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Every 18 Years On Average Investors Lose Half Of Their Money
Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we’re going to be talking about why every 18 years on average, investors lose half of their money. As we kind of wrap up 2019 and we start getting towards 2020, a brand-new decade, I think it’s important that we just remind ourselves of just how volatile markets can be moving forward in the future and how good we’ve really had it over the last 13 years as far as volatility, market shocks and black swans are concerned. We really haven’t had any major market movements in the last 13 years for US markets and that is a rare thing. And so, that would lead me to believe that in the future, potentially even the near future, the next couple of years, two years, three years or so, we’re going to have a significant move in the market in one fashion or another. And so, I want to revisit some of the things that we talked about actually in our weekly podcast show number 15 which is a really, really long time ago, we started looking at market drawdowns and crashes and started to build some numbers and some data points, some references around how often and how big market moves actually happen. And the first one is that on average, every 18 years, investors lose half of their money. Now, 18 years is a long time, but a 50% drawdown every 20 years or so is a significant move and in many cases, can set you back considerably towards your financial goals. And so, my goal is to of course, avoid situations like this. This is exactly why we started implementing a more aggressive VIX hedge strategy just in the last couple of months because we’re coming up on 13 years here of no major market volatility and I am more than willing to pay a little bit of money to hedge some of this black swan risk.
Now, what’s even more shocking to me is not necessarily the major drawdowns which are every 18 years, but the intermediate drawdowns of 30% and 20%, the typical bear markets if you will. Nine times in our history, we have seen stocks fall 30%. That’s basically once every 10 years. Again, I remind you, we’re coming up on 13 years of this bull market run in US equity markets. Does that mean that it’s going to stop next year? Of course not. It could continue on for another couple of years, but it’s getting long in the tooth and we just typically see a lot of cyclicality at some point in the future. 21 times in the past, we’ve seen at least a 20% drawdown in stocks. That’s once every four years. 41 times, we’ve seen a drawdown of at least 15%. That’s once every two years. Now, to be fair, we actually really had one of these drawdowns back at the end of 2018 which just goes to show you that we continue to have these 10% to 15% drawdowns on a regular basis. The 20%, 30%, 50% are more rare, but they’re not rare enough that we should consider them. And then of course, more than 90 times, we’ve had drawdowns of at least 10% which is correction territory which happens generally once every 11 months. It’s just really important that we keep these numbers in the back of our mind especially as we move forward to 2020 just to keep an eye on the risk for our positions and our portfolio moving forward. Hopefully this helps out. As always, if you guys enjoy this, let me know and until next time, happy trading.
How Is The CBOE VIX Calculated?
Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we’re going to be answering the question, “How is the CBOE VIX calculated?” The VIX is actually a measure of 30-day expected volatility for the S&P 500. You could basically say that the VIX is a gauge for judging the implied or the expected movement in the S&P 500 over the next 30 days. And so, what they do is they have a bunch of formulas and ways that they do it which they have on their site, but it basically boils down to looking at at the money and out of the money puts and calls that are more than 23 days from expiration and less than 37 days from expiration for the SPX. And so, what they do is they take all of the AM settlement SPX options along with any PM settlement weekly options that expire and they basically weight this to somewhere around 30 days of expected volatility. And so, what happens is that each week, the contracts and the calculations roll to the next maturity. As one week falls off, then they start accumulating the pricing of the options at the next week.
And so, it’s this constant moving target that basically is trying to judge or calculate how much people expect market to move in the next 30 days. Now, again, just keep in mind that the VIX is a judge of just market implied volatility for the SPX. It is not based on the RUT or the Dow or any other securities. It’s not based on any tech stocks necessarily unless they’re included in the S&P. It’s basically a broad market expectation of where implied volatility is going to go in the future. And so, that’s basically how they do it. Again, you can look at the details of the calculations, all of formulas. CBOE does a really good job of detailing this in a white paper. You can just search VIX calculation. But again, what they’re basically doing is just taking a weighted measurement of at the money and out of the money calls and puts no more than 23 days and less than 37 days from expiration for SPX. Hopefully this helps out. As always, if you guys have any questions, let me know and until next time, happy trading.
Can I Buy VIX Stock?
Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we’re going to answer the question, “Can I buy VIX stock?” No. You cannot buy VIX stock itself. It’s actually not anything that you can trade. It’s not an ETF. It’s not an underlying stock security. The VIX is an index, but you can trade options on it and you can trade derivative products that are based on the VIX. One of the derivative products that’s very popular to trade is VXX which is an ETN that tracks the rolling 30-day level of the VIX futures contracts. The problem with a lot of these is that sometimes they have little bit different pricing structures which you’ll want to investigate and learn more about. You can do that right here at Option Alpha as well. But you can’t buy the VIX directly. You can trade options on it. You can trade the VIX futures. You can trade VIX derivative products if you want. You just can’t go out and buy VIX itself. Hopefully this helps out. As always, if you guys have any questions, let me know and until next time, happy trading.
Why Is Backtesting Important?
Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we’re going to answer the question, “Why is back-testing important?” I actually get a lot of pushback on this and I think that many people look at back-testing as irrelevant and I think that back-testing has a lot of relevance if you use it correctly. Sure, back-testing is not perfect in the sense that a perfect back-test is not going to be the perfect expectation of what we should expect moving forward in the future. Obviously, what happened historically is not going to happen the same way in the future. We should all know this. This is a rational logical thought process that we should follow. But a lot of people think that when we say that something is going to back-test and win 70% of the time that it will exactly win 70% of the time in the future. We know this is not the case, that the future is still out there, it is unknowable, it is unpredictable, but for me, back-testing gives us parameters, bumper lanes if you will from which we should start to develop a guidepost to work towards. Now, does this mean that we have a back-tested strategy that we will exactly use just like that moving forward in the future? Definitely not because in some cases, we see that one particular back-test might just randomly be at a time period where it’s got a lot of high profitable trades. And so, it could be at the top of a peak in a series of peaks and valleys.
