20% annual returns over 40 years...interested?

[Kbg]

Summary post on our paper futures PP.

We are net long ~16k for each asset for a 48K portfolio. Margin is ~6400. To absorb a 25% DD we would need 12K in cash and to absorb a 30% DD we would need 16K. So let's be conservative and go with 22.4K as our minimum cash amount which will put us at 2.14x leverage. I won't track it but if we had high interest rates it would be a very big deal...and that is putting some of our cash in 90 day T Bills. How much to put in T Bill vs straight cash would take some figuring out. Again, we won't do it but take something like the 1970s-1980s this would be a significant advantage for using futures.

[clacy]

My only concern with the futures strategy of ES-YM would be that while the Dow and S&P generally move in the same direction, there can be a moderate diversion in terms of momentum.

Over time, months to years, it would wash out but you would have some occasions where your short Dow position lost as much as you gained from your long S&P position, even though both markets were up (Dow gained more relative to S&P and you were short Dow).

Would it be a better fit to go Long EMD (S&P Midcap 400 futures contract), which has a notional value of $154,090 (using yesterday's closing price) and shorting ES which had a notional value of $107,279 leaving you net long approximately $46,800?

Either way, that is another way to creatively trade stocks via futures. Same principle as looking at 30 yr vs 10 yr as another alternative to UB-ZB, depending on account size.

You could also long 1 EMD + long 1 YM and short ES x 2 which would leave you net long $30,852. And 1 midcap 400 contract plus 1 Dow 30 contract might average very closely to step for step for how the S&P moves.

The possibilities are endless, but the more contracts involved, obviously the more you are paying in commissions and bid/ask spreads.

[Kbg]

The possibilities are endless, but the more contracts involved, obviously the more you are paying in commissions and bid/ask spreads.

For sure.

Looking at correlations to other indexes the best stock futures contract match is the Russell 1000 to the S&P 500.
But I already mentioned why that pair could be problematic. Options could be different/optimal based on account size as well. There absolutely isn't going to be a perfect match unless your account is big enough to do it precisely the same as the normal instruments in the correct percentages. The paper portfolio was primarily designed to be the smallest possible with good correlation between the hedged parts. This one is 16K per position while going the EMD route means portfolio size and cash requirements are tripled. Not a problem in and of itself, just a constraint on cash required. If someone wants to build their own recipe and post results that would be awesome.

Just in one day's price action the first thing I've noticed is the impact of contract size on maintaining portfolio balance. In the current mix the daily results are going to be heavily influenced by the LTT contracts. No big surprise here, but the practical implication is that one is going to have to actively rebalance the LTT component to keep it in alignment. Yesterday gold and LTTs were balanced almost perfectly and today there is almost an $1100 difference. To deal with this we will need to either roll profits to the other components or increase the short end of our hedge. I will need to do some thinking on the best way to adjust.

[MachineGhost]

Don't forget the hassles of rolling and the negative roll yield.

If the leverage is no higher than the 2x-3x ETFs, I really don't see the point in using futures.

[Kbg]

Yep more work for sure. These three futures are extremely efficient. If there's a difference between them and spot you can be sure the same factors are playing out in the ETFs and probably the physicals when you account for the cash balance differences/interest and dividends. The real issue is can you trade for less than leveraged ETF fees? On this small example port, maybe. It will be close.

[clacy]

Yep more work for sure. These three futures are extremely efficient. If there's a difference between them and spot you can be sure the same factors are playing out in the ETFs and probably the physicals when you account for the cash balance differences/interest and dividends. The real issue is can you trade for less than leveraged ETF fees? On this small example port, maybe. It will be close.

If nothing else it gives you an option if leveraged ETF's, and in particular, the more liquid 3x ETF's are made illegal.

Secondly, for the right account size, it would be a great way to only risk 10 or 15% of your funds in a futures account, and have the rest earning interest in TIP's or something.

The remaining 85-90% of your funds could be placed into a total return bond fund or a 5 year treasury ladder.

[Kbg]

If nothing else it gives you an option if leveraged ETF's, and in particular, the more liquid 3x ETF's are made illegal.

Secondly, for the right account size, it would be a great way to only risk 10 or 15% of your funds in a futures account, and have the rest earning interest in TIP's or something.

The remaining 85-90% of your funds could be placed into a total return bond fund or a 5 year treasury ladder.

