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Leveraged Anchor: A Three Month Review


Steady Options has now been tracking the Leveraged Anchor from the unlevered version for three months.  The results so far have substantially beat expectations, though there is a possibility for improvements discussed at the end of this piece. 

For those who may not be familiar, the original Anchor strategy invested approximately ninety percent of its holding in broad market S&P 500 ETFs and hedged 100% of that value using long dated put options (typically a year out) with the other ten percent of the funds (depending on market conditions, a full year at the money hedge can range from 5% to 12% of the value of the portfolio).  Over time, we would attempt to pay for this hedge using a short put selling strategy. 

Over the years, a few shortcomings in Anchor were identified.  First and foremost was the certainty that it would always lag the S&P 500.  Since only 90% of the investment is in S&P 500 ETFs, at the very best, Anchor would lag 10% behind.  Also, in bull markets where the long hedge had to be frequently rolled, the cost of hedging could become prohibitive.


To combat these issues, Leveraged Anchor was developed.  Instead of owning actual ETFs, deep in the money calls are purchased.  Depending on their risk tolerances, this allows investors to end up owning the equivalent of 125%-200% of just long, without using all of their investment capital.  (Options allow for leverage).  Extra funds can be invested in secure assets, such as BIL, which currently yield around 2.25%.  The second change implemented was no longer buying an at-the-money hedge, instead buying approximately five percent down.  This means the portfolio can suffer a five percent loss that the older Anchor would not have, but given that it makes the cost of the hedge significantly less, we felt as if the slight increase in loss was more than increased by the savings in the hedge.  This has largely eliminated the drag on the portfolio from the cost of hedging.


Prior to implementing the changes to Leveraged Anchor, a decade long back-test was conducted followed by six months of paper trading.  Three months in, having gone to live trading, these changes have been performing exactly as anticipated. Since January 1, 2019 when we started officially tracking the leveraged version of the Anchor, the Anchor model portfolio produced a 14.9% gain, compared to 13.1% gain of S&P 500. In that three month period, despite having to roll the long hedge up once (and thereby incurring a new cost very quickly into the year), Leveraged Anchor has outperformed the S&P 500, while maintaining its hedge.  We would have been content, given the fast roll, to be lagging slightly at this point, but that has not occurred.  So far (and it’s a very short so far period), actual performance has exceeded expectations.


However, we are always striving to improve the strategy.  When analyzing the current trade setup, the biggest potential risk comes from the short positions.  Short positions, when rolled, are typically rolled one to two strikes (around a 55 delta) in the money.  This means, if the market falls, these short puts will lose value quickly, thereby harming the portfolio.  The risk of loss on the short puts is limited, because they also are hedged. 
 

In traditional Anchor, the short puts were hedged at the money, just as the underlying ETFs were.  When switching to Leveraged Anchor, we also moved the hedge on the short puts to 5% out of the money.
 

Practicality, this means as the market goes up, our risk from the short puts increases.  Here’s a simple example:

  1. Assume SPY is trading at $100;
     
  2. Assume we need 5 puts to hedge our portfolio.  We buy 5% out of the money and buy our long puts at $95;
     
  3. Assume we need to buy an additional 2 long puts to hedge the short selling we’ll be doing.  We buy those at $95;
     
  4. The market increases to $105. We are now selling puts at $107 (two strikes in the money);
     
  5. If the market falls back to $95, those short puts lose $17 each – a significant loss; and
     
  6. Our long puts actually would have LOST value over this time due to time decay.

In other words, we are at the exact same starting price of the S&P 500, but we’ve lost money (not $17, because we would have made some money selling puts as the market rose, but we still would have lost).  Whereas, any investor that had just owned SPY would be flat.
 

If possible, we’d like to avoid this situation as much as possible. 


