SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

Anchor Maximum Drawdown Analysis


One of the most common questions asked about the Anchor and Leveraged Anchor strategies relates to “what’s the most I can lose on the trade.”  Fortunately, that’s a fairly easy number to calculate for any one given time on a known portfolio.  A yearlong dynamic calculation is a bit more difficult. 

Below is a presentation of both calculations. Note this is a discussion on the current portfolio.  Actual losses in new or differently structured portfolios may vary dramatically. 

The current Leveraged Anchor portfolio looks like (as of July 15, 2019):
 

image.png

     

Before we continue, lets take a look at the model we posted in our Leveraged Anchor Implementation article when we just started the Leveraged Anchor implementation:

image.png           

The current implementation is using 50% leverage. 

SPY was up around 20% YTD on July 15, 2019. Based on the table, the Anchor was expected to slightly lag (1-2%). In reality, it produced 23.8% return, actually outperforming the markets.


Now, lets look at the maximum loss. It is going to occur at some point after the long call is worth zero.  Hypothetically, that would occur Dec 31 when there is zero time value left in the long calls. Let’s say there’s a catastrophic September 11 type event, and the markets open on December 31 at SPY 175.  We picked 175 because that’s the “worst case” ending price of SPY.  If it continues to go down after that point, our long puts become more profitable.  In this hypothetical on December 31, the Leveraged Anchor Portfolio would look like:
 

image.png

               

Our starting investment of the year was $100,000.  In the event that the market declines 41% from its current position (30% from the start of the year price), the Leveraged Anchor portfolio would be down 7.5% on the year -- and that’s ignoring any additional cash we’d get between now and the end of the year from BIL dividends and put rolls.  At that same time, the market as a whole would be down just over 30%.  In other words, a good result.

 

For those who want to see what a bigger crash would look (as opposed to just trusting that bigger crashes are better), below assumes a price of SPY 100 on December 31:
 

image.png

 

As noted earlier, the farther the market drops below 175, the better the Leveraged Anchor will perform. If the market dropped 60% YTD, Anchor would be up 37.7%. As currently constructed if we make no more trades, the worst case scenario of the year is down 7.5%. This is significantly better than being simply long in the market.

 

However, all of the above assumes a “static” investment – ignoring the rolls of the short puts, the return of BIL, and other dynamic events.  It is entirely possible to end with a result worse than above if the market enters a prolonged “slow” decline, as you would lose some on the short puts each time they were rolled.

 

Take the following example which assumes that on July 29, the market is at SPY 295.5 – only slightly below our present price of around 298.5 (prices were derived using CBOE’s option calculator):
 

image.png

               

Due to the small decline in SPY, a loss on the short puts would be realized, but the benefit of the long puts has not really kicked in.  This can easily continue until SPY gets to the 270 range.  If the market follows a down trending pattern which looks like:

 

image.png

 

then we end up with the true worst case scenario, as not only have the long calls lost value, but we have lost value rolling the short puts every three weeks.  Note to reach this worst case scenario, there is a price decline over 3 weeks, so we fully realize the loss on the sort puts, but then there’s a market rebound leading to a sale of a put at a higher level (that is not quite as high as the original price), followed by another 3 week decline.  Both Leveraged Anchor and Anchor suffer the most when there is a 3 week market decline, followed by a rebound back up, followed by a three week decline, and this pattern continues for an extended time.  This can lead to the bleeding of a few thousand dollars each roll period. 

 

If you assume that style of decline over the entire year leading up to the long call expiration  (7 more three week periods), it would be possible to lose another $20,000 or so, just depending on the angle of descent of the market decline – the shallower the decline, the worse off Anchor would be.  This is part of the reason why Leveraged Anchor has the short puts hedged at the money, while the long calls are hedged five percent out of the money.  By hedging the short puts at the money, we reduce the potential drawdowns from a slow decline pattern.

 

Of course, in the history of the stock market, the above charted pattern has never declined in that orderly of a fashion for a six month period, much less an entire year.  It’s much more frequent to have sharper declines, rebounds back above the original price, flat periods, etc..  The chance of going down then back up almost to the starting point, then back down – all on exact 3 week cycles, isn’t likely, but it could happen.  Once the stair step down pattern hits the long hedge, small bleeding really starts to be limited, as that hedge goes up in value. 

 

In this worst case, performance of the Anchor strategy will be the worst in a market with an extended pattern as graphed above until the hedge kicks in.  This result would be worse than the 7.5% “one day” catastrophic worst case loss scenario.

 

In our opinion, the “worst” loss someone should expect in the current portfolio is somewhere around a 15% decline from the starting $100,000 investment.   That would require significant “stair stepping” down, in three-week cycles, and the price of SPY ending up right at 175 in December.  That is an awfully specific set of conditions that has to be met to reach that point, but it certainly could happen.  (Note: this is not the maximum theoretical loss, rather our maximum expected loss.  The maximum possible loss should everything go wrong is higher). 