I agree which is the reason why I started looking into futures. I want a large cash balance and if we only end up with 2x ETFs that narrows the cash cushion more than I personally would prefer. I need to do some studying/searching to see how CTAs manage their cash portion. It is broker specific, but 90 day T-Bills (so I hear) are considered cash for margin purposes in an account but they will still charge you margin interest if you get marked for more than your actual free cash balance. Thus, no margin call but paying interest to your broker. And of course their interest rate is going to be more than a ST T-bill. As a minimum that would require some pure cash for normal day to day volatility and then the remaining cash could be deployed in other instruments. Anyone want to help with researching cash options?

[MachineGhost]

What do you mean?

[Kbg]

What do you mean?

Figuring out how CTAs technically manage their cash vis a vis their futures positions. My guess is some of it proprietary and varies but I would think there is something out there where one could get a sense of how it is done and a range of what is considered standard practice. Things like how they invest their cash, are they subject to the same margin rules with regard to T-Bills and straight cash. What are their average leverage ratios. Stuff like that.

[iwealth]

In my brokerage's paper trading account, going net long approximately $245-250k each asset has a projected overnight initial margin of $43k.

30% DD would be $225k + $43k margin = $268k equity required. That's around 2.75x leverage. Mighty impressive.

[Kbg]

Day 10 of the futures port...down .32% overall. Currently, I haven't seen anything that would make this an unattractive alternative to replacing a leveraged ETFs version. It will take a bit more work and in a taxable account one will need to look at the tax impact for their personal situation. If one were going to pull the trigger the biggest issue encountered thus far is managing one's cash balance. Specifically, how to get the most out of it while leaving room for normal DDs. On the risk side, going with futures contracts eliminates counter-party risk for those who get freaked out about that.

[dragoncar]

How do futures contracts eliminate counterparty risk? What happens if there is a breach of contract?

[Kbg]

How do futures contracts eliminate counterparty risk? What happens if there is a breach of contract?

They are guaranteed by the exchange and your broker and the exchange are on the hook for any contract defaults. Needless to say, if your broker is concerned they are going to close you out involuntarily. Additionally, this is also why you pay/receive mark to market changes in your cash account. In fact, this element of futures contracts causes a far more likely risk to be worried about for the individual trader...an insane swing in prices that eats all your cash balance and closes you out only to snap back minus your cash. If you want to be worried about something, worry about that. However, in our experimental futures account with the offsetting contracts we have this should not be a big worry. First, we have both our stock and LTTs hedged directly, and secondly, anything truly earth shattering for stocks is likely going to send LTTs and gold in the opposite direction.

In terms of instrument risk, futures are safer than ETFs. Your risk in futures is cash management....but if you were totally unleveraged (e.g. cash balance equals sum of all futures at full contract price then there is only the risk of market movements.

[Kbg]

.

[Kbg]

How do futures contracts eliminate counterparty risk? What happens if there is a breach of contract?

They are guaranteed by the exchange and your broker and the exchange/broker are on the hook for any contract defaults. Needless to say, if your broker is concerned they are going to close you out involuntarily. Additionally, this is also why you pay/receive mark to market changes in your cash account on a daily basis...to ensure you have adequate cash on hand to meet your contract's settlement amount. Additionally, the overnight margin per contract is based on what the exchange calculates as a normal extreme daily move which can and will be adjusted up during periods of high volatility. For example, the mini S&P 500 contract's overnight margin right now is equal to about a 5% move.

In fact, this element of futures contracts causes a far more likely risk to be worried about for the individual trader...an insane swing in prices that eats all your cash balance and closes you out only to snap back minus your cash. If you want to be worried about something, worry about that. However, in our experimental futures account with the offsetting contracts we have this should not be a big worry. First, we have both our stock and LTTs hedged directly, and secondly, anything truly earth shattering for stocks is likely going to send LTTs and gold in the opposite direction.

In terms of instrument risk, futures are safer than ETFs. Your risk in futures is cash management....but if you were totally unleveraged (e.g. cash balance equals sum of all futures at full contract price then there is only the risk of market movements.

[dragoncar]

That's amazing. There's still counterparty risk, of course, but I see why it's relatively insignificant

[MachineGhost]

Generally, the rule of thumb is to have an account size 3x to 4x the historical MaxDD (absolute dollars) to be able to survive. That has held up in every situation I recall when backtesting futures trading systems.

Also, I think you're confusing the exchanges/brokers with the clearinghouses which are pre-Federal Reserve-style associations owned by the exchanges. The clearinghouses are who guarantee the derivative contracts. The ruckus about off exchange derivatives being brought on exchange via Frank-Dodd Act after the subprime collapse -- they had no clearinghouses by definition so it was direct counterparty risk with each other. Very, very bad! You simply cannot trust a counterparty, especially investment banks as their whole modus operandi is front-running your trades and ripping your muppet face off.

