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[Maverick74]

Quote from Jay_Ap:

Maverick, I honestly fail to see a more relevant and simple comparison. From a leverage perspective, Portfolio Margin is pretty much the exact same thing, except with a few more risk constraints.

No, it's not. And it adds no value to this conversation. This allocator is giving you capital. He is allowing you to do whatever the hell you want with it. Hedge it, don't hedge it, use it, don't use it, it's up to you. You can think of it as leverage if you want, but it's not. It's real cold hard cash. All you need to know is at what point will the allocator shut you down. And that point is when you lose 500k. How you lost it he doesn't care. See you keep wanting to "explain" things when there is nothing to explain.

Pretend someone just gave you a gift card for Christmas with $500 on it. You can spend it on whatever you want. Once you spend the $500, the card is done. The person who gave you the card just wants you to enjoy it. He/she doesn't care what you spend it on. You keep wanting to have long conversations about your shopping list. I'm trying to explain to you it doesn't matter. You get the $500 and when it runs out, it runs out. Game over.

 

[darkhorse]

Quote from pikerforlife:

could someone please go over some of the examples further. how much of that great 9 to 1 return does the trader actually keep? if he is only getting 20% of that return, he is making the *exact same* as he was before, per the example, best case. $150-180k a year, still only a dentist, right?

also, if/when that expected 6%-10% draw down happens, isn't the trader's money actually down that same 9 to 1, in a month? so, a somewhat expected bad -4% month puts his $500k down $200k, or off 40%, in one month, instead of the usual 4%, $20k hit he would have taken to his nut?

i don't see how this is a better return that what this fantasy "36% per year 12% draw down" trader (using no leverage already? really?) could gain by simply getting a margin account for himself and working for 'only' 20% per year instead. without the hassles of worrying about that next (expected!) small draw down taking half his money in a few weeks.

i'd rather pull out my teeth, and be my own dentist, than sweat the inevitable everyday ruining my equity. all while making a nice risk free nut for someone else. seems a step backward for that fantasy trader grinding it out year after year already with his own system.

You are misunderstanding a number of things here.

Re, payout structures, I don't have the numbers in front of me and I'm feeling too lazy to get them. But it's not the same regardless because, by cutting notional reward in half, you have also cut notional risk in half.

As for the 12% drawdown which was reduced to 6% via cutting notional size, that is a worst-case ANNUAL drawdown hypothetical, i.e. what you can reasonably expect as a max excursion, not what you might see in a month or even a few weeks.

If you had a minus 4% month trading a program with a 6% worst-case scenario for annual drawdown, then you either ran into outlier catastrophe or fucked up your calculations badly.

Re, 36 and 12, I never said the trader was getting that with zero leverage. The point was that whatever leverage he was using to start with, he would reduce that notional amount (in terms of position size) upon entering the first loss program so that his expected max DD was under 10% when running the $5MM.

Re, "taking half his money in a few weeks," again you're totally missing the point of calculating a realistic ANNUAL / WORST CASE drawdown, which is the way real traders do it anyway. Your max historical drawdown is the worst result you expect to get, statistically, over a meaningful length of time, not something that can happen in a random month or two.

Your whole cynical reply misses the entire point of the program. It's for traders who have an excellent methodology already in place, who want a proven and probable path for going from managing a small amount (hundreds of thousands) to an orders of magnitude larger amount, as a successful hedge fund manager running OPM. That is the whole point of the capital allocator program in the first place. It is a gateway to turn successful small to moderate scale traders into successful hedge fund managers, doing the same thing, making a hell of a lot more money. That is the process by which all participants win.

 

[Jay_Ap]

Quote from Maverick74:

Because it's a moot point to the conversation. All you need to know is, you put in 500k, they put in 4.5 million. Once the account is down 500k, you're done. How you trade is up to you. Leverage it up as much or as little as you want. They are not "giving" you leverage per se. They are giving you a 5 million dollar account of which 500k is yours. You can call it whatever you want. Trade it however you like. Once you are down 10%, your 500k is gone and the account is closed. That is the only thing you need to know. Portfolio margin is irrelevant.

Ummm.... if you say so Mav. All your comment tells me is that you don't understand what portfolio margin is, and further, you enjoy gross simplifications of inherently complex things.

I recommend that you stay away from any sort of leveraged trading cause "you will blow up and stuff".

 

[Maverick74]

Quote from Jay_Ap:

Ummm.... if you say so Mav. All your comment tells me is that you don't understand what portfolio margin is, and further, you enjoy gross simplifications of inherently complex things.

I recommend that you stay away from any sort of leveraged trading cause "you will blow up and stuff".

OK, let me try to explain this to you differently. Let's use IB. You open an account with IB with 100k. They set you up with a portfolio margin account OK? IB is not actually "giving you an extra 560k (6.5 to 1 margin). They are simply asking you to post less margin on your positions. You with me so far?

