention of time periods with rising or falling rates but not flat

I agree. Analyses done by posters here indicate that interest rates have generally been falling for the last 700 years, though there have obviously been periods where the opposite occurred. Taken together with other macro-level events, some of which are probably beyond the scope of what can be openly discussed on the forum, assuming that interest rates are likely to increase significantly in the future seems unwarranted by my estimation.

[jarjarM]

Karl Steiner came out with a blog post about the Hedgefundie strategy. tldr, doesn't seem good: https://www.mindfullyinvesting.com/why- ... the-lever/

Based on my quick read, he seems to be basically concluding that it's too risky. That's a reasonable assumption, and Hedgefundie himself concluded that the risk of the strategy was high enough that the majority of his portfolio was still invested in unleveraged index funds. My own version of the strategy is only taking up about 6% of my portfolio, so even if it completely implodes, my retirement plans won't be impacted that much.

It's a reasonable write up, but I think the possibility of interest rates staying low or flattish for a very long period of time has been discounted too much. Lots of mention of time periods with rising or falling rates but not flat

I agree. Analyses done by posters here indicate that interest rates have generally been falling for the last 700 years, though there have obviously been periods where the opposite occurred. Taken together with other macro-level events, some of which are probably beyond the scope of what can be openly discussed on the forum, assuming that interest rates are likely to increase significantly in the future seems unwarranted by my estimation.

+1. The interest rate concern is the reason why the hedgefundie changed to 55/45 allocation. He has always argue that the bond portion is really meant to use to counteract drops in stock during sharp drawdowns but of course there will always be some risk associated with this strategy if stock return going forward is well below historical averages (I think the article points to 5% or less). That's why this should be a small allocation of one's overall strategy and don't put all the eggs in one basket.

[Jags4186]

Karl Steiner came out with a blog post about the Hedgefundie strategy. tldr, doesn't seem good: https://www.mindfullyinvesting.com/why- ... the-lever/

Based on my quick read, he seems to be basically concluding that it's too risky. That's a reasonable assumption, and Hedgefundie himself concluded that the risk of the strategy was high enough that the majority of his portfolio was still invested in unleveraged index funds. My own version of the strategy is only taking up about 6% of my portfolio, so even if it completely implodes, my retirement plans won't be impacted that much.

It's a reasonable write up, but I think the possibility of interest rates staying low or flattish for a very long period of time has been discounted too much. Lots of mention of time periods with rising or falling rates but not flat

I agree. Analyses done by posters here indicate that interest rates have generally been falling for the last 700 years, though there have obviously been periods where the opposite occurred. Taken together with other macro-level events, some of which are probably beyond the scope of what can be openly discussed on the forum, assuming that interest rates are likely to increase significantly in the future seems unwarranted by my estimation.

+1. The interest rate concern is the reason why the hedgefundie changed to 55/45 allocation. He has always argue that the bond portion is really meant to use to counteract drops in stock during sharp drawdowns but of course there will always be some risk associated with this strategy if stock return going forward is well below historical averages (I think the article points to 5% or less). That's why this should be a small allocation of one's overall strategy and don't put all the eggs in one basket.

My main issue with the article is the assumption that 10-year forward returns are going to 5% for equities and 1% for bonds. If equity returns for the next 10 years are 5% that would mean we will have lived in a 30 year period where equities (SP500) would have returned approximately 5.5% annually...nearly 1/2 the long term historical average. I expect equity returns to be high through 2029. Bonds are a crap shoot and the 30 year treasury rate is the biggest go forward unknown.

[Steve Reading]

My main issue with the article is the assumption that 10-year forward returns are going to 5% for equities and 1% for bonds. If equity returns for the next 10 years are 5% that would mean we will have lived in a 30 year period where equities (SP500) would have returned approximately 5.5% annually...nearly 1/2 the long term historical average.

Bonds probably will return about 1% for the next 10 years (do you disagree?). And stocks have generally offered about 4-5% additional return over bonds to compensate for their risk. So 5% returns for stocks is about right.

To expect much more from stocks is to expect you to get compensated more for stock risk than people have in the past. Maybe that's your thesis but that wouldn't be my first inclination.

[Jags4186]

My main issue with the article is the assumption that 10-year forward returns are going to 5% for equities and 1% for bonds. If equity returns for the next 10 years are 5% that would mean we will have lived in a 30 year period where equities (SP500) would have returned approximately 5.5% annually...nearly 1/2 the long term historical average.

Bonds probably will return about 1% for the next 10 years (do you disagree?). And stocks have generally offered about 4-5% additional return over bonds to compensate for their risk. So 5% returns for stocks is about right.

To expect much more from stocks is to expect you to get compensated more for stock risk than people have in the past. Maybe that's your thesis but that wouldn't be my first inclination.

My crystal ball tells me that if bonds do indeed return 1%, more money will be pushed into equities as people reach for yield. More money pushed into equities means stronger equity prices. As more and more folks have an ever increasing amount of money in equities, the government will do everything it can to prop up the equity market as mass poverty does not make a happy populace. The biggest unknown to me is inflation. Despite valiant efforts, US monetary policy has been unable to stoke inflation. Is it a ticking time bomb or are we in a very long term low inflationary environment?

[000]

Kark Steiner came out with a blog post about the Hedgefundie strategy. tldr, doesn't seem good: https://www.mindfullyinvesting.com/why- ... the-lever/

I personally agree with his criticisms. Got rid of my entire bond allocation a month ago.

So you're just 100% UPRO now?

Man, any significant pullback is going to be brutal isn't it?

Indeed.

[Semantics]

Karl Steiner came out with a blog post about the Hedgefundie strategy. tldr, doesn't seem good: https://www.mindfullyinvesting.com/why- ... the-lever/

Based on my quick read, he seems to be basically concluding that it's too risky. That's a reasonable assumption, and Hedgefundie himself concluded that the risk of the strategy was high enough that the majority of his portfolio was still invested in unleveraged index funds. My own version of the strategy is only taking up about 6% of my portfolio, so even if it completely implodes, my retirement plans won't be impacted that much.

It's a reasonable write up, but I think the possibility of interest rates staying low or flattish for a very long period of time has been discounted too much. Lots of mention of time periods with rising or falling rates but not flat

+1

The market seems to agree with this too, the treasury yield curve being consistent with low interest rates for a long time. And not just low rates, but negative real short term rates, and neutral to slightly negative real LTT yields, assuming inflation can be stimulated.

Then the thing is, if real borrowing fees stay negative, LETFs are effectively adding 2 * (inflation - borrowing rate) to their nominal returns just by borrowing. I don't think his analysis covers those conditions. It might make sense then to consider a 5th class of conditions, which is stocks and bonds both facing headwinds but with lots of monetary and fiscal policy support.

Also, the real CAGR of the S&P 500 from 1962-1980 (his green period) was just 1.62%, and average borrowing rate would have been over 5%. That kind of scenario just looks really improbable right now. TMF may not provide anything for HFEA besides ballast over the next decade, but I think the total portfolio will still outperform the S&P 500 by 5%-ish on the strength of the UPRO component by itself.

[kjm]

I think the idea of hedging a 100% UPRO portfolio is an interesting one right now. Instead of holding VXX or VXX calls 100% of the time though, you could try only holding when volatility increases. I put together the following backtest for fun.

- Hold 100% UPRO
- When trailing 5-day (non-annualized) volatility exceeds 10%, move a quarter of the UPRO position into VXX.

