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Arbitrage, quantitative investing, strategy-based indices, systematic strategies
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Summary

  • Structural Arbitrage continues to outperform the S&P 500.
  • The strategy has outstanding Sharpe, MAR, and correlation statistics.
  • Structural Arbitrage is easily implemented using ETPs.

The idea behind Structural Arbitrage is that profits are possible by acting as a synthetic insurance company which sells expensive insurance in the volatility market, and then synthetically reinsures that market risk with long duration government bonds. The strategy has reached a new YTD high, returning 36.6% YTD.

Previously, we examined the logic behind the strategy, which arbitrages the different prices at which separate markets, on average, price equity risk.

To review, the strategy's rules are:

I. Buy XIV (NASDAQ:XIV) with 40% of the dollar value of the portfolio.
II. Buy TMF (NYSEARCA:TMF) with 60% of the dollar value of the portfolio.
III. Rebalance weekly to maintain the 40%/ 60% dollar value split between the positions.

Here are the strategy's results in a linear scale YTD:

(click to enlarge)

Truly outstanding, with a Sharpe ratio of 3.54, and correlation to the SPY (NYSEARCA:SPY) ETF of 0.33. Historically, the strategy has done excellently, as we have seen in previous articles.

Since Structural Arbitrage relies upon a structural mispricing between how two different markets price equity risk, it is important to remember that like any other strategy, that it could stop working if the inefficiency it exploits ceases to exist. However, the persistent difference between how these two markets synthetically price equity risk is exceedingly glaring, as we publicly documented over a year ago.

Source: The Quant Strategy That Returned 36% YTD With ETPs