Recommended Posts
Create an account or sign in to comment
You need to be a member in order to leave a comment
-
Similar Content
-
By Jesse
Although they may not be selling a strategy or investing concept to investors, they do have incentives to get their research published in academic journals that their peers may read and respect. There is also the financial incentive of job security by earning tenure at their university, for it’s“Publish or Perish” as the phrase goes. This means few, if any, are immune from the incentives to create an attractive looking backtest.
Does this mean we should dismiss all backtests? Certainly not, it just means we need a process, or series of scientific tests, that we run all our backtests through in order to keep ourselves out of trouble and from falling prey to good stories told by good salesmen. I must give credit where it’s due here. Both Dimensional Fund Advisors and the books and writings of Larry Swedroe have influenced my thinking when it comes to this topic. For those who want to go deeper, I recommend reading Larry Swedroe’s book, “Your Complete Guide to Factor-Based Investing.”
The 5 characteristics to look and test for when considering investments are:
Persistent across time. The strategy or factor can be tested on long periods of historical data to increase statistical confidence. Larry Swedroe often points out that the average investor thinks three years is a long time, five years is a really long time, and 10 years is an eternity...yet if you ask academics, they will tell you that 10 years is nothing more than random noise that likely should be ignored. For example, the S&P 500 returned -1% per year from 2000-2009. Would that have been a good indication of long term expected returns for buying large cap US stocks? Since then, the S&P 500 has compounded at more than 12% per year, which is better than its long-term average. This is similar to how in August of 1979 BusinessWeek wrote a cover story called “The Death of Equities” after the S&P 500 had experienced a similarly long period of poor performance. The S&P 500 went on to compound at more than 17.5% annualized for the next two decades, turning $100,000 into more than $2.6 million.
Pervasive across markets and geographies. The strategy or factor holds up when tested on other markets and countries. For example, the momentum effect has been found to exist in stocks, bonds, commodities and currencies. It’s also pervasive across sectors and in the historical data of nearly every country.
Robust to various definitions. An effect should still show up when constructed with similar parameters. For example, the value effect is both persistent and pervasive as well as robust to alternative specifications. Whether it's price to book, price to sales, price to earnings, price to dividends, price to just about anything...you find in the historical data that value stocks (low price relative to fundamental measurements) outperform growth stocks (high price relative to fundamental measurements) over the long term all across the world.
Investable. The strategy exists not just on paper but survives real world issues such as manager fees and realistic assumptions for transaction costs. Many anomalies discovered in the historical data persist simply because they are difficult to implement at size in the real world. Academics refer to this as "limits to arbitrage,” where an anomaly persists in the data because it's difficult or impossible to actually implement at scale and therefore it’s really only a paper illusion.
Intuitive. Does the strategy make intuitive sense with (preferably) a simple risk-based explanation or,at minimum, a logical behavioral based explanation? For example, the market factor (stocks producing higher returns than T-bills) has persisted for decades even though it's as "well known" as any factor there is. Since everybody knows about it, why doesn't it get arbitraged away? One rational answer is that you simply cannot arbitrage away risk. Not only do stocks occasionally underperform cash over 3, 5, and 10-year periods, they can do so by A LOT (S&P 500 example in #1). The same is true of all other academically accepted factors like size, value and momentum. For this reason, investors who have a sufficient time horizon and temperament can consider tilting their portfolio towards these "open secrets" that have a long history of producing higher than market returns. Now, which factors pass all five of these tests and therefore are eligible for inclusion in our client portfolios?
The market factor (stocks have higher expected returns than cash and bonds). Risk based explanation. The term factor (bonds with longer maturities have higher expected returns than bonds with shorter maturities). Risk based explanation. The size factor (small caps have higher expected returns than large caps). Risk based explanation. The value factor (value stocks have higher expected returns than growth stocks). Both risk and behavioral based explanations. The trend/momentum factor (stocks and asset classes that have outperformed over the last 6-12 months have near term higher expected returns than stocks and asset classes that have underperformed). Behavioral based explanation. The volatility risk premium factor (also known as the insurance risk premium…selling financial insurance in the form of puts and calls has positive expected returns). Risk based explanation.