When you do that you get the following going back to the inception date of VXX...

MODEL RESULTS
Annualized Return: 41.53%
Max Drawdown: -55.19%
Standard Deviation: 48.28%

UPRO RESULTS
Annualized Return: 34.37%
Max Drawdown: -76.82%
Standard Deviation: 52.07%

The "10% threshold" was met 3 times over that period:
- 8/10/2011 - 8/16/2011
- 8/28/2015
- 3/5/2020 - 4/8/2020

Who knows if this strategy would hold up in the future as we only have 11 years of data for VXX and only 3 pops.

This would work better using VXX call options. You could move maybe 5% of the portfolio to VXX calls to get the same outcome.

I picked the values for the lookback period, volatility threshold and VXX allocation size at random. You could make this more or less sensitive by tweaking these values.

This wouldn't be terribly hard for someone with some basic programing skills to implement or even completely automate. Definitely not a "set it and forget it" strategy though.

[perfectuncertainty]

I think the idea of hedging a 100% UPRO portfolio is an interesting one right now. Instead of holding VXX or VXX calls 100% of the time though, you could try only holding when volatility increases. I put together the following backtest for fun.

- Hold 100% UPRO
- When trailing 5-day (non-annualized) volatility exceeds 10%, move a quarter of the UPRO position into VXX.

When you do that you get the following going back to the inception date of VXX...

MODEL RESULTS
Annualized Return: 41.53%
Max Drawdown: -55.19%
Standard Deviation: 48.28%

UPRO RESULTS
Annualized Return: 34.37%
Max Drawdown: -76.82%
Standard Deviation: 52.07%

The "10% threshold" was met 3 times over that period:
- 8/10/2011 - 8/16/2011
- 8/28/2015
- 3/5/2020 - 4/8/2020

Who knows if this strategy would hold up in the future as we only have 11 years of data for VXX and only 3 pops.

This would work better using VXX call options. You could move maybe 5% of the portfolio to VXX calls to get the same outcome.

I picked the values for the lookback period, volatility threshold and VXX allocation size at random. You could make this more or less sensitive by tweaking these values.

This wouldn't be terribly hard for someone with some basic programing skills to implement or even completely automate. Definitely not a "set it and forget it" strategy though.

Interesting approach.

I ran it for 5-day trailing volatility >= 5%.

Here are the dates from 6/25/2009 when the VIX trailing 5-day volatility was greater than or equal to 5%. It would have got you into the hedge on 2/28/2020 (the day following the 2/27 breach). On that day the VIX was at $22.81. The 10-delta options were pointing at a $37 strike and sold for $0.26. On 3/18 the $37 strike options sold for $36.19.

