Ah, Sweet Leverage!
Rockets of Profit
Wealth with Treasury Bills and Big Indexes
Mostly USA ETFs Portfolio
Percent Gains--Weekly--Hypothetical
7.2 years April 12, 2002--June 26, 2009
See Comments below, Rules at the bottom
This updates the original study of February 2, 2008, 'Foolproof Failsafe' with details on how it works.
The Trend indicator here has been vastly improved over the original as we shall see in a moment, enabling potentially superb returns with less real risk.
The base systems, shown in the chart, beat the broad indexes by large margins, especially in bear markets like the present one. In an earlier version of the study (here), subscribers were invited to vote a preference for System 50 or 80. The results were six to one in favor of System 50, the higher return version with higher risk. The rest of today's study is devoted to it.
Its premise is minimum risk. From inception to date, over seven years, the worst 'realized' loss has been -1.8%. This would, I believe, be tolerable to the most scrupulous trustee. And, indeed that is the way the system can be used. Its base return is 9% per year (not counting dividends; including Tbills rates when holding cash). See the first row in the table below.
TABLE OF RESULTS
Relation of Leverage to Profit & Loss
|
profit |
compound |
worst |
|
levg |
%/yr |
tot%gain |
loss% |
|
1 |
9.0 |
86 |
-1.8 |
|
2 |
16.1 |
193 |
-3.7 |
|
3 |
22.9 |
343 |
-5.5 |
|
4 |
29.5 |
544 |
-7.3 |
|
5 |
35.7 |
800 |
-9.2 |
|
6 |
41.3 |
1109 |
-11.0 |
|
7 |
46.4 |
1459 |
-12.9 |
|
8 |
50.8 |
1827 |
-14.7 |
|
9 |
54.3 |
2179 |
-16.5 |
|
10 |
56.9 |
2472 |
-18.4 |
|
11 |
58.4 |
2655 |
-20.2 |
|
12 |
58.7 |
2682 |
-22.0 |
|
|
|
|
|
QQQQ |
1.1 |
9 |
-51.7
|
|
SPY |
-2.6 |
-18 |
-55.9
|
|
|
DIA |
-2.6 |
-17 |
-52.9 |
Note: the worst loss% column records 'realized' losses. For QQQQ, SPY, and DIA, worst-case drawdowns are used. There are no asset-value realized losses for indexes. These symbols, as you know, represent the tradeable ETFs for their underlying untradeable indexes respectively, the Nasdaq-100, Standard & Poor's Composite Index, and the Dow-Jones Industrial Average.
(Chart)
I wondered, as before, what would happen if I used options to scale up the leverage. As a risk-control technique, they are impervious to drawdown considerations. The better risk metric is 'realized' losses. Relative to profits and gains, the losses in the table above appear astonishingly low.
The question now is what level of leverage is desirable and practical, and how do I get it? To answer those questions, we must look the options themselves.
LONG OPTIONS RESULTS
Derived from QQQQ, SPY & DIA
Leverage Multiple 8x
Underlying ETFs
|
Buy |
Sell |
Buy |
Sell |
P/L |
%P/L |
wks |
|
5/2/2003 |
7/3/2003 |
100 |
211 |
111 |
111 |
9 |
|
8/15/2003 |
10/31/2003 |
211 |
337 |
126 |
59 |
11 |
|
11/28/2003 |
3/5/2004 |
337 |
326 |
-11 |
-3 |
14 |
|
6/10/2004 |
7/2/2004 |
326 |
283 |
-43 |
-13 |
3 |
|
9/17/2004 |
10/15/2004 |
283 |
250 |
-34 |
-12 |
4 |
|
10/22/2004 |
12/31/2004 |
250 |
323 |
73 |
29 |
10 |
|
6/3/2005 |
8/19/2005 |
323 |
338 |
16 |
5 |
11 |
|
11/4/2005 |
12/23/2005 |
338 |
308 |
-30 |
-9 |
7 |
|
9/15/2006 |
12/15/2006 |
308 |
458 |
150 |
49 |
13 |
|
4/13/2007 |
5/11/2007 |
458 |
492 |
34 |
7 |
4 |
|
5/25/2007 |
6/1/2007 |
492 |
420 |
-72 |
-15 |
1 |
|
9/7/2007 |
10/26/2007 |
420 |
864 |
444 |
106 |
7 |
|
5/16/2008 |
5/30/2008 |
864 |
947 |
83 |
10 |
2 |
|
5/8/2009 |
6/19/2009 |
947 |
1696 |
749 |
79 |
6 |
(Chart of column 4)
The results table above shows every trade multiplied by 8 times leverage and accumulates the compounded return . Why did I choose 8 times leverage? That was determined by calculation in the following manner.
