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.

The Downside of Anchor


Leveraged Anchor and its diverse counterpart have been performing above expectations so far this year. In fact, since Diversified Leveraged Anchor launched in April, it is up over 40% while the same index blend (SPY, QQQ, IWM, EFA) are up just over 33%. This has led to a growing increase in interest of the product, particularly given its hedged nature. 

Our confidence in the strategy continues to grow as well; enough that we are exploring how to more broadly market it next yearwith a goal of getting to $100m or more under management on the strategy.


Unfortunately, it has also led to some misunderstanding of what the strategy is capable of. In the past few weeks, I have received statements such as:

  • "I love being in a strategy that can’t go down.”
  • “I can’t believe I can beat the market without risk.”
  • “I like being able to sleep knowing my maximum drawdown is 5% or less.”
  • “I’m worried that I might lose all of my money in Anchor, can you explain it better?”

None of these statements are true.  Leveraged Anchor absolutely can, and at times will, go down.  There is certainly risk, and the maximum drawdown potential is over five percent.  At the same time, the only way to lose all your money is if the options markets completely collapse and cease to function.  The purpose of this article is to provide some clarity on these issues.

First, the strategy can, and will, go down.  If an individual invests $100,000 and purchase protection five percent out of the money, then the expected scenario in a market crash is the account drops to at least $95,000.  Actual performance may be slightly better or slightly worse.  If volatility goes up and the delta of the long calls declines, the account might not go down that much.  On the other hand, if volatility does not drop very much and the decline is not that sharp, the position may lose on the short puts and the decline may be worse (maybe in the 7%-9% range, depending on the changes in volatility).  In either case, a drawdown can certainly occur.  It is a virtual certainty at some point that the accounts go down in value.
 

Second, an assumption that Anchor cannot go down ignores the fact that the strategy does not roll the hedge every day.  Take the following situation:

  1. Open an account for $100,000 and hedge at $95,000;
  2. The account grows to $108,000 (right about the time to roll); and
  3. Just before rolling the long hedge, the market drops 50%.

The drop on the investor’s account will be back down to around the $95,000 level, plus or minus a couple of percentage points based on the performance of the short puts.  While this is a five percent loss from the opening balance it is twelve percent loss from the account high.  Investors need to remember the strategy protects from the opening level (or rolled level)not from the current high.
 

This leads to the question of why the hedge is not rolled more frequently, even up to every time the market goes up.  The simplest explanation is cost.  The largest drag on Anchor is the cost of the hedge.  Every time the hedge is rolled, the strategy incurs a cost.  At some point it becomes impossible to pay for the hedge in a year.  However, given that the strategy rolls as the market goes up, and the position is levered, the strategy can afford to incur some increased costs. 

There has been significant testing into the “optimal” time to roll the hedge.  What was learned is “optimal” is fluid – based on volatility, time left in the prior hedge, and a few other factors.  This led to the creation of a “range” on which to roll.  It is known if we roll every five percent market gain the costs can overwhelm performance.  If rolls only occur after 12.5% or more gains, then money is left on the table on drawdowns.  Thus, the rule of thumb of “7.5% to 10%” was created.


If you are an investor who is more conservative, comfortable with limiting upside some, then more frequent rolls of the hedge are fine.  If you are a longer term, more aggressive, growth investor, then less frequent rolls are just as acceptable.


Another factor many do not consider is the impact of using leverage.  The amount of leverage does matter and impacts risk of the portfolio.  Leveraged Anchor performs the worst in markets that are flat for long periods of time or that decline slowly in small amounts.  If the market slowly bleeds (1%-3%) over a three-week period, the strategy takes small losses on the short puts, without actually gaining on the long puts. 

One of the worst possible outcomes for the strategy would be if the market loses 1% every quarter for four quarters in a row in a very uniform manner.  Under that scenario, the strategy has lost money on selling the puts short (e.g., not paid for the hedge), has lost money on the calls (because the 5% hedge never kicks in – the market is only down 4%), and even the puts covering the shorts will not have increased in value.  It is entirely possible for the market to be down 4% and the strategy down 10%, or more. 


The use of leverage worsens this problem, as the cost of hedging has gone up, and if the hedge is not paid for, that increased cost has a larger impact.  A portfolio with no hedging may have a maximum loss of 8%, while a portfolio with over 100% leveraged may double such losses in small declining markets.  (Please note such numbers are for example only.)


Leveraged Anchor accepts this risk as historically less than 15% of annual stock markets tend to meet the “flat” criteria.  If the strategy outperforms in up markets and outperforms in large down markets, we feel having underperformance 15% of the time is acceptable.  This is particularly true for the long-term investor.  Of course, there is no guarantee that historic trends continue, and all Anchor investors should be aware of the markets in which the strategy may underperform expectations.


No investor should think Leveraged Anchor is risk free, that drawdowns are not possible, or that the strategy will outperform in all market conditions.  Such statements simply are not true.  What investors should expect is superior performance due to leverage in bull markets and having catastrophic market protection.  Given most market drawdowns are of the significant variety, this helps investors sleep.  The strategy provides superior risk adjusted returns – not risk free.
 