Code: Select all

Date	Adj Close	Close Return	5-Day  Volatility
11/3/20	 55.70 	5.23%	6.38%
11/2/20	 52.93 	3.44%	5.57%
10/29/20	 52.85 	2.98%	5.31%
10/28/20	 51.32 	-10.26%	5.01%
9/14/20	 57.35 	3.99%	5.94%
9/11/20	 55.15 	0.13%	5.34%
9/10/20	 55.08 	-5.18%	6.28%
9/9/20	 58.09 	5.77%	7.23%
9/8/20	 54.92 	-8.22%	6.51%
9/4/20	 59.84 	-2.35%	5.75%
9/3/20	 61.28 	-10.37%	5.88%
6/30/20	 44.36 	4.08%	6.17%
6/29/20	 42.62 	4.46%	5.75%
6/26/20	 40.80 	-7.15%	5.25%
6/17/20	 45.34 	-1.31%	9.39%
6/16/20	 45.94 	5.73%	9.39%
6/15/20	 43.45 	2.82%	8.51%
6/12/20	 42.26 	3.65%	8.68%
6/11/20	 40.77 	-17.47%	9.57%
5/22/20	 39.38 	0.54%	5.17%
5/21/20	 39.17 	-2.17%	5.14%
5/19/20	 38.12 	-3.08%	5.69%
5/18/20	 39.33 	9.25%	6.39%
5/14/20	 35.58 	3.64%	5.01%
5/5/20	 36.17 	2.67%	5.92%
5/4/20	 35.23 	1.06%	5.76%
5/1/20	 34.86 	-8.02%	6.20%
4/27/20	 36.73 	4.41%	6.35%
4/24/20	 35.18 	4.24%	6.62%
4/23/20	 33.75 	-0.12%	7.52%
4/22/20	 33.79 	6.76%	7.55%
4/21/20	 31.65 	-9.23%	7.04%
4/20/20	 34.87 	-5.37%	7.28%
4/17/20	 36.85 	8.16%	6.78%
4/16/20	 34.07 	1.46%	6.10%
4/15/20	 33.58 	-6.44%	7.33%
4/14/20	 35.89 	9.09%	5.65%
4/13/20	 32.90 	-2.92%	9.17%
4/9/20	 33.89 	4.53%	9.54%
4/8/20	 32.42 	10.16%	9.50%
4/7/20	 29.43 	0.00%	12.60%
4/6/20	 29.43 	20.22%	12.94%
4/3/20	 24.48 	-4.30%	9.41%
4/2/20	 25.58 	6.85%	10.03%
4/1/20	 23.94 	-13.36%	13.05%
3/31/20	 27.63 	-4.66%	10.69%
3/30/20	 28.98 	9.77%	13.94%
3/27/20	 26.40 	-9.03%	16.17%
3/26/20	 29.02 	17.44%	17.34%
3/25/20	 24.71 	3.90%	16.06%
3/24/20	 23.78 	27.97%	17.68%
3/23/20	 18.59 	-8.23%	13.81%
3/20/20	 20.25 	-13.58%	19.81%
3/19/20	 23.43 	-0.63%	25.36%
3/18/20	 23.58 	-15.33%	28.29%
3/17/20	 27.85 	18.66%	28.24%
3/16/20	 23.47 	-34.95%	27.63%
3/13/20	 36.08 	27.76%	25.07%
3/12/20	 28.24 	-29.01%	17.64%
3/11/20	 39.78 	-14.73%	14.66%
3/10/20	 46.66 	15.80%	16.27%
3/9/20	 40.29 	-23.36%	12.91%
3/6/20	 52.57 	-4.99%	11.21%
3/5/20	 55.34 	-10.04%	10.87%
3/4/20	 61.51 	12.58%	11.86%
3/3/20	 54.64 	-8.50%	9.73%
3/2/20	 59.72 	12.12%	9.82%
2/28/20	 53.26 	-0.67%	5.74%
2/27/20	 53.62 	-13.61%	5.16%
8/20/19	 51.27 	-2.33%	5.33%
8/19/19	 52.50 	3.60%	5.63%
8/16/19	 50.67 	4.37%	5.70%
8/14/19	 48.19 	-8.77%	6.03%
8/9/19	 52.43 	-2.05%	5.72%
8/8/19	 53.52 	5.75%	5.73%
1/9/19	 37.59 	1.39%	6.27%
1/8/19	 37.08 	2.78%	6.31%
1/7/19	 36.07 	2.28%	6.31%
1/4/19	 35.27 	10.17%	6.35%
1/2/19	 34.59 	0.20%	6.18%
12/31/18	 34.52 	2.69%	8.15%
12/28/18	 33.62 	-0.47%	9.00%
12/27/18	 33.78 	2.65%	9.34%
12/26/18	 32.91 	14.72%	9.32%
12/10/18	 40.78 	0.46%	5.48%
12/7/18	 40.59 	-7.00%	5.73%
12/6/18	 43.65 	-0.63%	5.09%
12/4/18	 43.93 	-9.50%	6.21%
10/30/18	 43.52 	4.64%	6.35%
10/29/18	 41.59 	-1.73%	5.45%
10/26/18	 42.32 	-5.44%	5.47%
10/25/18	 44.76 	5.55%	5.24%
10/16/18	 50.29 	6.27%	6.75%
10/15/18	 47.32 	-1.69%	5.34%
10/12/18	 48.13 	4.04%	5.46%
4/6/18	 41.03 	-6.58%	5.42%
4/3/18	 41.60 	3.79%	5.07%
4/2/18	 40.08 	-6.86%	6.36%
3/29/18	 43.03 	4.23%	6.51%
3/28/18	 41.29 	-0.84%	6.47%
3/27/18	 41.64 	-5.25%	6.50%
3/26/18	 43.94 	8.28%	6.35%
2/14/18	 46.42 	4.11%	6.66%
2/13/18	 44.59 	0.88%	6.38%
2/12/18	 44.20 	3.92%	7.03%
2/9/18	 42.54 	4.64%	8.50%
2/8/18	 40.65 	-11.14%	7.39%
2/7/18	 45.75 	-1.89%	6.69%
2/6/18	 46.63 	5.78%	6.99%
2/5/18	 44.08 	-12.30%	5.22%
6/30/16	 21.89 	3.89%	7.39%
6/29/16	 21.07 	5.24%	7.40%
6/28/16	 20.02 	5.42%	6.74%
6/27/16	 18.99 	-5.41%	5.81%
6/24/16	 20.08 	-10.86%	5.79%
1/20/16	 15.39 	-3.80%	5.18%
1/19/16	 15.99 	0.58%	5.55%
1/15/16	 15.90 	-6.54%	5.52%
10/2/15	 17.99 	4.18%	5.14%
9/9/15	 17.81 	-4.06%	5.47%
9/8/15	 18.56 	7.54%	6.83%
9/4/15	 17.26 	-4.45%	5.37%
9/3/15	 18.06 	0.16%	5.24%
9/2/15	 18.03 	5.56%	6.55%
9/1/15	 17.08 	-8.88%	8.18%
8/31/15	 18.75 	-2.54%	6.97%
8/28/15	 19.24 	0.02%	9.32%
8/27/15	 19.23 	7.47%	10.36%
8/26/15	 17.90 	11.79%	9.23%
12/18/14	 21.75 	7.13%	5.40%
6/7/12	 5.62 	-0.04%	5.27%
6/6/12	 5.62 	7.08%	5.28%
12/20/11	 4.73 	9.17%	5.08%
12/6/11	 4.94 	0.08%	5.42%
12/5/11	 4.93 	3.24%	5.33%
12/2/11	 4.78 	-0.15%	5.92%
12/1/11	 4.79 	-0.15%	6.10%
11/30/11	 4.79 	12.43%	7.68%
11/29/11	 4.26 	0.79%	5.60%
11/28/11	 4.23 	8.99%	6.17%
11/15/11	 4.99 	1.64%	6.54%
11/14/11	 4.91 	-3.00%	6.82%
11/11/11	 5.06 	5.80%	6.68%
11/10/11	 4.78 	2.73%	6.05%
11/9/11	 4.66 	-11.02%	6.54%
11/7/11	 5.04 	1.81%	5.52%
11/4/11	 4.95 	-1.78%	6.49%
11/3/11	 5.04 	5.37%	6.54%
11/2/11	 4.78 	4.81%	7.94%
11/1/11	 4.56 	-8.04%	7.70%
10/31/11	 4.96 	-7.72%	7.22%
10/28/11	 5.38 	0.38%	5.86%
10/27/11	 5.35 	10.22%	5.90%
10/21/11	 4.82 	5.66%	5.27%
10/20/11	 4.57 	1.21%	5.15%
10/19/11	 4.51 	-3.52%	5.16%
10/7/11	 3.96 	-2.06%	6.64%
10/6/11	 4.04 	5.40%	7.60%
10/5/11	 3.83 	6.09%	7.22%
10/4/11	 3.61 	5.96%	6.55%
10/3/11	 3.41 	-8.87%	5.69%
9/30/11	 3.74 	-7.13%	6.24%
9/28/11	 3.93 	-6.03%	6.85%
9/27/11	 4.18 	3.16%	7.54%
9/26/11	 4.05 	7.21%	7.17%
9/23/11	 3.78 	1.51%	5.02%
9/22/11	 3.72 	-9.48%	5.07%
9/21/11	 4.11 	-9.06%	5.38%
9/15/11	 4.59 	5.24%	5.20%
9/13/11	 4.19 	2.49%	6.11%
9/12/11	 4.08 	1.89%	6.06%
9/9/11	 4.01 	-7.74%	6.59%
9/8/11	 4.35 	-3.14%	5.94%
9/7/11	 4.49 	8.39%	5.95%
9/2/11	 4.23 	-7.69%	5.98%
8/29/11	 4.63 	8.63%	5.60%
8/26/11	 4.27 	4.39%	5.30%
8/25/11	 4.09 	-4.57%	6.09%
8/24/11	 4.28 	4.31%	8.65%
8/23/11	 4.11 	9.59%	8.24%
8/22/11	 3.75 	0.13%	5.47%
8/19/11	 3.74 	-4.63%	6.98%
8/18/11	 3.92 	-13.04%	7.19%
8/17/11	 4.51 	0.27%	6.12%
8/16/11	 4.50 	-2.44%	9.87%
8/15/11	 4.61 	5.97%	11.01%
8/12/11	 4.35 	2.20%	15.30%
8/11/11	 4.26 	13.34%	15.22%
8/10/11	 3.76 	-13.13%	13.52%
8/9/11	 4.32 	13.91%	13.36%
8/8/11	 3.80 	-19.75%	8.98%
8/5/11	 4.73 	-0.43%	6.38%
8/4/11	 4.75 	-14.15%	6.15%
9/1/10	 3.52 	8.64%	5.20%
7/22/10	 3.67 	6.59%	5.90%
7/7/10	 3.37 	9.44%	5.05%
6/10/10	 3.66 	9.01%	7.20%
6/9/10	 3.35 	-1.51%	5.05%
6/8/10	 3.41 	2.90%	6.80%
6/7/10	 3.31 	-4.14%	6.70%
6/4/10	 3.45 	-10.05%	6.69%
6/3/10	 3.84 	1.03%	6.76%
6/2/10	 3.80 	7.65%	7.01%
6/1/10	 3.53 	-4.82%	6.09%
5/28/10	 3.71 	-3.95%	5.79%
5/27/10	 3.86 	10.25%	5.38%
5/26/10	 3.50 	-2.07%	5.63%
5/25/10	 3.58 	0.33%	5.63%
5/24/10	 3.56 	-3.10%	5.42%
5/21/10	 3.68 	3.64%	5.64%
5/14/10	 4.24 	-5.40%	7.41%
5/13/10	 4.49 	-3.72%	7.19%
5/12/10	 4.66 	4.24%	8.73%
5/11/10	 4.47 	-0.87%	8.47%
5/10/10	 4.51 	12.97%	8.95%
5/7/10	 3.99 	-4.41%	5.38%
5/6/10	 4.18 	-9.96%	5.40%
5/5/10	 4.64 	-1.67%	5.10%
5/4/10	 4.72 	-7.22%	5.30%
5/3/10	 5.08 	4.01%	5.25%
2/5/10	 3.54 	0.58%	5.52%
2/4/10	 3.52 	-9.18%	5.63%
11/5/09	 3.58 	5.67%	5.25%
11/4/09	 3.38 	0.53%	5.43%
11/3/09	 3.37 	0.98%	6.02%
11/2/09	 3.33 	2.03%	5.92%
10/30/09	 3.27 	-8.54%	5.64%
8/21/09	 3.22 	5.59%	5.04%

