A Dead Simple 2-Asset Portfolio that Crushes the S&P500 (Part 1.5)

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A Dead Simple 2-Asset Portfolio that Crushes the S&P500 (Part 1.5)

In Part 1 of this series I shared a simple strategy which showed outsized performance relative to the SPY ETF since 2009. I made a small error in the implementation. The previous portfolio was not rebalanced according to a  risk-parity framework. It was actually the inverse. The strategy was rebalanced such that the ETF responsible for the highest percentage of the portfolio's volatility was weighted more heavily! Surprisingly this error did nothing to substantially alter the performance of the portfolio and in some ways was superior to the actual risk-parity approach. In this post I detail the performance of the actual risk-parity approach.

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USING IMPLIED VOLATILITY TO PREDICT ETF RETURNS (4/09/16)

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USING IMPLIED VOLATILITY TO PREDICT ETF RETURNS (4/09/16)

To see the origin of this series click here

In the paper that inspired this series "What Does Individual Option Volatility Smirk Tell Us About Future Equity Returns?" the authors' research shows that their calculation of the Option Volatility Smirk is predictive of equity returns up to 4 weeks. Therefore, each week, I will calculate the Long/Short legs of a portfolio constructed by following their criteria as closely as possible. However this study will focus on ETF's as opposed to single name equities. I will track the results of the Long/Short portfolio, in equity returns, cumulatively for 4 weeks before rotating out of that portfolio. The ETF's are selected from the following groups:

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COMPOSITE MACRO ETF WEEKLY ANALYTICS (4/09/2016)

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COMPOSITE MACRO ETF WEEKLY ANALYTICS (4/09/2016)

Notable Observations and Trends:

  • L/252 days the top 4 performing composites have a risk-off/defensive 'tilt': (1) Utilities (2) Telecom (3) T-Bond (4) Precious Metals Miners (PMM).
  • L/252 and L/126 the Large Cap composite is almost unchanged at ~1% and ~2% respectively. 
  • L/252 the correlation clustermap (dendrogram) groups T-Bond, Bonds, Precious Metals (PM), and PMM as most closely correlated. Based on the data this grouping has offered the most diversification vs the remaining composites.
  • YTD L/71 days the top 3 performers are PMM, PM, and Utilities. PMM is trending strongly over the period gaining over 43%.
  • L/21 and L/10 days Healthcare, PMM, and real estate have been the strongest performers. 
  • Financials appear to be trending negatively over the L/71, L/21 and L/10 days. The composite has been a bottom 3 performer across timeframes. This is likely related to the Fed signaling the pace of interest rate increases should be slower than expected. 
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A Dead Simple 2-Asset Portfolio that Crushes the S&P500 (Part 1)

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A Dead Simple 2-Asset Portfolio that Crushes the S&P500 (Part 1)

I'm going to share a portfolio with you that has absolutely annihilated the performance of the market (as proxied by SPY) since the recovery began in 2009*. The strategy has not had a down year since. This portfolio maintains constant exposure, has 1 un-optimized parameter and wins on a risk-adjusted basis even after considering reasonable transaction costs.

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USING IMPLIED VOLATILITY TO PREDICT ETF RETURNS (4/02/16)

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USING IMPLIED VOLATILITY TO PREDICT ETF RETURNS (4/02/16)

To see the origin of this series click here

In the paper that inspired this series "What Does Individual Option Volatility Smirk Tell Us About Future Equity Returns?" the authors' research shows that their calculation of the Option Volatility Smirk is predictive of equity returns up to 4 weeks. Therefore, each week, I will calculate the Long/Short legs of a portfolio constructed by following their criteria as closely as possible. However this study will focus on ETF's as opposed to single name equities. I will track the results of the Long/Short portfolio, in equity returns, cumulatively for 4 weeks before rotating out of that portfolio.

Read More