Q3 2018 Strategy Report - Volatility Trading Strategies

Updated: Dec 6, 2018

VTS Community,

Total Portfolio Solution:

Q3 2018 was a fairly forgettable quarter for our portfolio with very little action either way and not a whole lot to report on.  We neither caught any major uptrends nor suffered from any of the drawdowns in the overall market.  As far as monthly standard deviation goes it was the tightest trading range in the history of our Total Portfolio Solution.  The biggest losing month this quarter was September with a -0.26% return, and the largest winning month this quarter was July with a 0.25% return.

This past quarter though did mark the 12-month point since our last major drawdown in the portfolio.  Last August 2017 we got hit with a -4.23% monthly decline.  Taking losses is an unfortunate reality of investing as it’s just not possible to make any significant money without also occasionally suffering a few setbacks.  It wasn’t the first one and it won’t be the last.  However, in my opinion, the mark of any successful investor or successful person in any walk of life is how well they recover from adversity.  In this case, I think we did quite well.  Here are the trailing 12-month return since that drawdown in August 2017:

Tactical Balanced Strategy:

Our 12-month winning streak within the Tactical Balanced Strategy did come to an end with a -1.07% decline in September.  The strategy decisions and rotation mechanics weren’t the culprits, but rather the underlying performance of the MDY in relation to the S&P 500.  That comes with the territory though, of course we do have to choose an underlying asset to trade and the MDY has been very good to the strategy over the years.  However this year it’s definitely underperforming.

2018 YTD through October 26th:

S&P 500  (SPY):  -0.57%

S&P 400  (MDY):  -5.44%

The reason for the underperformance of the MDY compared to the SPY is due to the weighting of the big tech names that are crushing it this year in 2018.  The top 10 holdings within the SPY account for 22% of the index and include names such as Amazon, Apple, Microsoft, and Facebook.  In contrast, the top 10 holdings in the MDY account for only 6.5% of the index and include the top 3 names of Fortinet, Domino’s, and Jack Henry.  So clearly the MDY can’t keep up with the SPY in a year like 2018 when those top names are on fire, but it’s important to remember that a time will come when the opposite is true.  The heavy weighting to those few names may be a burden in a year when they are underperforming so it’s a balance.  I look at the long-term, and in that respect MDY is still our go-to underlying to represent stocks.  But yes, it’s been frustrating this year to say the least.  The Tactical Balanced Strategy is still up nearly 10% year to date so we’re killing as far as relative performance goes, but we’d be doing far better than that using the SPY instead of the MDY.  Win some lose some right?

Combined Volatility Strategy:

As you can see from the trade history of our strategies that I posted down below, we didn’t take that many trades this quarter in any of our three volatility strategies.  We’ve had some success here and there but actually we’ve been in cash a lot this year as the signals just haven’t remained stable for extended times.  It’s hard to catch a trend when there isn’t one.  One of the things I like to track as a potential benchmark for performance is the return of simply shorting volatility when the VIX futures term structure is in contango.  Now remember, no matter how many people on Twitter say this simple contango/backwardation M2:M1 crossover is a good signal, it isn’t and I’ve demonstrated that several times to the community so this isn’t any type of recommendation at all.  It’s simply a benchmark to get a sense of how well the “short volatility” trade has performed.

Short volatility only during contango is getting crushed this year, down -26%, and so are many other investors in the volatility space.  Our official benchmark, the CBOE Eurekahedge Short Volatility Index is down -5.32% this year and that doesn’t include October.  I suspect when the numbers come out next month it will be obvious that things are a lot worse for those hedge funds.

In my opinion, this year is entirely about managing risk.  You can’t win in every environment and everybody takes losses from time to time.  But something we talk about a lot here at VTS is risk management and avoiding major drawdowns.  With many investors down substantially, this is a good year to prove the “loss mitigation” side of our strategies.  Our Combined Volatility Strategy which is all three strategies with a 1/3 allocation each is only down -3% through Q3.  Nothing to write home about, and I’m certainly not going to use the word good or anything, but not bleeding any significant capital during this rough year in 2018 will mean that if things calm down going forward we’ll be in an exellent position to continue upwards and we won’t have to recover from any serious drawdowns.  A good day or two can get us right back to positive.  We’ll see if that comes to close out the year.

VTS Discretionary Options:

It’s very early in the life cycle of our newest strategy, Discretionary Options.  However, the initial feedback I’m getting is very positive so thank you for that.  There are two main goals I’m trying to achieve.  First and foremost, I don’t do anything that I don’t feel will outperform the broad markets on both absolute and risk-adjusted metrics and I definitely have high confidence in this strategy.  Secondly, I want to give back to the VTS community and actually teach some of the mechanics of these options trades we’re taking.  It’s one thing to make a nice profit and grow your investment fund, that’s what people pay me for, but I do think it will be even more value added if you also feel you’re learning how to eventually take the reigns yourself and dedicate some of your capital to trading your own ideas.  That doesn’t come quick and you should definitely take your time in building those fundamentals, but it’s absolutely possible for everybody out there to get to that point.  I hope to help you get there so please, keep asking as many questions as you have about these options trades.

Trade history for the past quarter for all our strategies

All videos released in Q3 2017.  Please enjoy, and as always questions are always welcome


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