Christopher Welsh is a licensed investment advisor in the State of Texas and is the president of an investment firm, Lorintine Capital, LP which is a general partner of three separate private funds. He is also an attorney practicing in Dallas, Texas. Chris has been practicing since 2006 and is a CERTIFIED FINANCIAL PLANNER™. Working with a CFP® professional represents the highest standard of financial planning advice. He offers investment advice to his clients, both in the law practice and outside of it. Chris has a Bachelor of Science in Economics, a Bachelor of Science in Computer Science from Texas A&M University, and a law degree from Southern Methodist University. Chris manages the Anchor Trades portfolio, the Steady Options Fund, and oversees Lorintine Capital's distressed real estate debt fund.
 

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

  • Questions to Ask Yourself Before You Start Investing

    Everyone has heard the success stories of people making tons of money from investments, retiring early, and living a life of luxury. But, before you start tying up all your cash in investments, it is crucial to understand more about what is involved.

    By Kim,

    • 0 comments
    • 62 views
  • How To Use Tech To Improve Your Stock Trading

    Technology is undoubtedly helpful in many aspects, and stock trading is no exception. Over the years, the stock trading market has experienced improvements as a result of leveraging technology. For instance, stock traders can have faster access to more comprehensive data to help them make a more informed decision.

    By Kim,

    • 0 comments
    • 253 views
  • Exploiting Earnings Associated Rising Volatility

    It was brought to my attention that Seeking Alpha now restricts the number of articles people can read for free, so I will reprint few of the key articles I wrote for SA. This one was my fist article, written in 2011, and it gives an introduction of the earnings straddle strategy that we have been using for the last 10 years with great success.

    By Kim,

    • 0 comments
    • 484 views
  • Why And How To Trade Objectively And Keep Your Emotions In Check

    Trading on the stock market is a serious profession. Individuals can make a very lucrative return whether trading professionally or personally. To successfully trade on the stock market it requires years of dedication, practice and thorough market understanding.

    By Kim,

    • 0 comments
    • 811 views
  • 3 Things You Need To Know About Investing As An Immigrant

    One of the most effective ways to prepare for the future is investing. This is because investing provides a way to have access to resources that are not readily available. While there are many ways to make a nest egg for you and your family, investing provides a way of earning passive income. 

    By Kim,

    • 0 comments
    • 1,094 views
  • The Benefits of Rebalancing

    A portfolio with multiple funds will drift away from the original allocation over time if it is not rebalanced. In this article I’ll show how rebalancing can be implemented and how it can be beneficial. It's called buy, hold, and rebalance.

    By Jesse,

    • 0 comments
    • 1,992 views
  • How To Manage Fear And Greed In Trading

    Why doesn’t everyone get involved in trading? And why doesn’t everyone “hit it big” on the stock market at least once? If you eliminate the main factors that drive the human mind (emotions) and only consider knowledge, logic, experience, and reason, everyone should be able to earn money from trading.

     

    By Kim,

    • 0 comments
    • 2,305 views
  • Probability vs. Certainty Trap

    We all would like all our trades to be winners, but we know this is not possible. We know some of the trades will be losers. Many traders think that if a trade has lost money, it was a bad trade. They try to identify what errors they made that lead to losses. Why? "Because I lost money! So surely I have made a mistake somewhere?”

    By Kim,

    • 2 comments
    • 7,032 views
  • How To Choose The Right Platform For Your Stock Trading

    The interest in stock trading has increased due to its higher returns and profit potentials. Like the many traders available, there are numerous approaches and platforms to set your trading environment. Online trading platforms provide adequate resources and tools for their clients' trading success.

    By Kim,

    • 0 comments
    • 4,223 views
  • How To Approach Passive Investing

    Passive investing refers to an investment technique that seeks to increase returns by limiting purchasing and selling. One of the most popular passive investment strategies is index investing, this means that a group of investors buy a representative benchmark, and keep hold of this over a long period.

    By Kim,

    • 0 comments
    • 3,944 views

  Report Article

We want to hear from you!


Thank you Chris for an excellent description of the risks.

I have been in the stock market for almost two decades, and I must admit that I have never seen a strategy that performs so well in most market conditions. It is outperforming the indexes by 5-7% a year second year in a row, and March 2020 crash proved that it also provides an excellent hedge (the Anchor portfolio was actually UP at some point in March while the major indexes were down 35-40%). 

That said, no strategy will outperform under all market conditions. It's important to have realistic expectations and be aware of the risks. We always provide a full disclosure to our members.

Share this comment


Link to comment
Share on other sites
On 12/13/2020 at 7:29 AM, FrankTheTank said:

Would love to see this as an ETF so I could put some of my IRA funds there and not have to worry about messing with it.   

That's ideally the long term plan (or a mutual fund), but being a little shop, market makers, brokers, and the like tend to ignore me.  So we're launching an actual fund structure. If I can get assets north of $25m or so and run it for 1-2 years, the conversion becomes much easier.

Share this comment


Link to comment
Share on other sites


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 Expertido