Another lynchpin of the futures industry is that customer funds may not actually be segregated off the broker's balance sheet as that recent futures brokerage collapse and suicide of its owner indicated... PFG was it? Perengine Financial Group?

[Kbg]

Check out who the clearing houses are...

Securities must be segregated. Cash, not so much. Stay loaded up with ST T-Bills to the max possible.

The moral of the story, don't go with small firms that offer a sketchy amount of leverage. Go large with lots of retail customers who will light up their local Congressman's office, good automated risk control and lots of assets. Fidelity, Schwab, Vanguard, IB and TDW should be just fine.

But again, short of major catastrophe, these are all some of the most liquid contracts on the face of the planet.

[Kbg]

For a 100K portfolio...

2.5x means 250K equivalent/25% each to SHY, TMF, UGLD, and SPXL/25K SHY and 225K (75K x3) equivalent everything else

2x means 200K equivalent/16.667 each to the above and 50% to SHY/50K SHY and 150K (50K x3) equivalent everything else

1.5x means 150K equivalent/8.333% each to the above and 75% to SHY/75K SHY and 75K (25K x3) equivalent everything else

1x means 100K/25% each to SHY, TLT, GLD, SPY

Purchase price was at the close 12/31/15 through the close on 7/29/16

2.5x = 43.07%/-5.76%DD

2x = 29.12%/-4.31%DD

1.5x = 15.20%/-2.51%DD

1x = 13.62%/-1.62%DD

Futures: +3.74% since 7/12/16. 1.9 percentage points separates gold from LTT so no need to rebalance.

Personal mix = 35.33%

Comment: The port is now at an all time (backtest) high again. In my personal mix I'm +6.5 percentage points vs. my tracking bogey due to timely rebalancing. We also had our worst DD for the year thus far in July before rebounding to a new high.

[Indexinvestor]

Hi all,

My first post :-)
I am new to this forum and invested in the HBPP using ETF's since a couple of years back.
I think I read this thread from start to finish about 3 times now....and I am hooked to say the least. Thank you for all your contributions and a special thanks to KBG!
I am in my "asset growth years" so to speak and I am contemplating doing the 3xETF version that KBG is talking about: 50% SHY, 16.7% SPXL, 16.7% TMF, 16.7% UGLD ie the 2x.
As I understand it backtests quite well and if a total meltdown is coming I will still be standing with 50% cash.
My dilemma is how much of my total portfolio I should allocate to the above? I am not thinking of doing it only as a VP but to a greater extent...

[Kbg]

Please, consider it a VP and not a PP. Personally, I would start out small and wait for a really bad drawdown to see if you actually can take the volatility...and I highly recommend you not look at the individual elements, just look at the portfolio bottom line ups and downs

[Indexinvestor]

Hi KBG...thanks for a quick response.
For me the individual asset classes do not matter at all...why should they? Its like having a portfolio of stocks and rank the overall performance on the least performing stock?
I definately can take the volatility....have done so some years ago with a 100% stock portfolio..
Contrary to my previous portfolios I like the max drawdown aspect and yet a considerable upside.

[Cortopassi]

Indexinvestor,

Don't do it! If you have researched the 2x/3x enough you'll see things like below, and will have read about decay.

YTD, woo hoo, look at that NUGT go! (Miners 3x). Looks like a great deal, right?



Then look at 5 year. Both are near zero from the starting level

[iwealth]

Also keep in mind that a falling 3x leveraged instrument will approach zero rather quickly so if the underlying asset rebounds, you will not participate in proportionate gains.

Quick example:

If the underlying asset price is 100 and it falls 30% to 70 then rises 50% to 105.
The 3x ETF is 100 and it falls 90% to 10 then rises 150% to only 25.

The only way you can track a 2x PP is if you frequently rebalance the 3x ETFs and keep them at 50% of your total portfolio. And if the 3x ETFs are all falling at the same time, you will be eating into your cash pile rather quickly.

[Cortopassi]

Good example.

What I tried once and made minimal money, not worth the effort, was to short two competing instruments. So you could short DUST and NUGT and take advantage of the decay. But many of these are not available for shorting, or if they are have shorting fees/expenses, so those costs ate into profits.

I did it with UCO and SCO. And found I could make a little. but eventually they get unbalanced, so you still have to watch too closely for my taste.

AND, you also need to start out when the funds are fresh or split to make them more even. Doing this strategy now with DUST at $5 and NUGT at $154, well, they are already severely unbalanced.

Go to the casino or track instead, at least you'll enjoy yourself for a while as you are losing money.