Best way to trade this setup

[frostengine]

Lets assume the following scenario exists every week. Where you can construct a trade with the following characteristics for SPY. Do you believe in the long run this strategy should be more profitable than simply buying and holding the index.

Profit based on 100 shares of SPY for the following SPY % moves:

+5% +$874
+3% +$486
+2% +309
+1% +$155
0% (unchanged) +$36
-1% -$50
-2% -$295
-3% -$516
-5% -$926

The market has to move down nearly 1% to result in the same loss as the gain experienced with the market just sitting still. The strategy does not go negative until a -.4% move.

For up to a 2% move the R/R is favorable to the long side, with greater than 2% moves the R/R is slightly more favorable to the downside.

In my opinion the R/R trade off is fine considering most weeks the market will move less than +/- 2%. In fact, here are some statistics I just ran (have not debugged the script to ensure accurate stats)

For 2000-today:
From Friday to Friday closing, the market is under a +/- 1% 68% of the time, and under +/- 2% 83% of the time. This means for 83% of the weeks, we have a favorable R/R.

In addition the market closed better than -.4% 62% of the weeks.

One thought is you essentially are receiving a .4% gain for 62% of the weeks. I believe this should help you to outperform the SPY by roughly 12% over the course of the year. However, I think its more complicated than that. Another way to look these stats is that the market is +/- 1% 68% of the weeks. And referring to the R/R above, 1% down is -50 while 1% up is +150.. A 3 to 1 advantage. So, I would anticipate that in many weeks we would outperform the broad market by 3x further extending the annual out performance..

What am I missing here?

What would you do with this setup? Would you trade it? Would you use it instead of buy and hold for longer term investing?

Seems like I have to be overlooking something as surely if a set up exists that allowed for 12%+ out performance of SPY it would be used up by big hedge funds?

 

[galvinlee888]

Are you include commission and slippage in your calculation? How about assignment? What is your "tail risk" if SPY tanked by 10% and are you worst than buy and hold? Are you underperform buy and hold in bear market? Are you collect the same amount of dividend as buy and hold? PM me in private if you don't want to discuss this in open forum.

 

[frostengine]

I did not include commission and slippage due to both being nominal when trading SPY (tight spreads).

As far as the tail risk, it maxes out around the 5% move range described above. So yes, it underperforms in that case, but not by a big margin.

While I like the prospect of this strategy out performing the S&P over the long run, I generally do not like any strategies where I have huge black swan risks.

As such, one thing I am considering adding to this strategy is to buy a long dated leap put. The time decay from the put would be more than offset by the fact this strategy makes roughly +$36 while sitting still. The deltas picked up from the put would skew my numbers some, but not drastically. Biggest issue with the leap put is that while it caps my downside to a known number, there can be big gyrations on a week to week basis based off of changes in IV.

I think that if I incorporated a leap put into the strategy the goal would be for it to be "ignored" generally speaking. Its time decay is being offset by the strategy naturally, and the IV fluctuations ignored. Only if there was August like action, then I would look to exit the leap put and capitalize on the inflated IV and downside protection it provided until the market settled out.

Does anyone have practical experience using a leap put to offset black swan type events? Would this be a bad idea to incorporate?

 

[frostengine]

Decided to put this strategy to the test for 100 shares. Price of SPY at time of entry: 204.85

In addition, I added a long Dec 2017 205 put for: 22.66 to provide downside protection as I am frankly very concerned about what the market may do the first few weeks of the new year.

Will check back in a week and see how it did. This small size trade over a few weeks will give me an idea if I am missing something or miscalculating the R/R.