Mon, Mar 28, 2011 | Jared Woodard
Traders who rely on mean reversion have witnessed some very frustrating periods over the last couple of years, and no tinfoil hats are required to see that Fed POMO operations have had a substantial reflationary effect on equity markets. I am not confident that equities will continue to rally aggressively in the absence of dramatic quantitative easing programs – ending in June, or possibly sooner – and in the face of high energy and food prices. The push for pro-cyclical fiscal policy (tax cuts, spending cuts) by evidence-allergic ideologues is not likely to improve matters. A bearish forecast for equity prices is unwarranted here absent some new catalyst, but I do expect more frequent periods of sideways trading for the remainder of 2011.
ETF Trend-following Strategy
The conventional wisdom about credit spreads and iron condors is that they require a mean reversion environment. That’s partially true, especially when it comes to positions with unhedged deltas. But there’s no law against trading credit spreads on the basis of trend-following price signals.
I introduced just such a strategy for newsletter subscribers last December. The strategy is straightforward: we conduct a daily scan of about 20 ETFs with active and liquid options for candidates with new price-based trend signals. When those buy or sell signals are issued, we sell out-of-the-money vertical spreads consistent with the trend. We hold the trades to expiration, or exit if the underlying touches the short strike of the spread. Performance since inception has been pretty stellar:
The chart reflects three expiration cycles, two of which (February and March) included about nine positions each. I may break this out as a separate newsletter strategy in the coming months, but for now access is freely available to current condor letter subscribers.
Iron Condors Performance Data
The delta-hedged iron condor strategy returned 5.45% in January and was basically flat for the March cycle, but a -11% return on the February positions left the strategy down for the quarter. Once again the delta-hedging component provided some very substantial protection against a momentum-driven environment, but when the market rises at a 45-degree angle week after week, strike-sensitive strategies will always face some pressure.
Our April positions are up substantially – about 6% on a portfolio basis – so as we close out those trades we will be flat on the year, and looking forward to the May cycle.
Performance data for the Condor Options newsletter is below, followed by monthly returns and a VAMI (value-added monthly index) comparison. Our benchmark, the CBOE Volatility Arbitrage Index (VTY), tracks the performance of a hypothetical volatility arbitrage trading strategy designed to capitalize on the difference between S&P 500 Index (SPX) option implied volatility and the historical volatility of the S&P 500 Index. All monthly returns measure expiration cycles rather than calendar months.