Selling Volatility Is Easy To Get Wrong

RCM Alternatives shared conclusions from Dunn Capital about the types of alternatives to use and how to size them in a portfolio. Cutting to the chase, they say it is more effective to have 15% in volatile alternatives like managed futures than to have 30% in low vol alternatives. I would think of low vol alternatives as being various types of arbitrage or the way client/personal holding PPFIX sells volatility that is very far out of the money. 

The argument is similar to the argument for capital efficiency. While I am not a fan of 15% in managed futures, putting 15% in high vol alts should be just as effective as a larger weighting to low vol diversifiers. Using their numbers, 15% in high vol alts allows more of the portfolio to be in equities which are the thing that goes up the most, most of the time. 

 

A 14 year sample size is pretty good. Clearly, 30% in low vol alts in Portfolio 2 caused a lag but the volatility was also noticeably lower which is probably more about the smaller weight to equities than the alts. The Sharpe and Sortino numbers don't show much difference. It's not clear to me that one approach is obviously better, some will be willing to have volatility to get more basis points of growth. 

The lack of differentiation between Portfolios 1 and 4 it noteworthy. Portfolio 4's result is essentially identical but it allows for better diversification with 5% each in three different high vol diversifiers instead of loading up on managed futures. 

Quick pivot, GraniteShares is continuing to add to its YieldBoost suite. The basic idea is that these funds sell put option spreads, a bullish strategy, on 2X levered ETFs. I believe YSPY which does this with a 2X S&P 500 ETF is the second longest tenured fund in the suite with one for Tesla being the first one. Sticking with YPSY to avoid crazy CEO risk, here's what YSPY has done.

And here is the one for Nvidia (NVDA) which started trading in May as NVYY compared to NVDY which is the YieldMax covered call fund.

These are not proxies for their underlying reference securities. They one way or another sell the volatility of the underlying reference securities and that is a different thing. 

The erosion of these, every time I look is always pretty swift but the total return is almost always positive. I can't think of an instance where the total return has been negative but there probably are at least a couple. Again, these should not be expected to track the common on a total return basis unless the common goes into a death spiral. Nvidia common stock is up 36% since NVYY started trading so not that far off but the articles that say these lag are correct in terms of simple numbers but miss the point of not being proxies for the common stock. And to make clear one point, whenever the next bear market comes along that lasts more than a month, all of the crazy high yielders should be expected to go down a lot.

GraniteShares listed two new ones including one AZYY which references Amazon. 

Selling volatility is a valid strategy but there are probably more ways to get it wrong than get it right. That alone might reasonably dissuade people. I continue to spend time on this because I am convinced funds that sell volatility will at some point figure out a way to lessen the drawbacks and I want to understand that evolution when it happens. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

A Catastrophe To Learn From

Here's a wild one by way of Bloomberg about the following high yield muni bond fund.

It holds/held mostly unrated bonds that don't trade, there really is no market for them. They are valued using pricing services that try to compare versus similar bonds. This is not uncommon but the pricing isn't necessarily accurate. The fund was carrying a couple of issues at 70-80 cents on the dollar that were more correctly valued at less than five cents. 

The fund faced heavy redemptions as part of the fallout from the April crash which cascaded into a series of unfortunate circumstances eventually leading to what looks like a permanent impairment of capital. 

Part of Bloomberg's coverage included an investor whose advisor put him into the fund leading to an arbitration filing. I asked Copilot to find the arbitration filing to see what percentage of the the investor's account was in the fund and while a percentage was not available, Copilot's conclusion from the filing was that it had to have been a large percentage. 

It was already a one star fund for poor risk adjusted returns before this happened, also according to Copilot.

If ever there was the perfect anecdote for diversifying your diversifiers, this is it. Over a long enough period, the odds of owning one or two things that blow up like this is pretty high. It may be unavoidable but the impact of such a blow up can be pretty easily mitigated with correct position sizing.

Per Bloomberg, RJMAX was yielding 300 basis points or so above high quality muni's. Whether that spread was a enough compensation is a different discussion but even if it was enough compensation, 300 or more basis points tells you it is risky. The way I size some of the esoteric fixed income segments is pretty small. If a client is 60/40 then I might go with 8-10% of the fixed income sleeve or 3.2%-4% of the overall portfolio. A 65% drop in a 4% weighted bond fund would be a 260 basis point hit to the portfolio. That is not a ruinous hit to the client's portfolio. 