Conclusion
When investors understand the concepts discussed in this article, your investing life will never be the same. Using this checklist dramatically improves the odds of success and can keep investors from falling prey to a good sales pitch or chasing a good looking backtest that is unlikely to persist going forward in time on a net of all costs basis (transaction costs, manager fees, and taxes).
The real opportunity now becomes the portfolio construction process. We know that the pursuit of traditional active management is largely a waste of time and money, because any manager or backtest performance can be largely explained by exposure to these well-known factors that can now be accessed at low or at least fair costs. These factors discussed have low correlations to one another, so diversifying broadly across them dramatically reduces the risk of your total portfolio. So much so that modest amounts of leverage may be appropriate for those with the patience and perspective to seek higher expected returns.
The biggest risk of a portfolio diversified by factors becomes more behavioral, where your portfolio will at times perform far differently than conventional market benchmarks that are only exposed to the single factor of market beta. Since the only purpose of investing should be to achieve your long-term goals with the least risk, this should be an acceptable trade-off for a well-educated and well-behaved investor.
Jesse Blom is a licensed investment advisor and Vice President of Lorintine Capital, LP. He provides investment advice to clients all over the United States and around the world. Jesse has been in financial services since 2008 and is a CERTIFIED FINANCIAL PLANNER™ professional. Working with a CFP® professional represents the highest standard of financial planning advice. Jesse has a Bachelor of Science in Finance from Oral Roberts University. Jesse manages the Steady Momentum service, and regularly incorporates options into client portfolios.
-
By Azov
Just wondering if anyone has ever had success negotiating with TOS to reduce/remove the $19.95 fee that TOS charges for assignment and exercise. If so, what kind of arguments worked best?
I agree with Kim that we shouldn’t have to negotiate to get the best rates. However, I greatly prefer TOS’s platform to anything else out there. I’ve been using tastyworks for a while now too, and their platform is only ok, but it’s still a work in progress, and they still charge $5 for assignment/exercise.
The reason I’m asking - and not considering IB’s $0 assignments- is because I’m evaluating a couple of candidates for wheel trades (sell puts, get assigned, sell covered calls, get assigned, rinse/repeat). Since the cycle involves two assignments, the $40-ish total fees at TOS is cost prohibitive. And I refuse to use IB because of their auto-liquidation algorithm - I don’t want to have my account blown up if I get assigned on a couple of different positions one night and don’t have a chance to close things out within 10 minutes of the market opening.
So if I could get TOS to come down or eliminate their assignment fee, that would be great. Otherwise I’m stuck with TW - I suppose I’ll get more used to their platform over time, but everything about their apps makes me feel like I’m playing an arcade game from the 80s. And not in a good way....
Any input is greatly appreciated!
-
By Kim
The impact of commissions on your results can be astonishing.
This excellent article by Business Insider is asking the right questions (and also answering some of them):
When you pay commission fees for online stock trades, where does that money go? Do you get better execution by paying $9.99 to TD Ameritrade than by paying $1 to Interactive Brokers? How much better? Enough to justify the difference in price?
Their conclusions:
At least 17 million investors overpaying for online brokerage Only 12% of commission fee is used for trade execution at top brokerages Over $1.8 billion per year wasted on unused premium services Lets analyze one specific month, January 2015, and see how different commissions structure can impact the returns of our SteadyOptions model portfolio.
SteadyOptions $10k model portfolio traded 228 contracts in January. If you paid $0.75/contract with no ticket fee, you spent $171 on commissions, which is 1.7% of your portfolio value. While not cheap, but considering the fact that we produced 20.7% ROI in January (12.4% return on the whole account assuming 10% allocation), it is completely reasonable.
However, if you had a ticket fee of $8, in addition to $0.75/contract, you would pay $427 in commissions, more than double. In this case, your returns will be reduced by 4.3%.
This will make HUGE difference in the long term. To see how huge, I went to pro-trading-profits.com, a third party website that tracks performance of 400+ newsletters. I clicked on SteadyOptions performance report and played with different parameters. Using the $0.75/contract with no ticket fee, a $10,000 portfolio would produce $35,693 gains since inception. Adding $8 ticket fee to each trade would reduce the gains to $23,869.
The impact of the ticket fee is especially significant if you have relatively small account.
