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January 2019 Performance Analysis


No one likes losing money, and no one likes hearing "excuses". However, in an effort to be fully transparent, solicit feedback, and to improve our own performance, we're writing this article to do a further breakdown of the losses which our model portfolio incurred in January 2019. 

January 2019 performance was negatively impacted by few big losers. We present below the analysis of those losing trades.

TLT butterfly trade

The TLT butterfly was opened on November 9. It started with slightly delta negative bias with the expectation that TLT will continue drifting lower. For various reasons, TLT reversed higher and never looked back. Our intention was to use any pullback in TLT price to reduce the loss. TLT continued higher almost in a straight line, and when it finally stabilized at the beginning of December, the trade was already down 70%+. We decided to keep it as a lottery ticket, but TLT continued higher and the butterfly expired worthless.

We believed that the TLT rise is temporary and irrational, and it should reverse. Sometimes when you strongly believe in your thesis, you have to stick to your guts. TLT thesis worked very well for us for over 1.5 years, but this time was different. We believe that in the long term, we should stick to our thesis - unless it changes during the live of the trade. This approach proved to work very well over the last 1.5 years.

To put things in perspective, TLT butterfly was one of our most successful strategies in 2017-2018. We closed 15 trades, 14 winners and 1 loser, for a cumulative return of ~300%. Few of those trades were down 40-50% just to reverse and produce solid gains. If we closed every trade that was down 50%, I doubt we would achieve similar performance. In summary, we believed in our thesis, and were right much more often than wrong - just not this time.

SPX and VIX butterfly trades

We implement the SPX butterfly strategy during periods of high volatility. We started using it during October volatility spike, and closed 5 winners in October-November, for cumulative return of 145% (29% average return per trade). Those trades work great if the markets continue lower, and can also serve as hedges. You can read about the strategy here.

The January trade was open on December 21, and February trade was opened on December 24. On December 27 we also opened VIX butterfly trade as an additional hedge, after closing the previous VIX butterfly for 36% gain. With the markets still in a free fall, we felt like this was still an appropriate hedge under the circumstances.

Those trades could benefit greatly from continuous market weakness. However, in the beginning of January the markets started to move up quickly, and all three trades started losing value. We had few other trades at that time that were bullish, so we decided to keep the SPX and VIX trades as hedges. The concern was that if we close SPX and VIX trades for 30-40% loss, and the markets reverse, we might lose the gains in the other trades as well.

While the markets continued higher, SPX and VIX trades continued losing value. During the same period of time, we closed few nice winners as a result of the market recovery (GS, XLV, FB, BABA, CRM, MCD and more). Unfortunately those trades did not fully offset the losses in SPX and VIX trades. 

When the market started to recover, we mentioned few times that we considered those trades hedges at that point (each one was half allocation). The main lesson from those trades is position sizing.

Putting things in perspective

We had an incredible winning streak in the last 3 years. We had only one small monthly loss since May 2016 (1.8% loss in March 2018). During the same period of time, our model portfolio produced an average monthly gain of 8.2%, including 17.3% gain in December 2018 (while most major indexes suffered double digit losses). January was our second worst month since inception, but it happened after the 17.3% gain in December, so even if you started in December, you would be down only 3%.

Occasional big losers are expected when you consistently produce such high returns. Without those few big losers, we would actually have had a decent month in January. But of course there is no woulda coulda shoulda in trading.. 

No rewards without risks

Charles Bilello of Pension Partners provided a pretty good perspective on drawdowns.

There is no such thing as a big long-term winner without enduring drawdowns along the way… Here are some examples:

  • Apple has gained 25,217% since its IPO in 1980, an annualized return of 17%. But Apple investors from the IPO would also experience two separate 82% drawdowns.
     
  • Amazon has gained 38,882% from its IPO in 1997, an annualized return of over 36%. But from December 1999 to September 2001, the stock suffered a 94% drawdown.
     
  • Microsoft has returned 25% a year over the past 30 years, a remarkable feat. But it also suffered two significant drawdowns, one of them as high as 70%.
     
  • Alphabet (formerly Google) has returned 26% per year since its IPO in 2004. It did not achieve these returns, though, in a straight line. Its largest drawdown: a 65% decline from 2007 through 2008.

