How To Profit In This Volatile Market

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Includes: ACTS, AXP, SVXY, USO, UVXY, VXX
by: Martin Vlcek

Summary

Since the inception on September 15, 2015, my subscription portfolio is up ~5.5%.

This is a massive, at least 10% market outperformance in just over four months. The speed of outperformance is not sustainable but it still shows resilience and low correlation.

This outperformance was not simply due to lower long exposure. The portfolio was not net short at all either.

Volatility strategies contributed significantly to the outperformance despite SVXY's 30% fall during the same period.

Special situations, "market-neutral" strategies and small shorts for hedging positively contributed as well. American Express was the biggest drag.

It's been just over four months since the inception of the portfolio built using the exact entry and exit points based on the articles I've been sending in real time to my premium subscribers.

The broad markets have been through a nasty selloff:

Click to enlarge

Since its inception on September 15, 2015, my portfolio is up just over 5% based on exact entry and exit prices as written in the respective articles in the subscription area at the time I entered the trade. On an annualized basis this would be an almost 15% return. While I don't expect to deliver 15% annualized returns in the long run (without leverage), I hope to continue delivering positive absolute returns on average in the long run regardless of where the broad markets may decide to move.

Please note that I didn't include trading fees but I estimate these would cut the profits by around 1% annually, depending on your broker. Shorting fees were negligible. The table with all the trades is attached and available to my subscribers whom I would like to thank for the continued support.

For the current volatile and treacherous markets, I believe my portfolio is proving to be an ideal source of true diversification because it is full of strategies that are either "market-neutral", have a low correlation to market returns, or outright hedge the long stock and Treasuries exposure.

Volatility trading delivered the best returns

The largest driver of positive returns was volatility trading via the ProShares Short VIX Short-Term Futures ETF (NYSEARCA:SVXY), the iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA:VXX) and the ProShares Ultra VIX Short-Term Futures ETF (NYSEARCA:UVXY). In total, these strategies delivered a ~4% positive impact on the entire portfolio while the various volatility strategies only risked ~30% of the entire portfolio at the highest point.

I simply love volatility trading ("selling insurance") and it is my core strategy where I seem to have at least some edge, if you believe a market participant has his core area of strength and can have at least a small edge in this area over the aggregate pool of investors. I would strongly suggest that you try to develop a deep skill in some specific investing/trading strategy on which you will subsequently focus most of your energy and risk (up to the risk limits of a reasonably balanced portfolio).

My volatility trading has delivered higher returns (without leverage) than the underlying ETFs such as SVXY or short UVXY for several years now. However (especially in case of such volatile instruments), one can outperform the benchmark for ten years and he still cannot be sure whether it wasn't just a streak of good luck.

Anyway, the most profitable part of the volatility trading was an interesting long SVXY collar where the trade consisted of a long SVXY stock position, a LEAPS covered call very far out of money (roughly at a strike price double the underlying price), and a protective out of money put. The long SVXY portion has already been closed for a ~8% profit within three months as the volatility regime significantly changed following the first FED rate hike so I wanted to decrease exposure no matter what profits or losses I might have on the trades at that time.

The two remaining parts of the trade are still open as they are effectively short the SVXY (long volatility). But the short out of money call has already delivered most of its time value because the SVXY fell so significantly away from the strike price. The long put is burning money now but it serves as a partial cheap, leveraged hedge of the long stock and short volatility positions (via UVXY and VXX).

Besides trading volatility ETFs, I also sold several out of money puts on indexes and individual stocks when volatility was relatively high.

A Special situation delivered a 23% return in a month

I described the Actions Semiconductor (NASDAQ:ACTS) special situation in an article to my subscribers and later to all SA readers. It was extremely far from a sure bet and I definitely would not say this specific component of the returns can be easily replicated or should be used on a large scale as a percentage of the portfolio risk.

The tender range for the shares had been raised and this signaled that there was perhaps not enough interest in the tender and that it might not be as oversubscribed as past tenders. The risk-adjusted, theoretical expected return was definitely lower than the spectacular real subsequent outcome but the risk/reward was still very favorable to begin with. The stock was quite illiquid and this may have kept larger arbitrage players out as they didn't see the opportunity as big enough on an absolute scale.

So finding these niche, small special situations may be an area where small investors can actually have an edge over larger pools of capital.

Small shorts provided a very good hedge and boosted returns

While I kept the short positions very small as a percentage of the portfolio based on their notional value (which I simply calculate as price times the number of stocks shorted but I sometimes take into consideration heightened volatility in specific cases), these smart shorts delivered very nice returns relative to their small size and value at risk. One of them was oil, of course, and I've covered the reasons for being short in several subscriber-only as well as public Seeking Alpha articles. Again, this short oil performance may not be repeatable. However, let's not forget that oil remains in contango and the oversupply is still substantial.

In my private portfolio, I shorted Chinese stocks as a hedge as well, so oil was not the only hedge that was clearly available.

The biggest drag on the portfolio came from American Express

Although I allocated a relatively small 5% weight to long American Express (NYSE:AXP) position, the massive 26% fall in the stock price took its toll and cost me 1.32% of the entire portfolio in losses. To be honest, there weren't many other major losers as I kept the more speculative positions very small. This is an important lesson.

Some of the volatility trades were significant losers, some accounting for 1% of the entire portfolio. However, overall, the volatility strategy was a success and delivered nice returns.

In terms of percentage gains of individual trades, the short UVXY strategy was among the more attractive but very volatile, with a more than 30% gain in total on the underlying notional.

Thank you for your support!

I hope my readers forgive me but I would like to keep some of the successful strategies private to the paying subscribers as I want to respect their right to exclusive content and because I believe my strategies can add true diversification to a long stock/long Treasuries portfolio during these turbulent times. While I am not a fortune-teller, I believe I can deliver solid risk-adjusted returns in the long run with low correlation to the overall markets.

At the same time, I continue to write articles for all SA readers and I hope you've found some of my latest articles on portfolio strategy, macro and hedging useful.

Disclosure: I am/we are short VXX, UVXY.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.