[Uncorrelated]

Karl Steiner came out with a blog post about the Hedgefundie strategy. tldr, doesn't seem good: https://www.mindfullyinvesting.com/why- ... the-lever/

Based on my quick read, he seems to be basically concluding that it's too risky. That's a reasonable assumption, and Hedgefundie himself concluded that the risk of the strategy was high enough that the majority of his portfolio was still invested in unleveraged index funds. My own version of the strategy is only taking up about 6% of my portfolio, so even if it completely implodes, my retirement plans won't be impacted that much.

It's a reasonable write up, but I think the possibility of interest rates staying low or flattish for a very long period of time has been discounted too much. Lots of mention of time periods with rising or falling rates but not flat

Then the thing is, if real borrowing fees stay negative, LETFs are effectively adding 2 * (inflation - borrowing rate) to their nominal returns just by borrowing. I don't think his analysis covers those conditions. It might make sense then to consider a 5th class of conditions, which is stocks and bonds both facing headwinds but with lots of monetary and fiscal policy support.

This is not how this works. The formula is:

daily return = mkt * L - rf - borrow_spread * B

Where mkt is the market return. L is the leverage (3), rf is the risk free rate and B is the amount of swap contracts inside the ETF (usually 2.5). Note that whether the real borrowing fee is real or negative doesn't even impact the calculation. Only the difference between the risk free rate and the borrow rate (the borrow spread) is entered into the calculation.

As I have said many times before, the height of the risk free rate and the real rate on bonds is completely irrelevant for the asset allocation decision.

[kjm]

Interesting approach.

I ran it for 5-day trailing volatility >= 5%.

Here are the dates from 6/25/2009 when the VIX trailing 5-day volatility was greater than or equal to 5%. It would have got you into the hedge on 2/28/2020 (the day following the 2/27 breach). On that day the VIX was at $22.81. The 10-delta options were pointing at a $37 strike and sold for $0.26. On 3/18 the $37 strike options sold for $36.19.

Wow... That's quite the return! Where are you digging up historical options data?

Something else to try would be using a VXX allocation size proportional to the 5-day volatility rather than a fixed value. Using the following...

Code: Select all

df['UPRO STD'] = df['UPRO % Change'].shift(1).rolling(5).std()
df['VXX Allocation'] = (df['UPRO STD'] > .1) * df['UPRO STD'] ** 0.5

I get...

MODEL RESULTS
Annualized Return: 47.16%
Max Drawdown: -51.2%
Standard Deviation: 46.98%

UPRO RESULTS
Annualized Return: 35.98%
Max Drawdown: -76.82%
Standard Deviation: 52.07%

Not sure these results are all that meaningful with only 1 big drop over the backtest period. I also don't see this being all that helpful over long, drawn out decline. I guess the best risk management for that type of scenario would be putting TMF back into the mix.

[perfectuncertainty]

I think the idea of hedging a 100% UPRO portfolio is an interesting one right now. Instead of holding VXX or VXX calls 100% of the time though, you could try only holding when volatility increases. I put together the following backtest for fun.

- Hold 100% UPRO
- When trailing 5-day (non-annualized) volatility exceeds 10%, move a quarter of the UPRO position into VXX.

When you do that you get the following going back to the inception date of VXX...

MODEL RESULTS
Annualized Return: 41.53%
Max Drawdown: -55.19%
Standard Deviation: 48.28%

UPRO RESULTS
Annualized Return: 34.37%
Max Drawdown: -76.82%
Standard Deviation: 52.07%

The "10% threshold" was met 3 times over that period:
- 8/10/2011 - 8/16/2011
- 8/28/2015
- 3/5/2020 - 4/8/2020

Who knows if this strategy would hold up in the future as we only have 11 years of data for VXX and only 3 pops.

This would work better using VXX call options. You could move maybe 5% of the portfolio to VXX calls to get the same outcome.

I picked the values for the lookback period, volatility threshold and VXX allocation size at random. You could make this more or less sensitive by tweaking these values.

This wouldn't be terribly hard for someone with some basic programing skills to implement or even completely automate. Definitely not a "set it and forget it" strategy though.

The approach is interesting. To date, we have not had a black swan (except for the flash crash) that has come out of nowhere. In the event of something like a mega cyber attack, we would remain unprotected.

[kjm]

The approach is interesting. To date, we have not had a black swan (except for the flash crash) that has come out of nowhere. In the event of something like a mega cyber attack, we would remain unprotected.

True, but you could always hedge your hedges! Keep a smaller permanent hedge and ramp it up according to the rules I laid out.

[Semantics]

Karl Steiner came out with a blog post about the Hedgefundie strategy. tldr, doesn't seem good: https://www.mindfullyinvesting.com/why- ... the-lever/

Based on my quick read, he seems to be basically concluding that it's too risky. That's a reasonable assumption, and Hedgefundie himself concluded that the risk of the strategy was high enough that the majority of his portfolio was still invested in unleveraged index funds. My own version of the strategy is only taking up about 6% of my portfolio, so even if it completely implodes, my retirement plans won't be impacted that much.

It's a reasonable write up, but I think the possibility of interest rates staying low or flattish for a very long period of time has been discounted too much. Lots of mention of time periods with rising or falling rates but not flat

Then the thing is, if real borrowing fees stay negative, LETFs are effectively adding 2 * (inflation - borrowing rate) to their nominal returns just by borrowing. I don't think his analysis covers those conditions. It might make sense then to consider a 5th class of conditions, which is stocks and bonds both facing headwinds but with lots of monetary and fiscal policy support.

This is not how this works. The formula is:

daily return = mkt * L - rf - borrow_spread * B

Where mkt is the market return. L is the leverage (3), rf is the risk free rate and B is the amount of swap contracts inside the ETF (usually 2.5). Note that whether the real borrowing fee is real or negative doesn't even impact the calculation. Only the difference between the risk free rate and the borrow rate (the borrow spread) is entered into the calculation.

As I have said many times before, the height of the risk free rate and the real rate on bonds is completely irrelevant for the asset allocation decision.

I'm not sure how your formulation is all that different than what I said.

real daily return
= daily return - inflation
= (real mkt + inflation) * L - rf - borrow_spread * B - inflation
= real mkt * L - rf + ((L - 1) * inflation - borrow_spread * B)
= real mkt * L - rf + ((L - 1) * inflation - borrow_spread * B)

Okay, so I assumed B = 2...

= real mkt * L - rf + 2 * (inflation - borrow_spread)

And I meant unleveraged real returns, not nominal returns. In any case, assuming inflation gets reflected in the earnings and valuations of companies, which from what I've read it does over moderate time periods, it sure seems to me like a LETF would do better with a negative real borrowing rate than a positive one, all else being equal. It seems to me that this should even be completely obvious with a simple thought experiment -- say inflation was 1000% and borrowing 0%, clearly you'd want to borrow as much as possible as long as you could get some return.

