Author Topic: Market Neutral Strategy matching the S&P  (Read 3039 times)

Ross812

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Re: Market Neutral Strategy matching the S&P
« Reply #10 on: August 02, 2018, 08:36:07 AM »
I think one approach you could take is to think about in which scenarios this strategy could "blow up" or underperform, if ever?

One scenario is a slow rising, low volatility market.  For instance, if the market grinds forward 5% one year, 0% the next, 10% the year after, plus dividends, you are not getting any of that gain if you have 10% OTM calls.


I would agree this strategy would underperform in your scenario. You can obviously adjust the % by which your call is OTM to compensate. At 10% OTM, you would expect the calls to expire worthless ~60% of the time. The caveat to buying calls closer to the money is the amount of leverage you can buy goes down. In back testing, the further out of the money the calls the more this strategy returns but the returns are even more lumpy. You can play with buying two different strike values say 5% and 12% otm or buy bull spreads, say buy the 5% OTM sell the 15% OTM capping your returns but allowing more leverage between 5-15%.

I think the worst case for this strategy is actually high volatility making the LEAP options more expensive thus decreasing the leverage. Think Jan 2009, the market returned 26% that year but this VIX started around 40ish. I have no idea what the 12 mo. realized volatility index was at. This is the VIX-1Y:

     

The realized volatility index was probably a bit lower, maybe 30. SP500 was at 890 so to buy calls at 980 (+10%) Black Scholes says Jan 2010 leap options would have cost about $8.10. This means you could have only bought 19 XSP leaps. The market at expiration of those leaps was $1144. So you made (114.4-98.0)*100*19 = $31,160 or 6.2%.

If volatility had been at 14.4 (average) those calls would have cost $2.75 and you would have bought 56 calls. (114.4-98.0)*100*56 = $91,940 or 18.3%.

The ideal scenario is low volatility high returns:
Let's look at 2013. The market returned ~30%. 2 Jan 2013 12m Vol. was 12.96%. SP500 was ~1426 and ended 1/17/2014 at ~1848. 10% OTM leaps cost $3.65 so you bought 42 leaps. Gain was (184.8-157)*100*42= $116,760 or 23%

 
« Last Edit: August 02, 2018, 08:37:38 AM by Ross812 »
96% Fixed Income CDs, Muni, Corporate Debt - 4% SPX Options


EliG

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Re: Market Neutral Strategy matching the S&P
« Reply #11 on: December 29, 2018, 08:28:07 AM »
Hi Ross,

How do you allocate the funds between taxable and tax-sheltered accounts?

My guess, with the caveat that I know little about the US taxation system:

Sheltered accounts: 100% fixed income.
Taxable accounts: whatever is left of the fixed income pie, plus calls.


Ross812

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Re: Market Neutral Strategy matching the S&P
« Reply #12 on: December 31, 2018, 11:36:33 AM »
Hi Ross,

How do you allocate the funds between taxable and tax-sheltered accounts?

My guess, with the caveat that I know little about the US taxation system:

Sheltered accounts: 100% fixed income.
Taxable accounts: whatever is left of the fixed income pie, plus calls.

That is correct. The SPX calls are taxed on a 60/40 long/short basis:

Under section 1256 of the Tax Code, profit and loss on transactions in certain exchange-traded options, including SPX, are entitled to be taxed at a rate equal to 60% long-term and 40% short-term capital gain or loss, provided that the investor involved and the strategy employed satisfy the criteria of the Tax Code.
 
96% Fixed Income CDs, Muni, Corporate Debt - 4% SPX Options