Inversely Correlated Investments with the Greatest Spread?

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SS Rambo
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Inversely Correlated Investments with the Greatest Spread?

Post by SS Rambo »

Curious about what could create two positions, inversely correlated, where the spread is as large as possible. For example TQQQ and SQQQ (though due to sequencing, I know they down always remain exact inverses over time). Modeling them over any length of time would ideally result in a similar shaped graph as seen below. But is there a way to proportionately leverage the positions for a greater spread (ideally not with derivatives)? Notional example for illustrative purposes:

Image

The theoretical example for this would be a two-color roulette game: an investment on Red and an equal investment on Black = one investment results in +100% and one results in -100%. Is there a way to build portfolios like this gamble, with securities?

Appreciate any thoughts/discussion/construction.
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David Jay
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Re: Inversely Correlated Investments with the Greatest Spread?

Post by David Jay »

What’s your goal?

Holding a product and the inverse is not a winning strategy. If it was, you could just buy TQQQ and sell TQQQ short. What would that achieve?
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius
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SS Rambo
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Re: Inversely Correlated Investments with the Greatest Spread?

Post by SS Rambo »

David Jay wrote: Thu Sep 17, 2020 7:24 am What’s your goal?

Holding a product and the inverse is not a winning strategy. If it was, you could just buy TQQQ and sell TQQQ short. What would that achieve?
As far as a goal, this is not for a portfolio/position I'm looking to establish.

Asking here under Investing Theory, for input/assistance with a course assignment.
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Re: Inversely Correlated Investments with the Greatest Spread?

Post by David Jay »

Portfolio diversification comes from uncorrelated assets, not from inversely correlated assets. If the stock market, over the long term has historically always gone up, something with inverse correlation would have always gone down. Not something you want to hold as part of any long term portfolio.

Uncorrelated assets will move independently from the stock market, hopefully providing reduced volatility compared to an all-stock portfolio.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius
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SS Rambo
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Re: Inversely Correlated Investments with the Greatest Spread?

Post by SS Rambo »

I don't disagree with anything there. Again, the question I am asking has nothing to do with creating a practical portfolio or diversification.

I am taking a graduate course on Investing Theory, which is the theme of this sub-forum, so before I finish my work I wanted to source other views. I agree with all of your points, but I didn't post this in Personal Investments for that very reason.
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Re: Inversely Correlated Investments with the Greatest Spread?

Post by firebirdparts »

It’s trivial to find inversely correlated assets, as fund providers offer plenty, but I think you can’t assemble anything useful out of them.

What you want is Short-term uncorrelated assets that both have high positive returns. That you can work with.
Last edited by firebirdparts on Thu Sep 17, 2020 4:03 pm, edited 1 time in total.
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Re: Inversely Correlated Investments with the Greatest Spread?

Post by 000 »

It's unclear what you're asking.

The obvious answer is that a long and short position on the most volatile underlying available will be inversely correlated with the greatest spread.

Is that what you mean? Or something else?
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Re: Inversely Correlated Investments with the Greatest Spread?

Post by columbia »

David Jay wrote: Thu Sep 17, 2020 3:19 pm Portfolio diversification comes from uncorrelated assets, not from inversely correlated assets. If the stock market, over the long term has historically always gone up, something with inverse correlation would have always gone down. Not something you want to hold as part of any long term portfolio.

Uncorrelated assets will move independently from the stock market, hopefully providing reduced volatility compared to an all-stock portfolio.
A lot of folks have relied on LTT being negatively correlated with stocks; one wonders when that party will be over (again).
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Re: Inversely Correlated Investments with the Greatest Spread?

Post by atdharris »

columbia wrote: Thu Sep 17, 2020 4:25 pm
David Jay wrote: Thu Sep 17, 2020 3:19 pm Portfolio diversification comes from uncorrelated assets, not from inversely correlated assets. If the stock market, over the long term has historically always gone up, something with inverse correlation would have always gone down. Not something you want to hold as part of any long term portfolio.