As I have said many times before, the height of the risk free rate and the real rate on bonds is completely irrelevant for the asset allocation decision.

Yes, my point was to disagree with the authors use of backtests and suggest it is inadequate to distill conditions into just four buckets.

[Uncorrelated]

Based on my quick read, he seems to be basically concluding that it's too risky. That's a reasonable assumption, and Hedgefundie himself concluded that the risk of the strategy was high enough that the majority of his portfolio was still invested in unleveraged index funds. My own version of the strategy is only taking up about 6% of my portfolio, so even if it completely implodes, my retirement plans won't be impacted that much.

It's a reasonable write up, but I think the possibility of interest rates staying low or flattish for a very long period of time has been discounted too much. Lots of mention of time periods with rising or falling rates but not flat

Then the thing is, if real borrowing fees stay negative, LETFs are effectively adding 2 * (inflation - borrowing rate) to their nominal returns just by borrowing. I don't think his analysis covers those conditions. It might make sense then to consider a 5th class of conditions, which is stocks and bonds both facing headwinds but with lots of monetary and fiscal policy support.

This is not how this works. The formula is:

daily return = mkt * L - rf - borrow_spread * B

Where mkt is the market return. L is the leverage (3), rf is the risk free rate and B is the amount of swap contracts inside the ETF (usually 2.5). Note that whether the real borrowing fee is real or negative doesn't even impact the calculation. Only the difference between the risk free rate and the borrow rate (the borrow spread) is entered into the calculation.

As I have said many times before, the height of the risk free rate and the real rate on bonds is completely irrelevant for the asset allocation decision.

I'm not sure how your formulation is all that different than what I said.

real daily return
= daily return - inflation
= (real mkt + inflation) * L - rf - borrow_spread * B - inflation
= real mkt * L - rf + ((L - 1) * inflation - borrow_spread * B)
= real mkt * L - rf + ((L - 1) * inflation - borrow_spread * B)

Okay, so I assumed B = 2...

= real mkt * L - rf + 2 * (inflation - borrow_spread)

And I meant unleveraged real returns, not nominal returns. In any case, assuming inflation gets reflected in the earnings and valuations of companies, which from what I've read it does over moderate time periods, it sure seems to me like a LETF would do better with a negative real borrowing rate than a positive one, all else being equal. It seems to me that this should even be completely obvious with a simple thought experiment -- say inflation was 1000% and borrowing 0%, clearly you'd want to borrow as much as possible as long as you could get some return.

As I have said many times before, the height of the risk free rate and the real rate on bonds is completely irrelevant for the asset allocation decision.

Yes, my point was to disagree with the authors use of backtests and suggest it is inadequate to distill conditions into just four buckets.

You're multiplying the inflation by leverage, but inflation should only be applied once. The third line of your equation is definitely not equal to the second line. Following your convention, I would expand like this:

Code: Select all

letf real daily return
= letf daily return                                    - inflation
= letf excess return                              + rf - inflation
= (mkt excess return * L - borrow_spread * (L-1)) + rf - inflation

You cannot gain the risk free rate or inflation rate multiple times by leveraging. You can obtain the excess return (risk premium) or borrow spread multiple times by leveraging.



I made a small typo in my previous post, rf should exist on both sites of the equation:
nominal returns:
letf excess return + rf = mkt excess return * L - borrow_spread * B + rf

[Semantics]

It's a reasonable write up, but I think the possibility of interest rates staying low or flattish for a very long period of time has been discounted too much. Lots of mention of time periods with rising or falling rates but not flat

Then the thing is, if real borrowing fees stay negative, LETFs are effectively adding 2 * (inflation - borrowing rate) to their nominal returns just by borrowing. I don't think his analysis covers those conditions. It might make sense then to consider a 5th class of conditions, which is stocks and bonds both facing headwinds but with lots of monetary and fiscal policy support.

This is not how this works. The formula is:

daily return = mkt * L - rf - borrow_spread * B

Where mkt is the market return. L is the leverage (3), rf is the risk free rate and B is the amount of swap contracts inside the ETF (usually 2.5). Note that whether the real borrowing fee is real or negative doesn't even impact the calculation. Only the difference between the risk free rate and the borrow rate (the borrow spread) is entered into the calculation.

As I have said many times before, the height of the risk free rate and the real rate on bonds is completely irrelevant for the asset allocation decision.

I'm not sure how your formulation is all that different than what I said.

real daily return
= daily return - inflation
= (real mkt + inflation) * L - rf - borrow_spread * B - inflation
= real mkt * L - rf + ((L - 1) * inflation - borrow_spread * B)
= real mkt * L - rf + ((L - 1) * inflation - borrow_spread * B)

Okay, so I assumed B = 2...

= real mkt * L - rf + 2 * (inflation - borrow_spread)

And I meant unleveraged real returns, not nominal returns. In any case, assuming inflation gets reflected in the earnings and valuations of companies, which from what I've read it does over moderate time periods, it sure seems to me like a LETF would do better with a negative real borrowing rate than a positive one, all else being equal. It seems to me that this should even be completely obvious with a simple thought experiment -- say inflation was 1000% and borrowing 0%, clearly you'd want to borrow as much as possible as long as you could get some return.

As I have said many times before, the height of the risk free rate and the real rate on bonds is completely irrelevant for the asset allocation decision.

Yes, my point was to disagree with the authors use of backtests and suggest it is inadequate to distill conditions into just four buckets.

You're multiplying the inflation by leverage, but inflation should only be applied once. The third line of your equation is definitely not equal to the second line. Following your convention, I would expand like this:

Why shouldn't I multiply inflation by leverage? If SPY returns 3% real/5% nominal and I lever 3x with no borrowing cost then my real return is 3% + 2*(3% + 2% inflation) = 13%. I just captured twice the inflation rate in my real returns by leveraging up, vs capturing no inflation in an unleveraged investment.

You cannot gain the risk free rate or inflation rate multiple times by leveraging. You can obtain the excess return (risk premium) or borrow spread multiple times by leveraging.

You absolutely can gain the inflation rate multiple times. To simplify the example, suppose I were to invest in an ETF that exactly tracks CPI. Then my return is exactly 1x inflation. If I borrow at 0% and lever 3x then my return is exactly 3x inflation. I gained the inflation rate three times.

I think the difference is just that I am decomposing market returns into a real component and an inflation component. This artificial adjustment makes sense to me because what I care about are real returns. Do you disagree with my high level point that a leveraged investor is better off when their real borrowing costs are negative vs when they are positive, all else being equal?

[Uncorrelated]

You're multiplying the inflation by leverage, but inflation should only be applied once. The third line of your equation is definitely not equal to the second line. Following your convention, I would expand like this:

Why shouldn't I multiply inflation by leverage? If SPY returns 3% real/5% nominal and I lever 3x with no borrowing cost then my real return is 3% + 2*(3% + 2% inflation) = 13%. I just captured twice the inflation rate in my real returns by leveraging up, vs capturing no inflation in an unleveraged investment.

You're capturing the risk premium trice, not the inflation. That's how asset pricing literature has worked since 1950-ish. In your example you are clearly converting the real return to the excess return (= risk premium), then multiplying by the leverage, and then converting the whole thing back to real return.

Do you disagree with my high level point that a leveraged investor is better off when their real borrowing costs are negative vs when they are positive, all else being equal?