Somewhere on an advisor's priority list (very high up) should be making sure clients aren't financially damaged by what you do. Let's be clear though, if the S&P 500 drops 50% and the equity allocation in a portfolio drops 55% that is not what I mean. A long time ago, a reader shared that he had 25% of his portfolio in a lottery ticket biotech that I believe was working on something for migraines. The stock blew up. It was his own doing but an advisor doing something like that is what I mean. Without knowing, if the advisor in the RJMAX story had 10% of the client's total portfolio, I don't think even that would rise to the level of ruinous but that is far more than I would ever do. A 20% weighting to something with the idiosyncratic risk of RJMAX would probably cross the line. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

How The Hell Are Stocks Going To Go Up?

It is difficult to look at the totality of what is going on in America and feel good. This post will not express true political ideology in the context of the current state of the country, but simply acknowledge there is division and disharmony and the observation that both parties blame the other. 

I've been a registered Libertarian for ages but my beliefs range from Libertarian to independent. On some issues I am conservative and others I am liberal. An anecdote from the aftermath of Tuesday night's structure fire that might tell you where I am coming from. 

The picture is a screen grab of two of our trucks from a drone video that a realtor came and took the next morning and posted online. The video includes shots of the front of what was the house, the rubble and the surrounding houses. This upset a lot of people, if your house burned down you might not want a detailed video of it posted online. Apparently, quite a few people called the president of the fire board to complain and we discussed it briefly and yesterday's monthly meeting. My penny and half of input was he's an adult trying to run a business here (as a realtor) and if he made a bad decision, let him own the consequences, it has nothing to do with us. There was agreement of course as it's an obvious conclusion. 

More succinctly, the starting point of my beliefs  is "between consenting adults."

A few times in the past I'd said that the country's economic issues related to things like debt, deficits and Social Security are bigger in terms of origins and solutions than our political cycles. The priority of getting reelected tends to make it hard to find political solutions but at the same time, I am not calling for longer political terms so I don't know what the answer is. Maybe a congressman or senator only gets eight years or ten years so you better make it count which might appeal to a sense of vanity and legacy. 

I don't place complete blame on the current party in power, these issues started years ago. Did our deterioration start under the second Bush? Did Clinton leave a little more of a mess for Bush when he left? Does it all land on Obamacare? There is probably no single right answer so there can be no single wrong answer either.

The initial reaction to Biden's presidency seems very negative, maybe this is odd but his term made no impression on me at all. He sat in the chair for four years. Whether you love or hate Trump, I'm not sure how the agenda resembles anything that is conservative in a political sense, it's unrecognizable as conservative ideology. I think it is fair to say the division in the country these days is terrible for everyone and I have no idea what the path to healing that division will be.

With all of that, how the hell are stocks going to up? Is the threat now worse than the reality of The Financial Crisis? I don't know. The 2000's were not a good decade for domestic stocks but some things still went up in value, notably foreign stocks and gold. 

If current threats cause another decade like the 2000's, that would be unfortunate but against a backdrop like that, there will be things that go up. If you have a diversified portfolio that goes narrower than a broad based index or a 60/40 fund then you probably already own some of what will go up whenever the next market malaise comes. 

With markets currently close to all time highs, it should be easier to take a more objective look at your portfolio to assess how robust it is or isn't in case bad things happen to the broad indexes. As is my typical viewpoint, I don't want to try to predict what, more like protect against if.

My idea of portfolio robustness means having some things that very reliably go up when stocks go down, owning a couple that probably will go up if stocks go down and a couple of things that pretty much always go up a little no matter what is going on. That describes protection but it is diversification like maybe foreign equities and a theme or two in the mix is where the chance for owning the non-hedge market segments that go up. If you include individual stocks, you might have luck that way too in a lost decade. 

Another aspect of robustness is having the proper asset allocation to prevent accumulators from panic selling and allows decumulators to meet their income needs without selling low. 

Again, with everything going on, how the hell are stocks going to up? I don't know but stocks do tend to go up far more often than not. That's not going to change over the intermediate and longer term regardless of whether there is a period where returns run below trend. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Is Selling Puts The Answer?

Update update I made a decimal error, the put sale proceeds would be $287.00 for two months, not $2870. The two month return would be about 1% annualizing out to 6% if it could be repeated six times. Really dumb mistake but I thought about this post overnight and realized the error. Sorry everyone. 

Barron's wrote about the prospect of yields going down and offered a couple of very standard ideas including a 2 star global bond fund. And on a related note, Bloomberg covered the success that PIMCO has had this year making a very good call on yield curve steepening leading to a strong 2025 up to this point. 

In terms of looking for yield, one of the comments (always read the comments) suggested selling put options. Selling puts is a bullish strategy where the person buying the put is protecting against or betting on a decline in the price of the underlying and the put seller wins the trade if the underlying doesn't drop below the strike price of the put. Winning in this context is getting to keep the premium without having the put assigned forcing the put seller to buy the stock at the strike price. 