At midweek, I priced QQQQ, SPY, and DIA exchange-traded funds and their in-the-money call options (about 7- to 8-percent in) expiring December of this year. I assumed various levels of gains in the underlying ETFs. Those parameters gave an 8x multiple of results of return on the options vs straight returns on the underlying funds, regardless of the level of gains.
Referring to the Table of Results (first table above) and looking up the leverage level 8 indicated approximately what to expect in the way of returns and loss. The 'real' results came reasonably close--an average profit per year of 56% and a total gain of 1596% compounded. This template will work for any combination of times and prices.
Note to fiduciaries. If this use of options is too experimental for the cautious trustee, I believe it would be difficult to fault the results embodied in row one of the top Table of Results. Add 3% dividend return to the annual average capital gain of 9% (=12%) per year, and you beat the long-term historic total return average of the S&P 500 (about 10%) by a wide mark. The worst loss of -1.8% is eminently tolerable.
The key to the successful performance in this study is due to the long-term trend indicator imported from the Worldwide ETFs portfolio. It acts as a 'failsafe' filter which trumps or confirms the normal and customary Market Trend indicator native to the USA portfolio. I have added it as a free upgrade to the Mostly USA ETFs trading-system weekly Rankings table. It is labeled 'Index options' and tracks the 'Long-term trend' indicator from the standard Worldwide ETFs Rankings table. Here is an example.
|
May |
|
|
|
Jun |
|
|
|
|
2009 |
8 |
15 |
22 |
29 |
5 |
12 |
19 |
26 |
|
MARKET TIMING |
|
|
|
|
|
|
|
|
|
Leading Trend |
79 |
80 |
86 |
95 |
98 |
99 |
100 |
96 |
|
Lagging Trend |
17 |
16 |
28 |
55 |
76 |
87 |
92 |
97 |
|
MarketTrend |
Up |
Up |
Up |
Up |
Up |
Up |
Up |
Dwn |
|
Index options |
50 |
73 |
95 |
100 |
100 |
100 |
100 |
100 |
How to Use This Method. In the table section above from the Mostly USA portfolio, the newly added row is 'Index options' when Index options rise above 50, and the Market Trend is 'Up', a buy signal is triggered. This happens May 15. Buy the best-performing option which was QQQQ in the Rankings table on this date. The option is held until June 26 when it is sold because the Market Trend turns down.
RULES
When MarketTrend is Up and Index options are greater than 50, buy a call option, otherwise stay in cash. Sell the option when either reverses, trend turns to Down or Index options falls to less than 50. Act promptly on any change in these signals.
The option to buy should be in-the-money and have five months or more to expiration. (Other combinations may do better--or worse--than the parameters used in this article.)
Caveat.
Boring. More than 70% of the time, these systems are invested in U.S. Treasury Bills. That's astonishing, and potentially
off-putting. Investors want action. It trades only twice a year. But it is investing. Can you stand this degree of inactivity? I'm not sure I can, but I intend to use the system for a portion of assets. The rockets of profits which erupt from the date plain are too tempting to resist. The cumulative loss sequence is marginally unsatisfactory--the three consecutive losses in rows three through five score -23%. The real number may be lower than that due to options dynamics.
Back to Start
Posted
7/22/2009 5:12 p.m. EDT
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