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Tactical Asset Allocation and Options Selling

The style of investing I use is most commonly known as Tactical Asset Allocation (TAA). The majority of investors who employ this style of investing with liquid ETF’s probably reallocate at the end of each month. Personally, I reallocate three times each month for a more robust investing methodology.

Very recently, as a means of producing additional investment income, I added a new component to my methodology which involves selling options on the more liquid ETF’s that I hold. I sell cash secured puts and covered calls. The rationale behind this component of my strategy is that the ETF’s I hold are most likely to rise in price in the very near term or, at the very least, not decline meaningfully. That being the case, properly selected puts with 30 to 50 days to expiry remaining should expire worthless more often than not.

Covered calls are a little different in that the ETF’s I hold should increase in price in the next 30 days or so and calls sold at a similar delta as the puts I sold are more likely to be exercised (i.e. the ETF units would be called away by the purchaser if the price of the ETF is above the strike price on expiry day).

At this point, I won’t get into how I select the puts and calls to sell other than to say I pick appropriate days to sell the options. In my opinion, not every day is a great day to sell either a put or a call.

The table below illustrates the small number of option trades that I have closed so far. Please note I do have open trades and some of them are in losing positions. If I closed out the losing positions at the time of writing this post I would have an overall positive result (i.e. my option selling would have produced positive income).

If you have some knowledge of option strategies you would recognize that selling a put and a call with the same expiration date is a short strangle. At a most basic level, that is what I am doing. A common short strangle approach used by options traders is to sell 30 delta puts and calls in equal numbers on the underlying stock or ETF and buy them back when a profit of 50% or 75% is achieved. Looking at the Gross Return column in the table above you will note that the lowest gross return so far was 75.6% so that gives you a very good indication of the profit return which will trigger me to close out the option.

In the future, I plan to provide updated tables for my closed option trades and time will tell if my selling puts and calls on the ETF’s I hold will prove to be a sustainable means of producing additional income within my investment portfolio.

All the best.

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Pure Momentum Performance Update. April 2019

The time has come for one of my rather infrequent updates on the performance of my trading as verified by Collective2.

Using more than one “system” which would fall under the banner of “tactical asset allocation”, I hold calculated allocations of a basket of ETF’s. Towards the end of each week, I make what are usually slight adjustments to the allocations based on the systems I use. The systems I use have evolved and, as far as I know, have improved over the past several years.

I benchmark my investing against a “do nothing” approach based on buying-and-holding a passive global allocation to seven ETF’s. As seen in the chart below, so far my investing style has produced a higher total-to-date return.

Visually, we can see that my monthly returns have not been as smooth as the global passive portfolio. The Gain-To-Pain ratios bear that out as the global passive portfolio has thus far produced a higher ratio.

My compound annual growth rate is 8.5% which is typical for a tactical asset allocation style of investing over the period covered.

As always, these investment performance posts have the goal of improving my accountability to myself for my investing. Publishing one’s personal investment performance results puts an uncanny responsibility on one to improve.

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January 2019 Update

I’m still alive!

Due to things that have been happening in my life, I haven’t posted an update on the performance of my ETF tactical asset allocation strategy in far too long. The wait is over!

As practically every major investment asset class lost value in 2018, so too did my strategy as it lost 6.94%. If there is any good news it is that much of that loss has been recouped already in 2019 and my strategy is still ahead of a passive global strategy in terms of total return.

The CAGR of my ETF asset allocation system that I have been publishing on this site currently sits at 7.9%. As seen in the chart above, that is higher than I would have achieved with a global passive ETF portfolio but, I have to say, it is lower than I would like to see. I am always searching for any tweak that I can make to improve my strategy’s performance and, as noted later, I have made a recent change which involves levered ETF’s (2X) when conditions are deemed to be right.

Even though I believe that a Gain to Pain ratio requires a minimum of five years of history to be valid, I track the ratio for my strategy understanding the limitations of calculating it for a short period of time.

The performance of my strategy in 2018 has resulted in a lower GTP ratio than I would like. We’ll see if it rises throughout 2019.