Of course commissions is only part of the whole package. Other factors include tools, platform, customer service etc. Barron's publishes a comprehensive brokers review every year. Here is the last one. Interactive Brokers (IB) was ranked #1 by Barron's third year in a row. This is the broker I personally have been using for the last 7 years and I'm very happy.
Barron's mention that "IB offers a lot more support to new clients, including individuals, especially those with larger accounts. Yes, using the word "support" in the same sentence as Interactive Brokers (without the modifier "dismal") is a change for us, but the firm has clearly made this a point of focus."
Their conclusion:
"Interactive Brokers continues to have extremely competitive pricing, and the lowest margin fees of any broker in our survey. You may incur some data fees, but the firm takes care of any options-exercise costs, which can generate unexpected fees at many other brokers."
On the open section of our forum, we have couple very useful discussions about brokers:
Brokers and commissions
Interactive Brokers tips, tricks, webtrader etc.
There is a consensus among our members that IB and TOS by TD Ameritrade offer the best combination of commissions, platform, and execution. If you decide to go with TOS, I highly recommend that you negotiate a commissions structure that does not include a ticket fee.
Here are couple more good articles worth reading:
The Truth Behind Broker Commissions - Learning Markets
Comparison of online brokerages in the United States
Relative Importance Of Options Brokerage Fees
For Canadian traders, here is an excellent study on the commissions schemas offered by Canadian discount Brokers.
-
-
By asteroids
I am wondering if anyone ever used or still uses the spread hacker in Thinkorswim. When they say this particular vertical spread or calendar has 70% chance of winning for example, how accurate is that and can I trust it?
-
By Kim
Hello all,
I just spent few hours chatting with Kenny Griffin, Manager of the Trade Desk at TOS, trying to get a discounted rate for SO members.
He offered us an initial rate of 1.50 per contract, with an option to negotiate lower on customer by customer basis. I realize that this might not do any good for many members who are already paying less. However, I believe that some members are still paying more and this deal might be attractive to them.
Remember: this is an initial rate, you can always try to negotiate less, and your starting point is still better than the general public. I personally still believe that unless you can get 1.00 or lower, IB presents better value, but some people just cannot stand IB, and for them TOS is probably the best option.
Thanks to Jesse for his help, if any of you will take advantage of this offer, please mention him.
To get this rate, contact the Trade Desk and ask to talk to Kenny Griffin or email him at kenny.griffin@tdameritrade.com
March 2013 Update:
Had another session with Kenny. He offered further discount for those on "standard" commissions structure: instead of 9.99+0.75, it is $8.00 ticket + $0.75 per contract for SO members.
In addition, TOS will conduct a one on one platform demo for every new customer who is SteadyOptions subscriber. The demo is done by an experienced trade desk rep and typically last about 30 minutes.
Please note that Anchor Trades members who select to auto-trade those products enjoy 0.75/contract with TDAmeritrade Institutional platform.
-
By equus
Kim, when backtesting the pre-earnings calendars, is the idea to track the price of the ATM spread each day in the runup to the historical earning date, whatever the ATM strike price happens to be on a particular day?
For example, FSLR calendar: the underlying might be 60.00 on Monday, 62.50 the next day and 65.00 the next day etc -- do you look at the price of the 60 calendar on Monday, the 62.5 calendar on Tuesday and the 65 calendar on Wednesday?
-
By Kim
Options Trading is a business. As in any business, there are costs. One of the major costs is commissions that we pay to our broker (other costs are slippage, market data etc.)
While commissions is a cost of doing business, we have to do everything we can to minimize that cost. This is especially true if you are an active trader. The impact of commissions on your results can be astonishing.
This excellent article by Business Insider is asking the right questions (and also answering some of them):
Click here to view the article
-
By tjlocke99
Hello. I have a few questions/comments about backtesting in TOS.
1. If you select that you entered a trade in TOS using the thinkback tool, is the price you enter supposed to be based on the opening price for legs in the options spread for that day?
2. When you close the trade does thinkback assume you are getting the mid of closing price for the legs in the options spread that date?
3. Is it the closing price for the underlying that day?
I always assumed it was based on closing prices, but I just wanted to check.
Also, I see this as a major issue with backtesting in TOS, you can only base it on whatever open/close condition it uses.
Thank you!
Richard
-
-
Recently Browsing 0 members
No registered users viewing this page.