“A smooth sea never made a skilled mariner,” goes the proverb, and we’ve sailed some rough waters in the relatively brief history of our calendar-spread newsletter. As Jared noted in his review of Condor Options performance for the first quarter of 2010, we’ve demonstrated time and again that market-neutral strategies can and do work in all kinds of markets. Nevertheless, some environments are more challenging than others, and the measure of a strategy depends as much on how it performs when the going gets tough as when the market hands us an “easy” month.
The two forces that work against a calendar-spread strategy are falling implied volatility and increasing realized volatility; this past quarter the market swung from one to the other and back again. The January cycle saw a 25% decline in the VIX, which was followed in February by an 80% jump in the realized volatility of the S&P 500 Index. The bulls charged back in March, with implied volatility dropping 35%. Even so, under what arguably could be the worst possible conditions for a calendar-spread strategy, we limited our drawdown for the quarter to less than the gains we’ve shown Calendar Options can achieve in a single month.
A Heartier Vessel
That’s a pretty good risk/reward ratio—but as far as I’m concerned, it isn’t good enough. I analyzed each month’s trades to see if we could better manage risk when the market deals us the rarest of bad hands, without a significant impact on returns under the best conditions, and developed a few small, but very effective, refinements (the details of which are available only to Calendar Options subscribers) that have shown excellent results both in backtesting—which included the fall 2008 meltdown as well as the historic rebound that followed—and in practice. Our return for the latest April cycle, which was in many ways a repeat of March, was 2.63%, compared to –3.47% in the prior month. And even as the uptrend continues, our unrealized Model Portfolio return for May is currently over 3.6%. (Incidentally, we’re spending less on commissions too.)
Before we get to the latest performance stats, I did some additional research to support Jared’s assertion, based on our long-term track record, that the newsletters’ underperformance last quarter says more about this market than it does about our strategies. Only three other times in the last century—March 1915 to February 1916, March 1935 to March 1936 and August 1982 to July 1983—has the broad market remained above a 60%/year rising trend line for a year or more. We never enjoy reporting a loss, but when our biggest drawdown in the context of a 30+ year event isn’t much more than what’s considered a normal “correction” for the S&P 500, it attests to the robustness of our strategy even before the latest improvements.
The table below (click to enlarge) includes Calendar Options performance data for the fourth quarter, for the year 2009, and since inception. We’re now including the CBOE Volatility Arbitrage Strategy Benchmark (VTY), because we believe it represents a more comparable strategy than either simply being long the S&P500, or other benchmarks we’ve used in the past. The table is followed by a graph of our returns since inception, compared to these two benchmarks.photo courtesy of Flickr user maessive under Creative Commons license.