What we look for in back-testing is we look for congruency and for clustering of performance around different metrics. And so, again, this gives us an idea or a frame of reference on guidepost, on rails, on bumper lanes, whatever you want to call it, so that we stay out of the sand traps on either side. If I know in back-testing that generally, 30 days performs better than 50 days, okay, great, that gives me a guidepost to say that we should generally enter trades around 30 days and 60 days, but maybe try to scale back the entry at 50 days. Does that mean that 50 days doesn’t work? No. It just means that 30 days or 60-day entry periods might work a little bit better and that might be on a wide breath of different strategies and ticker symbols and different expiration contracts and puts and calls and short strangles and straddles. We might see this clustering or this congruence of performance metrics around that type of data point. To me, that’s the value of back-testing. It’s getting you out of those very easy to fall in sand traps on either side of your hopefully trajectory on where you’re going with your portfolio.
Well, a very easy sand trap that a lot of people fall into is short Delta short expiration periods and long calls and long puts, trading these very cheap, very close to expiration, a week or two out from expiration long calls and long puts, little lottery tickets and it’s a very easy sand trap to fall into because we know from a lot of testing that they just flat out do not work. There’s no rhyme or reason necessarily as to why they don’t work. They just don’t. In any market environment, in any time period, most of the durations in Deltas that we’ve tested in profit-taking levels or stop loss levels, they just don’t work as well as something else. That alleviates that need to find something in that little small needle in a haystack of things that work. Instead, I would rather just play in a different pool, in a different arena of things that generally work. Am I going to pick the ultimate strategy moving forward in the future? I probably doubt it because I don’t know what the future is going to bring. But can I drive on the right side of the road? Can I be in the right lane? Can I be working towards the right guidepost? I think that’s where back-testing definitely has its value. Hopefully this helps out. As always, if you guys have any questions, let me know and until next time, happy trading.
Just Started Investing? Allocate Everything Now Or Over-Time
Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we’re going to be talking about a very hot topic which is, “Do you allocate everything now in lump sum or do you allocate over time if you’re just getting started in investing?” The good news here is that I think that a lot of data and research has already been done on this and in particular, Vanguard did a bunch of research on this which you can find online on Vanguard’s website that has the performance of lump sum investing versus some deviation of dollar cost averaging or systematic investing in the future, basically this idea that if you have this lump sum of cash that you’re going to invest in the market, do you do it all just now and throw it into a diversified portfolio or however you build your portfolio with options or do you dollar cost average into this over time and start to average down in the market or wait for a market fall or a better entry? And what they found and what a lot of people have also found is that generally, the lump sum investment does better. And the simple explanation is that when you get the money invested sooner, it has longer time periods to compound, so that just even small holding period that you are waiting to invest is loss opportunity. At the same time, what it also alleviates is this stress that you’re going to feel in the future when you start to go into your investment cycles. If you say, “I’m going to invest at the end of every year.” when you come around to that yearly investment that you would have to make, you start to run into friction with yourself because you think to yourself, “Things have changed.” or “Now it’s different.” or “Maybe the market will fall even further because it already has rallied so high.” or “Maybe the market’s falling and it might fall even further because it’s already fallen.” Whatever the case is, you start to basically roadblock yourself into making systematic mechanical decisions, so for that reason, lump sum investment is better.
I think when it comes to options trading, this makes it insanely more easy because when you start investing with options, not only do you have defined risk, defined profit, defined expectations which is unlike say a bond or stock portfolio which has a lot of downside risk, you carry a lot of market systematic risk in general market portfolios that are 60/40 bonds or 50/50 bonds and stocks, with options, you have the ability to cover and manage risk from the start and you have the ability to adjust where your portfolio is on a monthly or bimonthly basis. The reason I think that this works so well for options is because if you were to invest say all of your money into an options trading strategy and build out an entire portfolio of trades, if the market changes next month, because your options contracts that you’re trading are 30 or 60 days out, you have the ability to quickly readjust and re-center the portfolio over the new market price. That doesn’t happen with a regular stock or bond portfolio. If you invested now and the market is really, really high on a PE basis or on a valuation basis and the market goes down, you don’t have the ability to close those positions and readjust those positions lower. You’re basically going to take a loss all the way down. With options trading, you have the ability to adjust and systematically move with the market every single month. It’s really like getting both sides of this thing at the same time. You have the ability to lump sum, but you also have the ability with options trading to systematically dollar cost average or move your portfolio around where the market is trading. The market goes down, you move your portfolio down just by the sheer activity of entering new positions for the next month. The market goes up, you readjust your positions higher as you enter new positions for the month. Hopefully this helps out. As always, if you ha
Binging despite the warning not to.
I am binging all of these bite-sized episodes because I am trying to catch up to current events. I was on the October 2016 episodes this last October and the advice was oddly useful even 4 years later. Looking forward to getting all caught up.
The biggest let down is hearing about deals that are already expired, but no crying over spilled milk.
Great resource for options traders at all levels. Kirk covers a broad range of topics in a manner that makes it easy to understand.
Such A Great Resource
The Daily Call is an amazing resource for me. The episodes are short and digestable which allows for easy understanding. I spend most evenings binging episodes. Give it a listen!