In initial testing, it’s beginning to look like having a 5% out of the money hedge for the long portion (which is the most expensive part) and an at the money hedge for the short puts, may be more advantageous.  Similarly, we roll the long hedge after the market has moved up around 7.5% and always by 10%.  It may be prudent to roll up the hedge on the short puts more frequently – at closer to the 5% mark.  This would reduce losses on short term, and smaller amount, downward market fluctuations, without significantly increasing the cost of the portfolio.


The disadvantages to such a move are (a) it does increase cost, which will hurt performance, and (b) it increases the trades complexity through the number of moving parts and adjustments which occur.  However, if we can reduce risk further while still tracking the S&P 500 in up markets, we still meet our overall objectives.


I would like to invite our members to comment and question on these possible small changes.  Many of our improvements to the strategy have come through investor critiques and suggestions.  Feel free to ask questions and to share your thoughts. 

If you are not a member yet, we invite you to give it a chance.


Christopher B. Welsh is a SteadyOptions contributor. He is a licensed investment advisor in the State of Texas and is the president of a small investment firm, Lorintine Capital, LP which is a general partner of two separate private funds. He offers investment advice to his clients, both in the law practice and outside of it. Chris is an active litigator and assists his clients with all aspects of their business, from start-up through closing. Chris is managing the Anchor Trades portfolio. 

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We want to hear from you!


You guys are doing great work,making improvements to this strategy.

A couple of thoughts, I wonder if the strategy could be improved by writing calls when a timing signal is bearish, even something as simple as the 200 DMA?

Secondly, what are your thoughts on using synthetic stock instead of DITM calls? I just recently started a portfolio using synthetic stock and it seems to be working ok for the short time since I started it

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One of the biggest advantages of DITM calls is that in case of a big down move, move calls will start losing less than the stock because their delta starts to shrink. This is why at some point (when SPY is down around 40%) the whole structure actually starts to make money:

image.png 

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13 hours ago, Aristotle33 said:

You guys are doing great work,making improvements to this strategy.

A couple of thoughts, I wonder if the strategy could be improved by writing calls when a timing signal is bearish, even something as simple as the 200 DMA?

Secondly, what are your thoughts on using synthetic stock instead of DITM calls? I just recently started a portfolio using synthetic stock and it seems to be working ok for the short time since I started it

We actually were curious as to the same thing with a synthetic stock position when we were modifying the strategy.  When we were testing the new leveraged anchor, we ran the DITM call simultaneously with the synthetic stock from June 1 2018 through November 1, 2018.  This was a great test period, as it included fairly substantial up and down moves.  

 

I was stunned by just how much the synthetic stock under performed, using the same amount of leverage as the DITM call (almost 15% less).  In a six month period, that's gigantic.  So we scrapped the synthetic stock.  From an academic perspective, this shouldn't be true, they should perform close.  But in actual trading, there was a huge variation.  There is a thread discussing possible reasons for this -- but that's why we test things before launching.

 

As for the covered call, we have been trying to find a way to add that in without hurting performance.  I have EXTENSIVELY tested a variety of covered call scenarios using ORATS.  And the short answer is, in bull markets in particular, it always hurts performance -- which makes since, particularly using leveraged long positions.  The one caveat to that is weekly options on SPY have only existed since 2012 or so -- which has been virtually all bullish.  There are only three SHORT time periods where true "bear" signals where hit, and then only for a few weeks, which makes testing a little unreliable.

 

But, with the data we have to look back at, I haven't found a way to make covered calls actually help over any extended period.  We're going to keep looking though.

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On 4/4/2019 at 5:14 PM, cwelsh said:

We actually were curious as to the same thing with a synthetic stock position when we were modifying the strategy.  When we were testing the new leveraged anchor, we ran the DITM call simultaneously with the synthetic stock from June 1 2018 through November 1, 2018.  This was a great test period, as it included fairly substantial up and down moves.  

 

I was stunned by just how much the synthetic stock under performed, using the same amount of leverage as the DITM call (almost 15% less).  In a six month period, that's gigantic.  So we scrapped the synthetic stock.  From an academic perspective, this shouldn't be true, they should perform close.  But in actual trading, there was a huge variation.  There is a thread discussing possible reasons for this -- but that's why we test things before launching.