Within the usual asset pricing framework, expressing the borrow rate as a real number would result in a unit mismatch when performing the calculations. I don't understand how it would be possible to express the borrow rate as a real number in the first place, or how to interpret such a number.

Within the usual decision framework, the investment decision depends only on the excess return, not the inflation rate (https://en.wikipedia.org/wiki/Merton%27 ... io_problem. Note that the real rate or risk-free rate does not impact the investment decision). If the risk premium increases or decrease, or the borrow spread increases or decreases, or the volatility increases or decreases, those things affect the asset allocation decision. However if all those variables stay the same and the inflation rate or risk free rate increases, nothing happens to your asset allocation.

[keith6014]

Was curious if bond (TMF) portion is necessary if you have a monthly cashflow. Was thinking of doing %100UPRO and during a huge drawdown TMF won't be there to ballast but I will have steady cashflow to buy more of it.

[stockmaster]

So you're just 100% UPRO now?

I'm 25% FNGU and 75% YINN

I'm also in my 20's so I'm willingly taking on a lot of risk.

[Impatience]

So you're just 100% UPRO now?

I'm 25% FNGU and 75% YINN

I'm also in my 20's so I'm willingly taking on a lot of risk.

I don’t think you understand what you’re doing. Taking on a lot of risk for a lot of reward is fine but you’re taking a risk far in excess of the potential gains. The extra volatility and peculiar risks introduced by each of those ETFs far surpasses the potential upside and you have no protection at all. At all.

I would implore you to consider something like 70% TQQQ / 30% TMF if you want a hyper aggressive portfolio that will match most of your current gains with far less risk.

Some people have a very high risk appetite and that is great. However nobody should have an appetite for a lower risk/reward ratio. That is like having an appetite for pain.

[000]

So you're just 100% UPRO now?

I'm 25% FNGU and 75% YINN

I'm also in my 20's so I'm willingly taking on a lot of risk.

Thanks for sharing. Don't burn yourself out there.

[Aw0k3n]

So you're just 100% UPRO now?

I'm 25% FNGU and 75% YINN

I'm also in my 20's so I'm willingly taking on a lot of risk.

That IS a lot more risk.

FNGU
ETP Type: ETN Leveraged 3x
Asset Class: Equity
Net Assets: $783.7M
Net Expense Ratio: 0.95%
Sponsor: Bank of Montreal
Inception Date: 01/22/2018
Investment Philosophy: Passively Managed
Benchmark Index: NYSE FANG+ Index
Legal Structure: Senior, Unsecured, Unsubordinated Debt


"Thus ETN has an additional risk compared to an ETF; if the credit of the underwriting bank becomes suspect, the investment might lose value, the same way a senior debt would...ETNs don't actually own any underlying assets of the indices or benchmarks they are designed to track"

[langlands]

Based on my quick read, he seems to be basically concluding that it's too risky. That's a reasonable assumption, and Hedgefundie himself concluded that the risk of the strategy was high enough that the majority of his portfolio was still invested in unleveraged index funds. My own version of the strategy is only taking up about 6% of my portfolio, so even if it completely implodes, my retirement plans won't be impacted that much.

It's a reasonable write up, but I think the possibility of interest rates staying low or flattish for a very long period of time has been discounted too much. Lots of mention of time periods with rising or falling rates but not flat

Then the thing is, if real borrowing fees stay negative, LETFs are effectively adding 2 * (inflation - borrowing rate) to their nominal returns just by borrowing. I don't think his analysis covers those conditions. It might make sense then to consider a 5th class of conditions, which is stocks and bonds both facing headwinds but with lots of monetary and fiscal policy support.

This is not how this works. The formula is:

daily return = mkt * L - rf - borrow_spread * B

Where mkt is the market return. L is the leverage (3), rf is the risk free rate and B is the amount of swap contracts inside the ETF (usually 2.5). Note that whether the real borrowing fee is real or negative doesn't even impact the calculation. Only the difference between the risk free rate and the borrow rate (the borrow spread) is entered into the calculation.

As I have said many times before, the height of the risk free rate and the real rate on bonds is completely irrelevant for the asset allocation decision.

I'm not sure how your formulation is all that different than what I said.

real daily return
= daily return - inflation
= (real mkt + inflation) * L - rf - borrow_spread * B - inflation
= real mkt * L - rf + ((L - 1) * inflation - borrow_spread * B)
= real mkt * L - rf + ((L - 1) * inflation - borrow_spread * B)

Okay, so I assumed B = 2...

= real mkt * L - rf + 2 * (inflation - borrow_spread)

And I meant unleveraged real returns, not nominal returns. In any case, assuming inflation gets reflected in the earnings and valuations of companies, which from what I've read it does over moderate time periods, it sure seems to me like a LETF would do better with a negative real borrowing rate than a positive one, all else being equal. It seems to me that this should even be completely obvious with a simple thought experiment -- say inflation was 1000% and borrowing 0%, clearly you'd want to borrow as much as possible as long as you could get some return.

As I have said many times before, the height of the risk free rate and the real rate on bonds is completely irrelevant for the asset allocation decision.

Yes, my point was to disagree with the authors use of backtests and suggest it is inadequate to distill conditions into just four buckets.

After parsing the back and forth between you and Uncorrelated, I believe I've found a small mistake in your calculation that clears the whole thing up. I believe it should be:

real daily return
= daily return - inflation
= (real mkt + inflation) * L -(L-1) * rf - borrow_spread * B - inflation
= (real mkt) * L - (L-1) * rf + ((L - 1) * inflation - borrow_spread * B)

Note that this is equivalent to Uncorrelated's formula:

(excess mkt) * L - borrow_spread * B + rf - inflation

We see that the risk free rate and inflation only enter as the combined term rf - inflation, i.e. the real interest rate without a leverage multiplier. Leverage only acts on the risk premium.

In your example, it is highly unlikely that inflation would be 1000% and borrow would be 0%. In times if hyperinflation, interest rates rise to counter it. Or to put it another way, if your scenario held, then since stocks rise roughly with inflation (say), the risk premium would be a ludicrous 1007% (if the real return on stocks is 7%). So yes, you would borrow as much as you could, but it can all be explained by the size of the risk premium.

[blackball]

Interesting and really long thread. Thinking of doing this in my registered account which is about 10% of my total portfolio. Currently holds vti and zroz in 70/30 split. Risk level seems lower than my taxable account though where i am 4x levered with mostly futures.

[hell0men]

Shorting leveraged ETFs is better than going long leveraged ETFs. It is really that simple. I challenge you to find one case where going long would return more than shorting the inverse.

Don't forget about expenses for holding a short position and ETF splits. It seems that your tests do not take this into account.

[hell0men]

Karl Steiner came out with a blog post about the Hedgefundie strategy. tldr, doesn't seem good: https://www.mindfullyinvesting.com/why- ... the-lever/

Thanks! Its what we need here - research of different rates conditions.

I did not understand why UPRO shows a negative growth or a smaller growth than the index in the rolling CAGR test. It's a strange model. There was no such thing on the normal backtest.

One way or another, while they overtake the index. TMF can be replaced with cash or something else, or you can simply reduce the size of the leverage and increase it when the market has fallen and we do a rebalancing.

[Thereum]

Umh, if I go to submit a sell order on 100 shares of FAZ, IBKR says the maintenance margin is $855. An order of 100 shares of FAZ is roughly $950 dollars short, hence, my claim of 90%. But it sounds like I'm mistaken, how do you determine the MM on FAZ? Thanks!