It should be clear from these four examples that drawdowns are an inevitable part of achieving high returns. All big winners have drawdowns. Accepting this fact can go a long way toward controlling your emotions during periods of adversity and becoming a better investor.

The Big Picture

We all would like all our trades to be winners, but we know this is not possible. Losers are the cost of doing business in trading.

Most people know there will be losers. But to paraphrase Morpheus, "there's a difference between knowing that there will be losers... and actually experiencing them". In a probability game, we will eventually experience a string of losses. But even knowing that losses are part of the game, most traders still react the wrong way when those losses actually happen. How we react to our losses is what separates good traders from bad.

It gets tough when we experience periods of losses or poor performances and that's where many traders quit because in the first place they never accepted emotionally that they are playing a probability game. Only when we accept emotionally that we are playing a probability game, we will be able to take our trading to the next level.

After a losing streak, the natural thing is trying to "get it back". This would be a big mistake. The market doesn't know that we have lost money, and frankly, it doesn't really care. Trying to get it back will cause us taking more risk, and eventually, more losses. The best thing to do is to continue executing our trading plan that worked so well for us for over 7 years.

"The Stock market is a wonderful reallocation machine, moving money from those focused on today to those focused on their long-term goals; from the emotional to the dispassionate; from those who trade on gut feelings to those who use a systematic method and from the greedy to the patient." - Jim O'Shaughnessy

Sun always rises after the dark.

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Edited by Kim

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We want to hear from you!


Hey @Kim - I think the other trade that whacked us was the TSLA trade - I believe it lost someplace around 44% (if one got in on the exact setup you showed).   Not trying to rain on the parade, just wanted to keep everything on the table and as transparent as possible.  As I mentioned upon my new arrival, I'm in the learning phase - and I'm not putting a lot of money on the line.   And truth be told, I don't look at the $$$ as much as the percentages (especially in the learning mode).  Thanks for all you guys do - I'm learning - and have a long way to go.

Context and Mindset:  I'm new to your world (but have traded in regular stocks and futures a lot - both short and long).  One thing I'm curious about (and how you think about it) is the overall context of the Market?   Given any technical analysis (and how you guys use RV), the over-arching trends come into play as well - kind of the general crystal ball we bring to the table.  

There has been many a day when maybe I have what I'll call a "LONG" bias in a trade setup - and when it went poorly what I had to think about was my bias.  If my bias is wrong - my chances of a trade working out go way down.  I'm a completely non-expert in options setups (anewbie) but it would seem that regardless of the setup, one brings a certain contextual bias to the table.   I got into SO about the 2nd week in January (thank you!) - and only setup trades that were new at that point - deliberately ignoring some hedges for other trades that were open.  In looking back over the last 3 weeks, I have a hunch (just a feeling) that there was what I'll call a "SHORT or NEUTRAL" bias in the trades.   Outside of the big TSLA drop (news can hurt!), it seemed that where we were hurt the most is that the underlying either didn't move, or moved to the upside??? 

Just wondering the "mindset" you guys bring to the table in this - as I've found that in extremely valuable to understand (outside the technical aspects of any setup).

Anything you can share - is MUCH appreciated!  Thanks for the work . . .

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You are correct about TSLA trade - but 44% loss on half position is well within our risk parameters. We have a very good overall success with pre earnings calendars - around 80% winning ratio and average return of around 15%, so some occasional loser caused by big stock move are expected.

I'm trying to ignore my opinion about the markets and stay as neutral as positive. Of course some members do use their knowledge in TA or market sentiment in general. So for example, if we play a straddle or an RIC and start with delta neutral, we would usually close it and re position to remain delta neutral. But I have seen members letting it run based on their personal opinion, and booking much higher gains.

This is what we mean when we say "learn the strategies and make them your own".

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Thanks Kim - was just wondering your thought process . . .  as you mentioned, it can come into play and some traders do a lot of their trades based on it.  But, the bias by nature has to assume you have a semi-functional crystal ball . . . and we know how that goes!   Appreciate all the insight and communication by you and the whole community - it is the most important aspect of your services/site - and the whole reason I joined.  I look forward to the next trades!   :)

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I was very happy to read this post.    Experiencing a drawdown is not as bad if you know that you are not alone.