 

As for the covered call, we have been trying to find a way to add that in without hurting performance.  I have EXTENSIVELY tested a variety of covered call scenarios using ORATS.  And the short answer is, in bull markets in particular, it always hurts performance -- which makes since, particularly using leveraged long positions.  The one caveat to that is weekly options on SPY have only existed since 2012 or so -- which has been virtually all bullish.  There are only three SHORT time periods where true "bear" signals where hit, and then only for a few weeks, which makes testing a little unreliable.

 

But, with the data we have to look back at, I haven't found a way to make covered calls actually help over any extended period.  We're going to keep looking though.

Hi @cwelsh

Just the other day I stumbled upon orats for backtesting. They offer a trial for 7 days but are very cryptic about their pricing structure.

How sattisfied are you with orats overall, can you compare it to CML trademachine (I really do not like their calculation on gain to risk value) and offer insight to their pricing model?

I could not find data on your actual performance of the leveraged anchor or has it replaced the original anchor altogether and

the

2019 7.7% 4.4% 2.2% is the performance?

thank you for your insight and advice

 

Edited by urfiend
typo

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@urfiend I think ORAT should be compared to ONE, not CML trademachine.

As for real performance - yes, we switched to leveraged Anchor in January 2019, so 3 months of real time trading. Chris still posts Anchor trades as well, but for performance tracking, we are using the leveraged version since Jan.2019.

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I really like Orats -- I would of course change some things on it and add some more things to test for, but it's been one of the better option backtest tools I've seen.  (It's the only one I actually pay for).

 

I'm not sure what their current pricing structure is -- but I'm 90% sure there's still a Steady Options referral pricing structure (e.g. discount), just search through the forum for it.

 

As for performance reporting, we are now reporting Leveraged Anchor performance since that's what is being traded as the recommended strategy for most people.

 

You are not the first to ask that though, so we might start reporting both to eliminate confusion.  I'll discuss that with Kim

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On 4/9/2019 at 6:47 PM, cwelsh said:

I really like Orats -- I would of course change some things on it and add some more things to test for, but it's been one of the better option backtest tools I've seen.  (It's the only one I actually pay for).

 

I'm not sure what their current pricing structure is -- but I'm 90% sure there's still a Steady Options referral pricing structure (e.g. discount), just search through the forum for it.

 

As for performance reporting, we are now reporting Leveraged Anchor performance since that's what is being traded as the recommended strategy for most people.

 

You are not the first to ask that though, so we might start reporting both to eliminate confusion.  I'll discuss that with Kim

Hi @cwelsh @Kim

Thank your for your replies.

I searched SO and could not find a referral / SO member discount?

From what I saw of orats demonstrational videos it looked very much like CML with automated backtesting and not so much like One with the manual trade track keeping backtesting? I would do the free trial they are offering but am holding back for the new implimentations to come just this april. How is orats more like ONE in your consideration?

Thank you

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We don't have any agreements with ORAT at this point.

As for comparison, I will let Chris to answer, as I'm not familiar enough with ORAT, so I definitely could be wrong.

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I haven't used CML in a few years, so it might have improved, but one of the things I liked about ORATs Wheel  is how things could be customized fairly easily.  

 

For instance, when I was testing different ways the short puts should be rolled, I could get it to where the rules would be:

 

Roll between 0-28 days

Roll once delta has changed X or price has changed Y that varied based on how close to expiration I was or once a certain profit percentage was hit

 

Even Orats' earnings days features are a bit better (e.g. entering X days before earnings, existing Y days before earnings, exit post earnings, etc).  CML does have the earnings features, but I don't think they were as customizable.  

 

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I discovered that CBOE has a new index, BXMC, which conditionally writes calls when the VIX is above 20. It improved performance a bit over BXM. I only write covered calls occasionally but it does tend to reduce the volatility of returns while not necessarily improving CAGR

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