Bi-Directional Algorithm
Levkovich's Buy-Low, Sell-High Model
The chart below is a 12-year chart of SPY. In 12 years, SPY had 0
return. On Nov 11, 2010 SPY was at the same level recorded on Dec 24, 1998. No one
was able to buy at A, C, E and sell at B & D.
Citibank's analyst Levkovich discovered a buy-low, sell-high model that could beat
the market by selling 10% of SPY when it was up 20%, and buying 10% when it dropped 20%. The return was 14% in this 12-year period. |
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Using Stock Market Capitalization vs GDP as filter, the return was 36% (When Stock Market Capitalization / GDP
> 115%, sold 10%; if Stock Market Capitalization / GDP < 75%, bought 10%).
However, Levkovich's model is not perfect (it is directional). If we entered the
market at B or D, the model would generate a loss.
We built a bi-directional algorithm based on Levkovich's
model at much higher frequency. The back-testing shows impressive results. Sharp ratio is 2.80! Maximum risk for long
and short 10 contracts of YM is only $1,000 per day, $3,000 per day for +/- 10
contracts of GC, $1,000 per day for +/- 10 contracts of QM. We tested this model on 44 US
stocks. The results are impressive.
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From August 2011 we began trading this model live.
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The Collar Strategy
Collar is a proven strategy that can transfer the downside risk of investing in
stocks. Szado and Kazemi of the University of Massachussetts performed a study
of QQQ.
Over the 9-year period from March 1999 to March 2008, the collar strategy returned more than
150% cumulatively, while QQQ lost 12% during this period. Annualized return was
23.01% with standard deviation of only 9%. While the standard deviation of QQQ
was 27%!
Szado extended the study and discovered a way of boosting the return by
adjusting the strike prices of the collar. (When the stock price has moved up,
adjust the strike price of the call up. Szado called this the
Active Collar.)
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The Algorithmic Collar
We discovered a better way of boosting the performance of the collar strategy by
actively trading the underlying stock in addition to adjusting the strike prices
of the collar. » more
Most of the time, the stock does not move after adjusting the strike prices of
the collar which has to take loss on the existing collar.
Risk-Free
Dividend Arbitrage with a Collar
With proper timing and the collar strategy, we can capture rich dividends
risk-free.
The
strategy can be implemented every month. In the monthly approach, we need three
stocks. Each one has ex-dividend date in a different month. Assuming all three
stocks earn 10% per year, this translates to a quarterly return of 2.5%, each
and every month. Annual return is then 30%. Assuming that there is 50% chance
that the stock will be called away before the ex-dividend date, the annual
return will be 15%.
Many
stocks pay more than 15% annual dividend.
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