Are you using portfolio margin? My margin requirement for shorting FAZ is about 30-50% depending on how much SPX delta I have.

What you say boils down to claiming that it is always better to leverage and increase exposure as a market declines. To the extent you aren't forced to liquidate (because the position is small to begin with) and to the extent markets will recover, then this always makes money. I don't disagree given those assumptions. I only disagree with the assumptions being a given.

Buy low sell high

Are you referring to the PV graph? That's probably not delta-neutral, PV just thinks it because it uses monthly data. The only way to make money pair trading SQQQ and TQQQ is if you go delta positive after market declines (SQQQ short grows, TQQQ shrinks) and vice-versa. It's as though it was delta-neutral in a large time-scale but it really is just market-timing (increasing stock exposure when stocks drops and vice-versa).

Disagree here. You can actually make money being strongly delta negative. (I posted examples.) You are taking advantage of volatility decay. People here need to stop pretending that this isn't a real thing. Yes, it's exaggerated by the investing media, but it's real.

I don't think I follow, do you have an example? Thanks.

This requires portfolio margin. You just buy weekly OTM calls, which protect the short position. You can do call backspreads so that the spread is for a credit. IBKR gives me big margin reductions wit these trades, which means they think my risk is going down with these trades. (Example: buy two 22 calls and sell one 21 call for a credit)

Yes, I understand what you meant but vega is the wrong term there. In options lingo, realized volatility is known as "gamma". You're right that long TQQQ does poorly with high realized volatility. Like I said already, it is like TQQQ is short gamma.

TQQQ develops higher delta dollars as it goes up and lower delta dollars as it goes down. To me, that is the definition of long gamma. Short SQQQ develops higher delta dollars as it goes down and lower delta dollars as it goes up. To me that is the definition of short gamma.

Perhaps we are seeing things differently, but to me, long TQQQ is more like buying a call option, while short SQQQ is more like selling puts.

[Steve Reading]

Umh, if I go to submit a sell order on 100 shares of FAZ, IBKR says the maintenance margin is $855. An order of 100 shares of FAZ is roughly $950 dollars short, hence, my claim of 90%. But it sounds like I'm mistaken, how do you determine the MM on FAZ? Thanks!

Are you using portfolio margin? My margin requirement for shorting FAZ is about 30-50% depending on how much SPX delta I have.

I do use PM but I got plenty of delta in my portfolio so maybe that's why.

This requires portfolio margin. You just buy weekly OTM calls, which protect the short position. You can do call backspreads so that the spread is for a credit. IBKR gives me big margin reductions wit these trades, which means they think my risk is going down with these trades. (Example: buy two 22 calls and sell one 21 call for a credit)

Oh sure, I understand this. You called it something like a "diagonal" and I wasn't familiar with that. But yeah, protective calls. You obviously need them.

TQQQ develops higher delta dollars as it goes up and lower delta dollars as it goes down. To me, that is the definition of long gamma.

Delta-dollar is not a thing but I think I know what you mean. Provided I understood what you said, then that's definitely not the definition of gamma.

To clarify, let me ask you this. Is QQQ itself long gamma as well (based on what you think gamma is and the definition above)? It has "higher delta dollars" as QQQ goes up no?

Perhaps we are seeing things differently, but to me, long TQQQ is more like buying a call option, while short SQQQ is more like selling puts.

Maybe in terms of vega (TQQQ, like a call option, is positive vega).

[Semantics]

It's a reasonable write up, but I think the possibility of interest rates staying low or flattish for a very long period of time has been discounted too much. Lots of mention of time periods with rising or falling rates but not flat

Then the thing is, if real borrowing fees stay negative, LETFs are effectively adding 2 * (inflation - borrowing rate) to their nominal returns just by borrowing. I don't think his analysis covers those conditions. It might make sense then to consider a 5th class of conditions, which is stocks and bonds both facing headwinds but with lots of monetary and fiscal policy support.

This is not how this works. The formula is:

daily return = mkt * L - rf - borrow_spread * B

Where mkt is the market return. L is the leverage (3), rf is the risk free rate and B is the amount of swap contracts inside the ETF (usually 2.5). Note that whether the real borrowing fee is real or negative doesn't even impact the calculation. Only the difference between the risk free rate and the borrow rate (the borrow spread) is entered into the calculation.

As I have said many times before, the height of the risk free rate and the real rate on bonds is completely irrelevant for the asset allocation decision.

I'm not sure how your formulation is all that different than what I said.

real daily return
= daily return - inflation
= (real mkt + inflation) * L - rf - borrow_spread * B - inflation
= real mkt * L - rf + ((L - 1) * inflation - borrow_spread * B)
= real mkt * L - rf + ((L - 1) * inflation - borrow_spread * B)

Okay, so I assumed B = 2...

= real mkt * L - rf + 2 * (inflation - borrow_spread)

And I meant unleveraged real returns, not nominal returns. In any case, assuming inflation gets reflected in the earnings and valuations of companies, which from what I've read it does over moderate time periods, it sure seems to me like a LETF would do better with a negative real borrowing rate than a positive one, all else being equal. It seems to me that this should even be completely obvious with a simple thought experiment -- say inflation was 1000% and borrowing 0%, clearly you'd want to borrow as much as possible as long as you could get some return.

As I have said many times before, the height of the risk free rate and the real rate on bonds is completely irrelevant for the asset allocation decision.

Yes, my point was to disagree with the authors use of backtests and suggest it is inadequate to distill conditions into just four buckets.

After parsing the back and forth between you and Uncorrelated, I believe I've found a small mistake in your calculation that clears the whole thing up. I believe it should be:

real daily return
= daily return - inflation
= (real mkt + inflation) * L -(L-1) * rf - borrow_spread * B - inflation
= (real mkt) * L - (L-1) * rf + ((L - 1) * inflation - borrow_spread * B)

Note that this is equivalent to Uncorrelated's formula:

(excess mkt) * L - borrow_spread * B + rf - inflation

We see that the risk free rate and inflation only enter as the combined term rf - inflation, i.e. the real interest rate without a leverage multiplier. Leverage only acts on the risk premium.

I see, thanks for working through that. So I suppose there is a reference frame discrepancy - I was originally talking about real leveraged returns relative to the real market returns, which is a weird thing to consider, but seemed like one way to explain why this period could be different from the 70s.

In your example, it is highly unlikely that inflation would be 1000% and borrow would be 0%. In times if hyperinflation, interest rates rise to counter it. Or to put it another way, if your scenario held, then since stocks rise roughly with inflation (say), the risk premium would be a ludicrous 1007% (if the real return on stocks is 7%). So yes, you would borrow as much as you could, but it can all be explained by the size of the risk premium.

Yeah, that makes sense in the usual case, however the Fed has implied they want to keep rates lower than inflation for several years which is why this seems different than the 1962-80 period to me, assuming stocks and bonds both face headwinds going forward. Negative real borrowing rates mean that instead of paying a cost to leverage poor returns, we are "being paid" to leverage poor returns. Potentially. I'm imagining with modern understanding of monetary policy instead of seeing starkly contrasting periods like the four boxes in the article we might see much steadier markets.

[Raraculus]

Was curious if bond (TMF) portion is necessary if you have a monthly cashflow. Was thinking of doing %100UPRO and during a huge drawdown TMF won't be there to ballast but I will have steady cashflow to buy more of it.

