Why I Am So Relaxed.

Take a look at the two sets of figures below projecting polar opposite scenarios for my model trading portfolio at the 2012 year end book closing. Each existing position for my notional $100,000 model portfolio is listed with the anticipated profit and loss for December 31.

The best-case scenario assumes a continued “RISK ON” environment whereby prices either maintain current levels, or trend higher. All of my equity exposure appreciates and the downside hedges are written down to zero. The short plays in currencies and oil, either hang around these prices, or make new lows.

In that case, I should book a profit for the year of 46.4%, beating the Dow average by an awesome 40%. That is the same value added alpha that I conjured up in 2011, but this year, with half the market volatility. Obviously, I believe this is the more likely outcome, and I am positioned for such.

The worst-case scenario assumes a return to a “RISK OFF” environment and sees equity markets plunging to new lows, with most losses offset by my put option positions. My shorts in oil, the euro, and the yen fall out of bed and go to their maximum value. This still delivers a 20% net profit for the year, and maintains my much-envied position in the top 1% of all hedge fund managers, an outperformance of the Dow for 2012 of 14%.

Looking at the overall portfolio, which is a mash up of in-the-money call spreads, put spreads, and outright puts, what I have here is a gigantic short volatility position. If the markets just stayed closed for the rest of the year, and prices never changed, I make about 50 basis points a day just from time decay. This is the portfolio you want to have during a year when volatility has been falling almost continuously.

Volatility peaked this year in May at 27%, compared to 49% in 2011. Even in the latest hellacious selloff, it levitated no higher than 19%, versus the 90% we saw in 2008. This much maligned mathematical indicator is telling us that markets are about to get even more boring than they are now, very boring. We will die of ice, not fire.

The reality is that some of my assumptions will unfold as predicted, others will be woefully wrong, and others still will deliver half the expected move. Such is the life of a hedge fund manager navigating in markets that seem to become more untradeable with each passing year.

2012 Best Case Scenario

Assumptions: (AAPL) = $575, (FXY) = $119, (SPY) = $136, (GOOG) = $650, (IWM) = $80, (FXE) = $126, (USO) = $29


POSITION

(AAPL) 1/$525 call

3.8%

(AAPL) 1/$575 call
(AAPL) 1/$450 call

3.1%

(AAPL) 1/$500 call
(FXY) 1/$124 puts

5.6%

(FXY) 1/$119 puts
(SPY) 1/$131 Calls

4.8%

(SPY) 1/$136 Calls
(SPY) 12/$137 put hedge

0.0%

(SPY) 12/$137 put hedge
(GOOG) 1/$600 calls

1.9%

(GOOG) 1/$650 calls
(IWM) 1/$76 calls

3.3%

(IWM) 1/$80 calls
(IWM) 12/$78 put hedge

0.0%

(IWM) 12/$78 put hedge
(FXE) 1/$131 puts

4.7%

(FXE) 1/$126 puts
(USO) 1/$32 puts

11.2%

(USO) 1/$29 puts
2012 Best Case Performance

+46.4%

2012 Worst Case Scenario

Assumptions: (AAPL) = $500, (FXY) = $119, (SPY) = $130, (GOOG) = $650, (IWM) = $70, (FXE) = $126, (USO) = $29

(AAPL) 1/$525 call

0%

(AAPL) 1/$575 call
(AAPL) 1/$450 call

3.1%

(AAPL) 1/$500 call
(FXY) 1/$124 puts

5.6%

(FXY) 1/$119 puts
(SPY) 1/$131 Calls

0%

(SPY) 1/$136 Calls
(SPY) 12/$137 put hedge

6.6%

(SPY) 12/$137 put hedge
(GOOG) 1/$600 calls

1.9%

(GOOG) 1/$650 calls
(IWM) 1/$76 calls

0%

(IWM) 1/$80 calls
(IWM) 12/$78 put hedge

8.6%

(IWM) 12/$78 put hedge
(FXE) 1/$131 puts

4.7%

(FXE) 1/$126 puts
(USO) 1/$32 puts

11.2%

(USO) 1/$29 puts
2012 Worst Case Performance

+20.0%

 

I’m Relaxed; Totally Relaxed

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  1. Why I Am So Relaxed — Financial Press - November 29, 2012

    [...] Each existing position for my notional $100,000 model portfolio is listed with the anticipated profit and loss for Dec. [...]