Last week we closed our June positions, with a few good results—but they were offset by some disappointing losses:
- SPY June/July Double-Calendar #1 (132/137): Closed at a loss of 69% after 34 days;
- SPY June/July Double-Calendar #2 (128/134): Closed with a gain of 24% on total capital risked, in 25 days;
- SPY June/July Calendar Spread (137): Closed at a 96% loss in 17 days;
- SPY June Butterfly Hedge #1 (127/131/135): Expired with a gain of 16% on total capital risked over 17 days;
- SPY June Butterfly Hedge #2 (122/126/130): Closed after one day for a gain of 14%.
Our average return per trade was about –22%, but based on our Model Portfolio allocation and the hedge sizes specified, Model Portfolio return was –24.8%. There’s no sugar-coating it—this is a big hit, and it demands whatever effort it takes to determine what went wrong despite the fact that we precisely followed our latest strategy rules, which have a track record (historical and back-tested) of consistently outperforming the market.
I expect to complete my analysis of June’s loss within a week or so, but for now it’s important to remember two things (cue the broken record):
- Outliers happen, no matter how much we try to develop a strategy to protect ourselves from them—which is why we emphasize over and over again the importance of allocating capital in accordance with risk-tolerance.
- Returns tend to revert to the mean just like everything else, and the worst time to abandon a strategy with a winning long-term track-record is after an exceptional drawdown.
The latter tends to be the most difficult for traders to accept; nevertheless, anyone who allocated more to this one strategy than he or she is comfortable with after our June loss should consider scaling back. That said, cashing out after every loss and piling into the next promising strategy over and over is a recipe for failure. Long-term performance, appropriate capital allocation, and diversification are all key to achieving exceptional returns.
Status of Open Trades
Case in point: At today’s close, the July/August double-calendar we entered yesterday was showing an unrealized gain of 2.1%. Despite the delta and vega losses predicted by mathematical simulation, this trade is behaving as we generally would expect—the increase in back-month implied volatility is offsetting the delta/vega losses from our short positions to give us a net profit. Here’s what our risk profile looked like right at the bell:
The outer price slices mark our current risk-management price thresholds. (As close as we are to expiration, they’ve narrowed a bit even after just one day.) If today’s reversal turns into a trend, a downside hedge trade could be triggered as soon as tomorrow…but with three-quarters of our capital in cash and three weeks left in the July options cycle, we have plenty of time and money (the Dynamic Duo of trading) to manage risk and win back at least some—perhaps even most…but let’s not get ahead of ourselves—of June’s losses in the current cycle.
I’ll send out a trade notice tomorrow morning if it looks like SPY is set to open under $127.75.