If a stock is trading around $310 and a two month put struck at $270 is sold for $2.87, the seller keeps the $2.87 as long as the stock stays above $270. The multiplier on all of this is 100. One option controls 100 shares so the strike price is 100 shares at $270 so $27,000 worth of stock potentially and the option premium taken in would be $2870. 

Those numbers are JP Morgan (JPM) common stock and a put struck at $270 that expires on November 21. The reason I picked JPM as an example is that over the long term it has looked like the stock market so I am on the lookout for whether the stock has a lot of seriously negative divergences versus the market. In early 2005, the S&P 500 was going higher and JPM took a real turn lower. That was the only incidence I can find of a meaningful divergence. However, the stock very consistently goes down a lot more than the S&P 500 when the index turns down. So maybe anytime the market catches a cold, JPM tends to catch pneumonia and there have been a few instances where the index caught a cold and JPM caught tuberculosis. 

Sticking with our example, selling a put would mean segregating enough cash to buy the 100 shares for each put sold. So there would need to be at least $27,000 in the money market to pay for the stock if assigned so the $2870 in premium could be thought of as the return. $2870/$27,000 is 10.6% for the two months. If, and it's a big if, that trade can be repeated six times, two months six times equals one year, and the return is compelling of course. If that is too close to the money, a lower struck put could be sold instead, the November $260 was bid at $1.93 late Friday for a two month return of 7.14%. 

If between now and November 21, the stock crashes or the index crashes (expecting JPM would feel a crash worse), the put seller would be paying $270 per share for a stock that might be trading at $240 or $250 or whatever. Not a riskless trade by any means but reasonably a differentiated return.

There are funds that sell index puts targeting different types of outcomes that we've looked at many times before. 

YSPY is a crazy high yielder on track to yield 50%. WTPI from WisdomTree used to be PUTW and it yields about 11% and looks similar to the types of covered call funds that are not crazy high yielders. Client and personal holding PPFIX as you can see is very absolute return-ish only selling puts very far out of the money. The yield is a round 4%, so similar to T-bills but is differentiated, and there might be some price appreciation along the way too. 

The price only PPFIX has had the highest CAGR in the very short time sampled, the tortoise/hare analogy might fit here. The erosion to YSPY, the chart goes back to its inception, has been swift. At some point I'm sure it will reverse split. The index it tracks isn't going to zero so it won't go to zero but the percentage drop could resemble some of the VIX products. That could be fine for some sort of drawdown or depletion strategy but this is not one to misunderstand.

Back to the PIMCO trade about yield curve dynamics, great for them they got that right, there is some differentiation in doing that but that is not one I would ever attempt with client money, it seems like a binary bet akin to guessing what interest rates will do. 

One of the other comments suggested closed end funds for yield. Yes there is yield there but there is also volatility. 

Copilot says that for the last ten years, JPC's yield has averaged between 7-8%. Yahoo shows the yield now at 9.67%. It had 7and 8% yields back when treasury yields were sub-100 basis points so that much of a spread over riskless T-bills tells you there is risk and/or volatility. Again, according to Copilot the characterizations of the distributions has been mostly actual yield but there have been some periods where ROC was kind of high. 

Looking at the backtest stats, the price only CAGR has only been a decline of 91 basis points, that's not so bad in exchange for that yield but...

...the drawdowns have been brutal. FWIW, the volatility profile is much lower than YieldMax funds or other crazy high yielders but JPC doesn't "yield" 50% either. 

I haven't used CEFs for clients in ages but I am not dismissive of them. I think the volatility potential calls for small allocations for anyone interested. A small slice can create disproportionately high income to a portfolio and like with other very yieldy products, a normal allocation to equities has a good chance of more than overcoming any price erosion. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Structure Fire!

Tuesday night, Walker Fire was called out to a structure fire around 10pm. Part of the process for responding to any incident is an evaluation of what is actually happening which can sometimes differ what what the person calling 911 might think they're seeing. For a fire, we tell dispatch that there is a "working fire" when there's actually fire.

Sometimes it may come in as a fire but not actually be one but this was. One of our firefighters lives very close to the scene and let us know on our tactical channel that it was a fire and I in turn relayed to our dispatch. My telling dispatch "working fire" signals to any other departments coming to assist (this is known as mutual aid) that there is really a fire too. 

The fire occurred about a minute or two away from a substation we have that has one engine that is four miles from our main station. We have six firefighters that live up in the area I am talking about so they were able to grab that engine get to the scene quickly and start the process of trying to prevent things from getting worse. In this instance, getting worse would have meant embers blowing onto other houses, there were quite a few very close by including one that might have only been 50 feet away. Another potential bad outcome could have been ripping as a ground fire and then taking out other houses.