Do you see anything fundamentally different between the current market environment and historically that would suggest some of these SO trade setups may not work the same moving forward or was January more of a fluke that is (hopefully) not likely to repeat very often?

 

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"The Iron Condor is a combination of a bull put spread and a bear call spread. The basic construction is:

    Sell 1 OTM Put
    Buy 1 OTM Put (Lower Strike)
    Sell 1 OTM Call
    Buy 1 OTM Call (Higher Strike)

All options expire at the same month. The distance is usually the same between the short and the long legs of the calls and the puts."

Doesn't the spread (difference between bid and ask) make it very difficult to make money on this strategy?

 

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5 hours ago, FrankTheTank said:

I was very happy to read this post.    Experiencing a drawdown is not as bad if you know that you are not alone.

Do you see anything fundamentally different between the current market environment and historically that would suggest some of these SO trade setups may not work the same moving forward or was January more of a fluke that is (hopefully) not likely to repeat very often?

 

I believe you can see from our track record that those 20% drawdowns are very rare - in fact, this is a second one since inception. The reasons are clearly described in the article, I don't think this is something fundamental.We already experienced several times the transition from high IV to lower IV environment. While some trades might suffer during this transition, it is not something that usually causing major drawdowns. We experienced something similar in Feb-March 2018, and it didn't cause any major issues.

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3 hours ago, taxman128 said:

 

"The Iron Condor is a combination of a bull put spread and a bear call spread. The basic construction is:

    Sell 1 OTM Put
    Buy 1 OTM Put (Lower Strike)
    Sell 1 OTM Call
    Buy 1 OTM Call (Higher Strike)

All options expire at the same month. The distance is usually the same between the short and the long legs of the calls and the puts."

Doesn't the spread (difference between bid and ask) make it very difficult to make money on this strategy?

 

If the underlying is liquid enough, you should be able to get filled very close to the mid price between the bid and the ask. 

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11 minutes ago, Kim said:

I believe you can see from our track record that those 20% drawdowns are very rare - in fact, this is a second one since inception. The reasons are clearly described in the article, I don't think this is something fundamental.We already experienced several times the transition from high IV to lower IV environment. While some trades might suffer during this transition, it is not something that usually causing major drawdowns. We experienced something similar in Feb-March 2018, and it didn't cause any major issues.

I'm using a little bit of the "dollar cost averaging" concept on my SO portfolio thinking that if I'm adding capital in a draw down month, I should have a much richer portfolio going forward - I believe in you guys! I was looking around on the internet where somebody was giving their personal review on options trading services that they participated in and they ranked SO as the best performance from their own personal experiences as a past member.

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11 minutes ago, Dadeeman said:

I'm using a little bit of the "dollar cost averaging" concept on my SO portfolio thinking that if I'm adding capital in a draw down month, I should have a much richer portfolio going forward - I believe in you guys! I was looking around on the internet where somebody was giving their personal review on options trading services that they participated in and they ranked SO as the best performance from their own personal experiences as a past member.

Thanks for the voice of confidence!

As a general note, we recommend starting small and increasing the allocation very gradually.

P.S. Just curious - which personal review it was?

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20 minutes ago, Kim said:

As a general note, we recommend starting small and increasing the allocation very gradually

I was referring to just adding to my account from the draw down not to your recommended position size....I'd have to have more confidence in the trade before I allocate more to the position if that's what you mean....

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I was very happy to read this post.    Experiencing a drawdown is not as bad if you know that you are not alone.

Do you see anything fundamentally different between the current market environment and historically that would suggest some of these SO trade setups may not work the same moving forward or was January more of a fluke that is (hopefully) not likely to repeat very often?

 

 

That’s a concern which I had also.

We’ve been in cyclical bull market since the recovery from 2008 began. Most options trading services in business today started after 2008. The results they’ve achieved have been in that general bull market mode. All the sugar hits inc. tax cuts are done and cheap money over.

If it’s likely to be a different market than the last 10 years, then how will SO and the other Options services do in an ‘unfamiliar’ type market environment, whatever that might be?