If you have an interest in developing your own ETF asset allocation strategy you can’t go wrong reading this post over at TrendXplorer. I have incorporated some of the research from that post into my strategy and expect to see improved returns going forward.

The purpose of this site is for me to hold myself accountable for my investing performance. The easy thing to do would be to not show my strategy performance and tell friends about the trades that worked out well while not mentioning the losers. If you are reading this and want to become a better investor/trader I encourage you to post your results. You may have heard the saying about one of the best ways to accomplish a goal such as losing weight or quitting smoking is to publicly announce your goal. The thought is you will then have peer pressure working on you as your friends and family will be watching to see if you accomplish your goal. I see this site in a similar way. The cure for poor performance is poor performance (not always but sometimes). If I see that my investment performance is lacking then it is up to me and nobody else to take action.

All the best.

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Timing Luck with Tactical Asset Allocation

Tactical asset allocation (TAA) is most often based on the investor trading once-per-month and that once occurs on the last trading day of each month. There may be an inherent problem in the selection of the same day each month on which to rebalance the portfolio and this is referred to as timing luck.

Fortunately, Walter at Allocate Smartly and Corey Hoffstein at Newfound Research wrote about timing luck as it pertains to TAA so there is no need for me to reinvent the wheel.

The Allocate Smartly post is here and the Newfound Research post is here.  If you are a TAA investor, I strongly suggest you read both articles and consider the timing luck issue if you are making allocation adjustments only at month end.

The take away from both articles is that trading on the same day each month, be it the last trading day, the eleventh trading day, etc, introduces the risk that the performance results are due, in part, to the day selected to trade. To remove timing luck from a TAA, both articles present the solution that the investor divide their TAA portfolio into equal weights and rebalance each segment on a different day of the month. The assumption is that the rebalancing days are equally spaced apart.

I have decided to take the advice of Water, Corey and other professionals that I have spoken to. I divided my portfolio into four equal segments and, going forward, will adjust the weights of the ETF’s on a weekly basis. Segment 1 which is 25% of my portfolio will be adjusted on the last trading day of week 1 (which was last week in my case). Segment 2 which is 25% of my portfolio will be adjusted on the last trading day of Week 2. Repeat for segments 3 and 4. On the fifth week, the process repeats starting with segment 1.

As for my portfolio, it slipped by 2.54% in March resulting in a year-to-date loss of 3.34%.

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Process Versus Outcomes in Investing

Outcomes. When you are a long-only investor and the markets behave like they did in 2017 it is easy to focus on outcomes and tend to allow your mind to diminish the importance of process. When your equity chart increases every month for twelve months straight you have full confidence in your process because the outcomes are so darn favorable.

Then February 2018 hits you. The outcomes that your brain has become accustomed to change dramatically and your focus switches to process. Every day the financial media reminds you that volatility has returned with a vengeance like you haven’t experienced in so long that you forgot what it feels like. This is very unpleasant. Gut-wrenching even. Suddenly there is a voice in your mind screaming that there must be something wildly amiss with your process.

Process. It is far more important than outcome and it is what we, as investors, should be focusing on but why would we when we produced positive returns every single month in 2017. Our investing process must have been sound given how smooth and upward sloping our equity curve was last year.

Doubts. If you have them about your process there is nothing quite like a spike in volatility and a swift drawdown to make you question whether your investing strategy is in dire need of an update. New rules perhaps. Tighter stop losses would have worked so well this month. Buying cheaply priced puts in January now seems like such an obvious move that you should have made.

Relax. If you have a sound strategy that has proven itself over time then now should be no different and you must ignore the alarms from the financial media and relax. Now is not a time to jump ship and abandon your strategy. Surely you have read about the gains you would have enjoyed had you bought stocks in Berkshire Hathaway and Apple decades ago and just held. I suspect you also understand that you would have had to endure many drawdowns in excess of 40% between then and now. What we are experiencing lately is child’s play compared to those drawdowns.

My advice is to stay the course (assuming that your course is a systematic investing strategy that suits you and will provide you with returns and drawdowns that are acceptable), don’t pay attention to the alarmist headlines in the media, and if you are in the accumulation phase of your investing plan continue to contribute each month.

Fred

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