Uncorrelated assets will move independently from the stock market, hopefully providing reduced volatility compared to an all-stock portfolio.
A lot of folks have relied on LTT being negatively correlated with stocks; one wonders when that party will be over (again).
Yep. I worry about my LTTs more these days. Unfortunately, TLT has remained fairly flat despite the market sell-off, unlike in March when it spiked 20%. It's worrisome to be sure.
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Re: Inversely Correlated Investments with the Greatest Spread?

Post by vineviz »

David Jay wrote: Thu Sep 17, 2020 3:19 pm Portfolio diversification comes from uncorrelated assets, not from inversely correlated assets. If the stock market, over the long term has historically always gone up, something with inverse correlation would have always gone down. Not something you want to hold as part of any long term portfolio.

Uncorrelated assets will move independently from the stock market, hopefully providing reduced volatility compared to an all-stock portfolio.
This isn’t true: inversely correlated assets would provide perfect diversification to each other, especially if their variances are similar.

The practical difficulty in portfolio construction is finding pairs of inversely correlated assets that BOTH have a positive expected returns. Such pairs are clearly rare, but it’s not theoretically impossible for them to exist.

Stocks and US Treasury bonds are the closest pair most investors have access to.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: Inversely Correlated Investments with the Greatest Spread?

Post by David Jay »

vineviz wrote: Thu Sep 17, 2020 4:34 pm
David Jay wrote: Thu Sep 17, 2020 3:19 pm Portfolio diversification comes from uncorrelated assets, not from inversely correlated assets. If the stock market, over the long term has historically always gone up, something with inverse correlation would have always gone down. Not something you want to hold as part of any long term portfolio.

Uncorrelated assets will move independently from the stock market, hopefully providing reduced volatility compared to an all-stock portfolio.
This isn’t true: inversely correlated assets would provide perfect diversification to each other, especially if their variances are similar.

The practical difficulty in portfolio construction is finding pairs of inversely correlated assets that BOTH have a positive expected returns. Such pairs are clearly rare, but it’s not theoretically impossible for them to exist.
Sorry, but I live and invest in the real world.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius
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Re: Inversely Correlated Investments with the Greatest Spread?

Post by vineviz »

David Jay wrote: Thu Sep 17, 2020 4:36 pm
vineviz wrote: Thu Sep 17, 2020 4:34 pm
David Jay wrote: Thu Sep 17, 2020 3:19 pm Portfolio diversification comes from uncorrelated assets, not from inversely correlated assets. If the stock market, over the long term has historically always gone up, something with inverse correlation would have always gone down. Not something you want to hold as part of any long term portfolio.

Uncorrelated assets will move independently from the stock market, hopefully providing reduced volatility compared to an all-stock portfolio.
This isn’t true: inversely correlated assets would provide perfect diversification to each other, especially if their variances are similar.

The practical difficulty in portfolio construction is finding pairs of inversely correlated assets that BOTH have a positive expected returns. Such pairs are clearly rare, but it’s not theoretically impossible for them to exist.
Sorry, but I live and invest in the real world.
But we’re commenting in a forum dedicated to investment theory, so being correct has some value yes?
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: Inversely Correlated Investments with the Greatest Spread?

Post by Steve Reading »

David Jay wrote: Thu Sep 17, 2020 3:19 pm Portfolio diversification comes from uncorrelated assets, not from inversely correlated assets. If the stock market, over the long term has historically always gone up, something with inverse correlation would have always gone down.
That’s not what inversely correlated means at all.
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Re: Inversely Correlated Investments with the Greatest Spread?

Post by vineviz »

Steve Reading wrote: Thu Sep 17, 2020 5:11 pm
David Jay wrote: Thu Sep 17, 2020 3:19 pm Portfolio diversification comes from uncorrelated assets, not from inversely correlated assets. If the stock market, over the long term has historically always gone up, something with inverse correlation would have always gone down.
That’s not what inversely correlated means at all.
Thank you for saying this so directly.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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SS Rambo
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Re: Inversely Correlated Investments with the Greatest Spread?