We came from where the arrows are, driving uphill to what I called lower road. The reporting party or RP called from that one house at the bottom of the drawing marked RP so we were called to that address. The fire though was actually on Upper road. It was all very bunched up and the fire was easily reached with hose from Lower road. Both Upper and Lower roads dead end.

Engine 85 is the truck stationed in the area and was on scene first. I drove Engine 86 with two other firefighters and I assumed IC (incident command) when we arrived and also functioned as the engine operator (engineer) of 86 for most of the incident. Having two roles on an incident this complex is not ideal but it just played out that way. 85 pulled hose straight up from their truck toward the back of the house and 86 pulled hose up toward the front of the house. 

Shortly thereafter, mutual aid arrived at what seemed like the same time, one engine from two different departments. They checked in with me when they arrived and asked "where do you need us?" Fortunately, I knew they layout of the area also I did not want to turn Lower road into more of a parking lot than it already was so I asked them to go in on Upper road and work from up there. For anyone who has been a firefighter my thinking was that engines 1 and 2 (not their real numbers) could get the A and B sides while we worked the C and D sides. 

The larger red box is the house and the smaller was a wood pile that went up that some of our personnel worked on. WT stands for water tender which is a water truck. Ours hold 2000 gallons, far more than what engines carry. They'd fill the engines, run dry eventually, then go refill and come back.

We were able to knock down the fire pretty quickly which greatly reduces the threat of the fire spreading. Shortly after this point I released the two mutual aid engines. 

From there it went from drama and high leverage to the drudgery of trying to actually extinguish the fire. There was what was essentially deep rubble inside footprint of the house. The rubble was deep like quicksand so there was no way to get in there with hose and effectively, fully put it out, this would have been unsafe in my opinion. 

At this point we started to use foam to try to smother the heat. We used a lot and got to the point where there was just one area that was still obviously retaining heat. There could have been other areas holding heat, we couldn't be certain but there was the one area where after foaming it up pretty good, smoke would start coming up again 10-20 minutes later. 

All in it was about 12 hours and one of those calls that we'll always remember.

WSJ Joins The Party

The WSJ wrote about three alternatives to the typical 60/40 portfolio allocation, all three of which we've looked at here before. I added a fifth.

The results

Our backtest goes to Aug 30, 2000 because that was the timeframe WSJ cited. Portfolio 5 simulates 67% in NSTX which leverages up in such a way that 67% to that fund equals 100% in VBAIX. 

Was the leverage in Portfolio 5 worth it? Based on growth rate it seems like it was. Because of the volatility, the Sharpe Ratio wasn't impressed just being right in the middle of the pack and there hasn't been reliable crisis alpha.

If you're interested in very simple 30/70, iShares has an ETF for that with symbol AOK which has $630 million in AUM. For what it's worth, I think 70% in bonds in the AGG/intermediate or longer treasuries sense is a dreadful idea. 

I've been writing about most of these alts for a very long term and certainly the idea of avoiding duration for much longer than that and I am convinced it works. MERIX/PPFIX are client and personal holdings.

VBAIX' return with AOK's volatility. IRL, I might want smaller weightings to more alts though or maybe a larger allocation to something like TFLO or add in T-Bills.

We just got back from a quick trip, so just a short, fun post. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

I Made A Bored Ape!

Remember NFTs, bored apes and pudgy penguins?

"Ryder Ripps" shared his story on Twitter about buying the following bored ape a few years ago for $425,000 and just now selling it for $37,000. 

I would be willing to let this go for just $25,000.

Don't even think about right clicking on it.

This is a part of the crypto mania I never understood when it was at its height and still don't understand it now. I said pretty much the same thing several times regarding my interest which was they are fun to look at for a moment before moving on. I don't understand they're having any monetary value.

Ripps got a lot of comments about right clicking and so on and he kept talking about the sense of community with these, "You cannot access the Culture through Right Click Save" he said. The loss though left a "hole in my chest."

The whole thing from Ripps might be satirical but if you were following this you know the dollars involved were this big. I still see some of this now, people posting these so it's not dead but the decline has been staggering for anyone who paid up. DappRadar says the decline has been 93% from the peak which is consistent with Ripps' story. 

I have this card of Darnell Hillman that I doubt was even $5. If you're any kind of basketball fan and don't know about Hillman or the ABA, it would be a very fun rabbit hole to go down. Get the book Loose Balls by Terry Pluto. The book is fun and so is having the card.

See the forest for the trees on these things and make good decisions. Is a bored ape akin to a baseball or basketball card? That seems plausible from the outside looking in or maybe Garbage Pail Kids? NFTers would tell me to fuck off with that comparison but maybe one you really like is worth $10-$20. Not $10,000, a plain $10, a fun little thing.

But I will still let Ape With SCBA go for $25,000. No takers? How about if I reduce it slightly to $100? 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.