I tried to answer that question by looking back at how SO has done in various markets since inception:

In months where vix went:

 over 30 – ave SO monthly return – 15%

between 20-30 – 5.7%

under 20 – 6.9%

So I’d say Kim’s assertion that SO has done well in all mkts is justified, which underlines how exceptional SO performance has been compared to any other Option service I know of.

 

That said, a 20% drawdown is not ‘steady’ and needs 25% return to get back to break even and when it happens at start of the year it’s a more significant hit, given it’s all from starting capital and none out of casino money ie. already booked profit for the year.

If ‘hedging’ trades like SPX can lose 100%  and winners much less than that on average, albeit there’s far more of them, I’m still concerned about how the large losses might be lessened.

I believe these butterfly trades need some managing – not rolling though.

I’ll post my ideas on non earnings trades discussion, as it doesn’t seem appropriate to this thread.

 

 

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While I'm definitely not happy about 20% drawdown, but having just two 20%+ drawdowns in 7 years while delivering around 6-8% average monthly return is not too bad.

Also, when comparing to other services, please don't forget that unlike many other services, we never roll our losing trades. We could easily roll both TLT and SPX trades for months, and eventually reduce or even eliminate the losses. But our track record is real - no rolls, all trades are clearly reported.

Starting a year with 20% down is not really different than having it in the middle or end of the year. For members who just joined it is equally unpleasant, for those who are with us for a while it doesn't really matter which calendar month we have those losses.

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Thank you for the analysis.

@Kim, @Yowster: I have a question regarding the VXX ratio spreads in relation to the two SPX butterflies which ended in 100% loss.

As volatility was rising since October 2018, the official portfolio had multiple winning SPX butterfly trades and, as a consequence, each of the companion VXX ratio spread trades were closed for a relatively small loss. But in January, when SPX rose as volatility dropped, there were no VXX ratio spreads which could cover at least part of the huge losses. In fact I cannot recall even one single winning VXX ratio spread since October 2018.

I would like to understand why VXX ratio spreads, after many repeated small losses (which, of course, were offset by the solid gains in the winning SPX butterflies of October-December 2018), could not be the big winners of January 2019.

And, more important than that, I would like to know what should we do in the future to ensure that, when a new high volatility period comes, VXXB ratio spreads will be able to offset most of our losses when the volatility drops again.

Edited by BlackBat

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VXX ratio is suited mostly for periods of extreme VIX levels (usually above 25-30) when you expect fast and sharp reversal. When we closed the last VXX ration on January 8, VIX was already down to low 20s. From those levels, you might expect a slow drift lower, but not necessarily sharp reversal. Under those conditions, VXX ratio wouldn't work well. In addition, VXX was scheduled to end its life at the end of January, and VXXB still didn't have enough volume.

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Yes, the VXX ending and lack of volume (wide bid/ask spreads) in VXXB made we wary of entering trades using VXXB.   The fact that VXXB has plenty of volume now does indicate the very short term nature of those buying/selling VXXB options.

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Bill Ackman is making a comeback with his hedge fund up more than 24% so far this year - https://www.cnbc.com/2019/02/13/bill-ackmans-pershing-square-is-up-more-than-24percent-so-far-this-year.html

Quote

The good times for Ackman and Pershing Square come after a spell of negative returns for the renowned activist investor. By early 2018, the hedge fund's assets had been more than halved from their peak above $20 billion in 2015. The fund saw its net asset value decline 4 percent in 2017 and slip 0.7 percent in 2018; the S&P 500 gained 19 percent in 2017 and fell more than 6 percent in 2018.

I'm wondering about all those people who withdrew money from the fund after couple not so great years. They must feel like complete morons now...

 

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Billionaire Bill Ackman's hedge fund delivered 58% returns in 2019 after making a big investment in Warren Buffett's Berkshire Hathaway

https://markets.businessinsider.com/news/stocks/bill-ackman-pershing-square-outperformed-returns-2019-berkshire-warren-buffett-2020-1-1028800197

I'm wondering how those "smart" investors who pulled money from the fund a year ago feel now? Maybe the same as some of our members who cancelled after our January 2019 drawdown, and missed the 63% recovery in the second half of 2019?

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