This allocator deal, they are not "giving" you margin. What they are giving you is CASH. You put up 500k, they write a check for 4.5 million. Pretend the money is an a cash secured IRA account, no margin allowed. It's simply 5 million in cash.

Still with me? So the allocator deal is simply a one for one deal. You have a 5 million dollar account. At IB, you have a 100k account but which they will grant you less restrictive margins (in some cases). Do you follow now?

The whole sales pitch on this allocator deal is to go to this large institutional investor and tell him that you were trading this big 5 million dollar account. That's the whole pitch. Not to say we have this guy who traded a 500k with 10 to 1 leverage. No investor is interested in that crap.

So in your example of portfolio margin, you keep talking about leverage. With the allocator, it's a straight cash deal. THAT is the difference.

P.S. I've been in this business for 15 years. Ran a regional JBO office in Chicago for 8 years and our firm was one of the first firms to offer portfolio margin accounts when they came out. I know them quite well thank you.

 

[Jay_Ap]

Quote from darkhorse:

Well, for one, portfolio margin will give you increased leverage only under certain circumstances - and they may not be the circumstances that are ideal for your strategy. Keep in mind too that, under certain concentrated position circumstances, portfolio margin will give you less leverage than Reg T.

If you have allocator leverage, on the other hand, you can take your leverage up or down as you choose.

So think of portfolio margin leverage as coming with all kinds of caveats - and for directional traders, the concentrated position caveat is a HUGE one.

Let's say, for example, that a major, major macro event has just taken place. A discretionary trader is already up 20% for the year, having brilliantly played the secular bear decline.

Now, in the flash of an instant, this trader sees that the entire game has changed... that the time has come to go "long the world," so to speak -- risking 500 basis points, or a quarter of his accumulated profits, to do so -- and he is able to do this with a very tight risk point, say in S&P futures, because of the epic inflection point that has just crystallized, allowing him to put on a HUGE amount of upside leverage in a very concentrated space.

Our hero trader tries to go long S&P futures, all above considerations taken, with his portfolio margin account.

The portfolio margin engine says "sorry, no dice - that's too much concentrated risk." One of the biggest opportunities of the year, maybe the decade, to make a sick killing has been cut short. Our hero trader makes a lot of money, but not NEARLY as much as he could have made, had he not been reined in by a robot.

With allocator leverage, there would be no such automated restriction on concentrated positioning. Allocator leverage is thus not subject to one of the biggest flaws of treating portfolio margin as a source of leverage - the fact that concentrated positioning is not always a negative, depending on planned risk, situational dynamics, and other factors.

And the same can apply in complex ways to more advanced market neutral type strategies, though the details are too hairy to come up with a quick example here...

Bottom line being, portfolio margin leverage is not "true" leverage in that it is not "always available" leverage. It is subject to a pre-determined robotic formula, the calculations of which do not alway properly account for situational dynamics.

I appreciate the reply Darkhorse. It makes complete sense. The advantages of the allocator's capital over a PortMargin account really come down to the type of trading strategy in quesstion and its level of position concentration.

On a different note, how the hell do you guys type so quickly?! You and Mike generate a lot of good content. thanks for that.

 

[darkhorse]

Quote from Jay_Ap:



On a different note, how the hell do you guys type so quickly?! You and Mike generate a lot of good content. thanks for that.

90+ wpm cruising speed

Most welcome, it's been great fun so far. We benefit from "thinking out loud" and the intellectual rigor of clarifying our thoughts for the consumption of others. The more you do it, the easier it gets (the communication part anyway).

 

[Jay_Ap]

Quote from Maverick74:

OK, let me try to explain this to you differently. Let's use IB. You open an account with IB with 100k. They set you up with a portfolio margin account OK? IB is not actually "giving you an extra 560k (6.5 to 1 margin). They are simply asking you to post less margin on your positions. You with me so far?

This allocator deal, they are not "giving" you margin. What they are giving you is CASH. You put up 500k, they write a check for 4.5 million. Pretend the money is an a cash secured IRA account, no margin allowed. It's simply 5 million in cash.

Still with me? So the allocator deal is simply a one for one deal. You have a 5 million dollar account. At IB, you have a 100k account but which they will grant you less restrictive margins (in some cases). Do you follow now?

The whole sales pitch on this allocator deal is to go to this large institutional investor and tell him that you were trading this big 5 million dollar account. That's the whole pitch. Not to say we have this guy who traded a 500k with 10 to 1 leverage. No investor is interested in that crap.

So in your example of portfolio margin, you keep talking about leverage. With the allocator, it's a straight cash deal. THAT is the difference.

P.S. I've been in this business for 15 years. Ran a regional JBO office in Chicago for 8 years and our firm was one of the first firms to offer portfolio margin accounts when they came out. I know them quite well thank you.

OK Mav, let's make this easily comparable. Take these examples:

1. I have an IB Port Margin account with 500k cash. I use my 500k to borrow 4.5mil from IB so that I can trade 5 million. I make a trade of $5 million notional exposure. Then, if the notional portfolio loses 5%, my 500k is wiped out and I pack my bags.

