A Trade Plan in Three Phases for 500% Profit by 2021

This is a journalised public entry for my case study. It is possible I could be preparing for the launch of my first financial product. The trades and strategy described have only educational value - trying to execute them at the time of publishing would have unpredictable outcome and is not recommended. I am an amateur financial hacker and if you need investment advice you should always talk to a registered professional.

Several friends from a WhatsApp trading group I founded asked what was my plan for trading this crisis. I am trying to separate the technique from the current trade plan here and use this article as a quick reference if the question arises again.

The general rules:

1. I use "Portfolio Margin", also known as risk-based portfolio or CPM.
2. I trade mostly equities and options.
3. I aim for high capital utilization - about 90% of my liquidity is always deployed.
4. My account is highly leveraged (around 10x) and dynamically hedged.
5. I have developed my own approach for managing portfolio risk and margin calls.
6. I tend to be long stock and short options as a broad rule.

It is my personal belief that confronted with extraordinary market moves like we have seen since January, retail traders have an inclination to act along one of the following strategies:

• hold and manage their losses if they were long/short already
• trade short term if they have reserve capital and choose discretionary allocation
• liquidate and take flight to safety in cash or traditional "safe" instruments such as gold and bonds

None of these approaches appealed to me as they are all reactive - doing something in response to the market moves. As with all lagging signals, I find this approach inefficient and possibly compounding uncertainty between the market and the trader's biases.

The Interactive Brokers account I am using for this case study was seeded with 103,000USD and traded discretionary until the last week of January 2020 as seen below. That was the time when I changed focus from growing the principal to protecting it and preparing for the downturn ahead (equity curve courtesy of IBKR captured at the time of writing).

It feels important to mention that I did not liquidate my positions at the time - I have a strong thesis on ROKU and I had used it as a volatile underlying to write options strategies around it and generate premium. This is possibly the biggest difference between other downturn strategies and what I have chosen to implement - I did not want to abandon my assets and I went looking instead for means of protecting and nurturing them through the very volatile times ahead.

After deploying timely my #meltdownhedge against SPX and RUT at the end of January, let's see two months later and in the wake of the largest market move since 1987 how did my account survive it in terms of composition (equity curve above already gives an idea of the 35% drawdown that I experienced).

I used time-weighted return instead of money-weighted return (over 44%) vs SP500 in order to give context to the Sharpe Ratio and Standard Deviation. The large drawdown was managed but constitutes a source of concern as recovery was entirely passive (I waited for the hedges to catch up once VIX passed 75) since I had no capital left to deploy. It was a valuable lesson in the price of expressing conviction and the risk of having deployed almost all your liquidity in a highly leveraged account.

During the most aggressive drops in SPX, the total gross exposure (long+short) reached 2.6M, but it tends to stabilize around 1.5M when VIX is around 60.

After the hedge matured and started showing massive unrealised profits once the SPX went down from January levels and its volatility increased, the next phase of the trade plan is to convert said profits into longs and covered calls with long expiration date in order to harvest and preserve its margin impact (again, this is a CPM account where margin requirements are calculated in real time for T+0).

The transient nature of the #meltdownhedge is part of the strategy of rebalancing the account. In the current setup, the hedge position has the expiration date around mid-June 2020 and I have a reasonable understanding of its Greeks in the last 45 days before that. As execution that means when the SPX drops I have to be prepared to go long on equities that I have identified as anti-fragile (immune or benefiting from the current crisis).

Shown today is the current asset class distribution in the account (needless to mention, my ROKU position has increased and I have averaged down the price to a manageable level).

The Fed intervention and officially-denied systemic crisis in the US economy (over-leveraged corporate loans and liquidity issues come to mind) has made rebalancing a timely act. I need SPX to make one or preferably several excursions towards 2,000 levels while I get this right. This Friday looks promising, hence the article banner image. I sure am looking for some discounts and I am prepared to go on a buying spree given the opportunity.

As far as this phase is concerned, I am about 50% there - you can see the sector distribution in pre-market today expressing my conviction that a recovery curve is going to play out in the next 12-18 months.

These are the criteria for selecting longs to replace the hedge in total gross exposure:

1. low debt-to-capital ratio
2. low margin requirement
3. likely to grow and retain market share
4. large or medium cap
5. high options liquidity

Since mid-March I have been executing this last phase, as reflected in the chart below. The long equities positions are now at comparable levels with mid-January, but in a vastly different/more diversified mix. My portfolio beta remains close to 1, and the main focus is on managing margin requirements during market convulsions on the upside.

In closing, to summarise - my current trade plan 3-phase breakdown:

1) protected the capital in January

2) get margin credit / liquidity from the hedges

3) convert them in long holdings with low margin requirements and resilience to market turbulence before hedges expire.

Overall I am trying to convert 1.4 - 2.6M gross exposure with hedges into 0.5 - 1M long positions plus 0.5 - 0.8M in short options on the same underlyings for a total of over 1M "resilient" gross exposure. Then repay the margin loan on the recovery path and hopefully close with a 500% return on the capital invested back in September 2019.

Thank you for reading so far, I hope it gives you some actionable ideas and as always I appreciate any feedback or questions on the plan described in the article. Happy trading!

#OptionTradeClub #investing #GULPbet