Post by SS Rambo »

000 wrote: Thu Sep 17, 2020 4:02 pm It's unclear what you're asking.

The obvious answer is that a long and short position on the most volatile underlying available will be inversely correlated with the greatest spread.

Is that what you mean? Or something else?
That's exactly what I mean. Assuming a long and a short position could be established, the question boils down to "what is the most volatile security". The thought exercise comes into play when you try to limit it to 'home-runs and strikeouts' (not the volatile stocks that have a probability of ending up relatively close to their basis).
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Re: Inversely Correlated Investments with the Greatest Spread?

Post by 000 »

SS Rambo wrote: Thu Sep 17, 2020 6:52 pm
000 wrote: Thu Sep 17, 2020 4:02 pm It's unclear what you're asking.

The obvious answer is that a long and short position on the most volatile underlying available will be inversely correlated with the greatest spread.

Is that what you mean? Or something else?
That's exactly what I mean. Assuming a long and a short position could be established, the question boils down to "what is the most volatile security". The thought exercise comes into play when you try to limit it to 'home-runs and strikeouts' (not the volatile stocks that have a probability of ending up relatively close to their basis).
I would start looking in microcap land. A stock screener like finviz.com can show volatility and whether a given stock is shortable and/or optionable.
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Re: Inversely Correlated Investments with the Greatest Spread?

Post by vineviz »

SS Rambo wrote: Thu Sep 17, 2020 6:52 pm
000 wrote: Thu Sep 17, 2020 4:02 pm It's unclear what you're asking.

The obvious answer is that a long and short position on the most volatile underlying available will be inversely correlated with the greatest spread.

Is that what you mean? Or something else?
That's exactly what I mean. Assuming a long and a short position could be established, the question boils down to "what is the most volatile security". The thought exercise comes into play when you try to limit it to 'home-runs and strikeouts' (not the volatile stocks that have a probability of ending up relatively close to their basis).
Among exchange-traded instruments, UVXY is about as volatile an asset as I’ve seen. Annualized standard deviation of 130% or so.

https://www.proshares.com/funds/uvxy.html
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: Inversely Correlated Investments with the Greatest Spread?

Post by LadyGeek »

SS Rambo wrote: Thu Sep 17, 2020 1:27 pm As far as a goal, this is not for a portfolio/position I'm looking to establish.

Asking here under Investing Theory, for input/assistance with a course assignment.
SS Rambo wrote: Thu Sep 17, 2020 3:59 pm I am taking a graduate course on Investing Theory, which is the theme of this sub-forum, so before I finish my work I wanted to source other views. I agree with all of your points, but I didn't post this in Personal Investments for that very reason.
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Re: Inversely Correlated Investments with the Greatest Spread?

Post by 000 »

I want to clarify that the greatest terminal spread (as opposed to ongoing spread) will be generated by the underlying asset that has the greatest growth over the timeframe in question. Over a handpicked short timeframe, these can be the same, but likely not if the timeframe is many years.
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Re: Inversely Correlated Investments with the Greatest Spread?

Post by NoRegret »

SS Rambo wrote: Wed Sep 16, 2020 7:17 pm Curious about what could create two positions, inversely correlated, where the spread is as large as possible. For example TQQQ and SQQQ (though due to sequencing, I know they down always remain exact inverses over time). Modeling them over any length of time would ideally result in a similar shaped graph as seen below. But is there a way to proportionately leverage the positions for a greater spread (ideally not with derivatives)? Notional example for illustrative purposes:

Image

The theoretical example for this would be a two-color roulette game: an investment on Red and an equal investment on Black = one investment results in +100% and one results in -100%. Is there a way to build portfolios like this gamble, with securities?

Appreciate any thoughts/discussion/construction.
A straddle on a triple leveraged ETF.
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