That was my thinking as well, but for the SSO ETF. I did a small backtest (Just the past 12 months) of UPRO alone and just contributed on the dips. The volatility of UPRO meant this strategy has incurred trading costs and losses. UPRO did recover eventually. But, if I had invested in such a strategy, would I have recovered or bailed quickly?

I'm thinking of just investing in SSO alone and use whatever cashflow I have to paper over the dips. Backtesting (past 12 months) this strategy did reasonably well. Sure, it was volatile, but nothing like UPRO. I could actually keep at this strategy for a whole year, just using my regular contributions.

I do have one question for those a lot more experienced than I... Given that SSO is a leveraged (2x) fund, what are the margin requirements at Interactive Brokers? Let's say I have $1,000 invested in SSO, and can I invest another $1,000 in SSO using margin? During my small backtest of SSO, I found that I could reach into margin reserves to paper over the dips on 1-2 occasions before it recovered. I could then use my regular contributions to pay off the margin loan(s).

[cooljack4u]

Thank you, this is very helpful. I am finding that just like March 2020 Feb 2018 had 2 to 3 days where VIX options were in the money. Most noticebly around the Feb 5. Additionally 15 May 2018 VIX options with a strick price of 37 were priced higher than same expiry strike price of 30 which if right, does not make sense. Thinkorswim thinkback tells me so at the peak level of hedge that they offered.
Most of the times the options expired worthless, which is fine with insurance aspect. I am wondering if there is some rule of thumb where one would cash out and make a change to equity allocation when it happens. Now that would be timing the market, isn't it and we know it is hard if not impossible to accomplish. I believe March 2020 the options ended in the money however that was very volatile and I wounder how often one would see such a scenario. In general even at othe times when VIX was elevated the montly options expired worthless.

Coming back to the 10 deltas, if we cannot get a realstic VIX option at around stike of 50 would you consider getting smaller number of VIX options or tweaking equity allocation itself would be a better choice?

One more question, the 0.3 % a month is about 4% a year assuming none of the VIX options expire in the money. So underperformance is a insurance that you pay for keeping HFEA and sleep better at night. Is that the right way to look at it?

We want the VIX options to expire worthles. Just like car insurance - we don't want to use it.

Yes, with a strategy like HFEA we are chasing high returns and expect to at least double the market return (else it's not worth the risk). So I'm content giving up the 3.6% return for the insurance. I know without any doubt that the VIX hedge will hit. I don't know when. But I do know it will more than cover the losses during a black swan since it is inversely correlated (VIX is based on the SP500 and so is UPRO).

Does it make sense to have rules as when to hedge and when to cash out ? I understand the insurance concept. Is there a way to reduce the cost have the same benefit. What if we but the VIX options only in the months when VIX is below 15 ? Also, is there a optimal cashing out number ? like you sell the options when VIX is crossing 40 and invest that money back into TQQQ ?

[djeayzonne]

Here is a detailed description of how HFEA (55/45 UPRO/TMF) portfolio has performed with the protection of a VIX options hedge. The numbers are refined from my prior post which overstated the performance. The reason for the overstatement was due to the fact that I did not derive the current monthly value of HFEA to be used as a basis for purchasing the monthly VIX option tranches that would be in effect in mid-March 2020. Nevertheless, the performance of HFEA with the protection of the VIX options hedge was substantially better than the performance of HFEA without the benefit of the insurance that was in effect since the beginning of the model.

Background Setup.
Start Date of 9/1/2011 based on stockmaster's question on page 132 of this thread.
Starting Capital: 100,000
Allocation: 55% UPRO / 45% TMF
UPRO Peak is the focus and occurred on 2/19/2020

VIX Hedge Setup.
We start with the 100,000 in starting capital
Allocate 0.3% of Net Liq each month and buy 10 delta VIX call options ~ 120 days to expiration. Purchase this on the 3rd Friday of the month.
This created 4 tranches of VIX call options that would be in effect during mid-March 2020.

The tranches were as follows:
11/15/2019 Net Liq: 648,793 to purchase VIX call options expiring on 3/18/2020. Strike price 45.00 Cost per option 0.300. Number purchased 6,400.
12/15/2019 Net Liq: 653,806 to purchase VIX call options expiring on 4/15/2020. Strike price 45.00 Cost per option 0.275. Number purchased 7,100.
01/15/2020 Net Liq: 718,380 to purchase VIX call options expiring on 5/20/2020. Strike price 40.00 Cost per option 0.200. Number purchased 10,700.
02/15/2020 Net Liq: 778,954 to purchase VIX call options expiring on 6/17/2020. Strike price 42.50. Cost per option 0.200. Number purchased 8,400.
Total Cost of the VIX Options Hedge in effect in mid-March 2020: 8,399.80

HFEA Value as of2/19/2020.
As of 2/19/2020 HFEA with the VIX Hedge applied each month since 9/1/2011 was worth 778,954.40.

This is derived using PV and daily prices from TradingView charts as follows:
PV Model with 0.3% monthly withdrawal LINK
As of 1/31/2020 HFEA with VIX Hedge applied had a Final Balance of 718,380
Price UPRO on 1/31/2020 = 69.37
Price of TMF on 1/31/2020 = 31.99
UPRO 55% allocation = 5,696 shares
TMF 45% allocation = 10,105 shares
Price of UPRO on 2/19/2020 = 80.36
Price of TMF on 2/19/2020 = 31.79
Using the # of shares for each calculated above the value for HFEA with the monthly 0.3% allocation for the VIX hedge is 778,954.40.

Performance During Mid-March 2020 for HFEA and the VIX Option Hedge
By 3/9/2020, HFEA declined by 3.57% from the 2/19 highpoint to a value of 751,182.60.
By 3/13/2020, HFEA declined by 25.64% from the 2/19 highpoint to a value of 579,204.14.
By 3/16/2020, HFEA declined by 26.86% from the 2/19 highpoint to a value of 569,763.08.

By 3/9/2020, the VIX hedge increased by 1242.53% to a value of 104,370.00.
By 3/13/2020, the VIX hedge increased by 2549.63% to a value of 214,164.00.
By 3/16/2020, the VIX hedge increased by 6912.03% to a value of 580,597.00.

By 3/9/2020, HFEA combined with the VIX hedge increased by 9.83% to a value of 855,552.60.
By 3/13/2020, HFEA combined with the VIX hedge increased by 1.85% to a value of 793,368.14.
By 3/16/2020, HFEA combined with the VIX hedge increased by 47.68% to a value of 1,150,360.08.

Point of Reference
As a point of reference if one had not utilized any hedging HFEA would have been worth 1,055,118.98 on 2/19/2020 but worth 771,762.57 on 3/16/2020.
This model and analysis does not include any application of hedging comparison for declines in HFEA in August 2015, February of 2018, and December 2018 even though the costs of the protection are modeled as being in effect at that time. The VIX hedge would have provided substantial benefit in 2008 and contained any drawdown. And again in 2010 and 2011 - I have not modeled those periods to ascertain how effective the insurance would have been.

Here is my spreadsheet with the analysis for 3/2020 LINK.

Hello, I wanted to revisit this discussion.
Why 10 deltas and 120 days out resulting in very cheap options requiring you to buy so many?
I would think the commissions on doing this would make this SIGNIFICANTLY more expensive to actually implement.

For that reason, why not 60 days out and a strike price of 40% over current VIX levels, for example?
Or 30 deltas instead of 10?