 

Remember, the above is a “worst case” analysis – which Anchor is certainly designed to combat and provide better alternatives than simply being in the market.  The above analysis shows Anchor will still significantly out-perform the market in major declines, but it is not “lossless” as some people believe. 

 

Personally, I greatly appreciate the tradeoff in a catastrophic event or even in sharp downturns.  But I also understand the risks, worst case scenarios, and the market conditions which damage the trade the most.  Anyone trading the strategy should have such an understanding. 

If you would like to give it a try, you can sign up 
here.

 

Christopher Welsh is a licensed investment advisor and president of LorintineCapital, LP. He provides investment advice to clients all over the United States and around the world. Christopher has been in financial services since 2008 and is a CERTIFIED FINANCIAL PLANNER™. Working with a CFP® professional represents the highest standard of financial planning advice. Christopher has a J.D. from the SMU Dedman School of Law, a Bachelor of Science in Computer Science, and a Bachelor of Science in Economics. Christopher is a regular contributor to the Steady Options Anchor Trades and Lorintine CapitalBlog.

 

Related articles:

 

 

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Try It Free

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • Probability and Option Risk

    A lot is said about probability of profitable outcomes in option trades, but do we truly understand what probability is or how it works? Options traders can become better informed and even wiser by looking a step beyond the well-known conclusions.

    By Michael C. Thomsett,

    • 0 comments
    • 343 views
  • Using ORATS in Anchor Testing

    The purpose of the below piece is to demonstrate how Lorntine Capital uses ORATS (Options Research and Technology Services) in our own backtesting. Note: ORATS does not pay me for writing this but has requested that if we like the software, we assist in promoting it.

    By cwelsh,

    • 1 comment
    • 399 views
  • Calculating the Probability of Option Payoff

    A calculation of “breakeven” as well as maximum profit or loss, sets up a single system for modeling and comparing one option to another. But it might also require traders to adopt an unrealistic assumption about outcomes based on best-case or worst-care scenario.

    By Michael C. Thomsett,

    • 0 comments
    • 444 views
  • Realistic Expectations: Using History as A Guide

    One of the biggest challenges I come across with the typical investor is maintaining realistic expectations and being able to properly understand the tradeoffs between risk and return. We all want high returns with low risk and there’s no limit to the efforts we’ll make to find it.

    By Jesse,

    • 0 comments
    • 460 views
  • CAPM As an Alternative Option Pricing Model

    Options traders endlessly debate the merits of the Black-Scholes pricing model. Some swear by it and others don’t even try to use it. Given the many profound flaws in the model, it is not an accurate tool for developing a sense of where price is likely to move in the future. But there are alternatives.

    By Michael C. Thomsett,

    • 0 comments
    • 625 views
  • Option Payoff Probability

    Options traders must, naturally, be concerned with the likelihood of payoff for a strategy. Ironically, one of the most often cited statistics about profit and loss is simply incorrect. That statistic is captured in the headline of a story posted online “Trading Options: Data Shows That 75% or More of Options Expire Worthless.”

    By Michael C. Thomsett,

    • 0 comments
    • 718 views
  • The Minimum Effective Dose (MED) For Cash Flow Planning

    Financial planners can usually give generic advice that will be appropriate for the majority of Americans, and that’s the goal of this article. If we can get the fundamentals of cash-flow planning right (where to put your money after you earn it and pay your taxes and bills), we’re 80% of the way towards maximizing our financial situation.

    By Jesse,

    • 0 comments
    • 712 views
  • Are You Breaking Even? Or Losing?

    Among the good reasons to trade options is the need to meet or surpass your breakeven yield. This is the yield you need just to preserve your purchasing power; and it higher than most people think. In fact, most people relying on moderate to conservative yields from stocks, mutual funds, real estate and savings accounts might be earning well below this breakeven level.

    By Michael C. Thomsett,

    • 0 comments
    • 813 views
  • Buy When You Have the Money, Sell When You Need the Money

    Money can be quite an emotional topic for many of us. Emotions can enhance our experiences and relationships in many ways, but they can act as mental roadblocks especially when trying to make wise financial decisions. One of the most common emotional roadblocks I come across when working with individuals is an unwillingness to invest idle cash to meet long-term goals.

    By Jesse,

    • 0 comments
    • 1,647 views
  • Strategy Selection vs. Risk Management

    "A billion here, a billion there, and pretty soon you're talking about real money." Everett McKinley Dirksen. Let’s begin with the bottom line: When I talk to anyone about the concept of choosing an option strategy (or two) to adopt for trading, I stress that the strategy should have certain characteristics.

    By Mark Wolfinger,

    • 0 comments
    • 788 views

  Report Article

We want to hear from you!


There are no comments to display.



Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account. It's easy and free!


Register a new account

Sign in

Already have an account? Sign in here.


Sign In Now

Options Trading Blogs