2. I have a non-margin account with 500k and 4.5 mil from the allocator. I make a trade of $5 million notional exposure. Then, if the notional portfolio loses 5%, my 500k is wiped out and I pack my bags.

How is this different?

Now, if you are saying that it is more a matter of "optics" with respect to marketing to institutional investors, then that is a valid but a different point completely. Up until now we've been talking about the mechanics, not the optics.

 

[Maverick74]

Quote from Jay_Ap:

OK Mav, let's make this easily comparable. Take these examples:

1. I have an IB Port Margin account with 500k cash. I use my 500k to borrow 4.5mil from IB so that I can trade 5 million. I make a trade of $5 million notional exposure. Then, if the notional portfolio loses 5%, my 500k is wiped out and I pack my bags.

2. I have a non-margin account with 500k and 4.5 mil from the allocator. I make a trade of $5 million notional exposure. Then, if the notional portfolio loses 5%, my 500k is wiped out and I pack my bags.

How is this different?

Now, if you are saying that it is more a matter of "optics" with respect to marketing to institutional investors, then that is a valid but a different point completely. Up until now we've been talking about the mechanics, not the optics.

Yes, there is a difference. IB's margin is "variable". It's situational. It's not static. In the case of the allocator, you are getting 5 million. That means in theory with IB you can "manipulate" their system to get more or less margin based on their margin parameters.

With the allocator you are trading 5 million in cash.

In our JBO, our traders use to manipulate their sheets all the time. We measured risk up and down 15% overnight and traders became very clever on how to hide risk. You can do that with margin. With cash, it's cash. It's not variable. You have to understand this concept. It's crucial to the conversation.

 

[Jay_Ap]

Quote from Maverick74:

Yes, there is a difference. IB's margin is "variable". It's situational. It's not static. In the case of the allocator, you are getting 5 million. That means in theory with IB you can "manipulate" their system to get more or less margin based on their margin parameters.

With the allocator you are trading 5 million in cash.

In our JBO, our traders use to manipulate their sheets all the time. We measured risk up and down 15% overnight and traders became very clever on how to hide risk. You can do that with margin. With cash, it's cash. It's not variable. You have to understand this concept. It's crucial to the conversation.

OK. I appreciate the less hyperbolic response Mav. I think we're getting somewhere.

So, to recap - from what you and La Horse Noir are saying, the biggest difference is that with the allocator's capital I am not exposed to the vagaries of my broker's margin system. And those vagaries can be difficult to manage. Ergo, I should prefer the allocator's capital, especially if I have a trading strategy that won't pass muster with a portfolio margin risk system.

These are all important and valid points. But, let's say I have a strategy that easily clears the hurdles of the Portfolio Margin risk system (just for kicks, say, like, err, ummmm...a market neutral strategy). Then, these advantages are no longer relevant.

This is an unfortunate paradox though because one would think that the First Loss type of program would be most attractive to Portfolio Managers with tightly risk controlled strategies (i.e. the exact kind of folks that would flourish under portfolio margin).

 

[darkhorse]

Quote from Jay_Ap:


So, to recap - from what you and La Horse Noir are saying, the biggest difference is that with the allocator's capital I am not exposed to the vagaries of my broker's margin system. And those vagaries can be difficult to manage. Ergo, I should prefer the allocator's capital, especially if I have a trading strategy that won't pass muster with a portfolio margin risk system.

Pretty much... though it's not that, say, a directional strategy "won't pass muster" with a portfolio margin system.

Most of the time, a directional strategy will fit within the parameters of a portfolio margin system just fine, because directional traders simply don't need that much excess leverage to make their strategies work.

Every once in a while, though, a directional trader may see an attractive inflection point where the addition of concentrated leverage is a cool option to have.

If you are trading cash, you have this option to "take it up" as much as you need to (within sane reason), whether it be your own (margined) cash or the allocator's cash. If you are relying on portfolio margin to provide a synthetic form of additional leverage, though, such may not be available to you.

You also inadvertently hit on a hidden downside of market neutral type strategies - when embedded leverage is built into the structure of the methodology, the possibility of things going bad can be very bad.

There is a meaningful risk difference between generating 20% returns with a modest or low leveraged strategy, versus generating 20% returns with a highly leveraged strategy, where the assumption of low risk hinges on the relationship between two assets remaining stable. Most of the time that assumption is correct, but when it fails you can wind up like this: http://i.imgur.com/rpzVa.jpg

So the "paradox" here goes into even deeper theoretical waters, re, which strategies are truly "risky" and which are not, e.g., a robust strategy with more drawdowns but a reliable long-term profile and low reliance on stable relationship assumptions, or a low drawdown strategy that relies on levered asset relationships, that looks good 99 months out of 100 but every so often, "oh shit" etc...