Strategy indices should be elegantly Zen - simple, powerful, and effective. Today, we will examine such an index.
Here are the Ultra-Low Volatility Index's rules:
- Buy ZIV (NASDAQ:ZIV) with 20% of the dollar value of the portfolio.
- Buy UPRO (NYSEARCA:UPRO) with 40% of the dollar value of the portfolio.
- Buy TMF (NYSEARCA:TMF) with 40% of the dollar value of the portfolio.
- Rebalance weekly to maintain the 20%/40%/40% dollar value split between the positions.
Here are the results:
The logic behind the strategy is that ZIV, the inverse mid-term VIX futures ETP, is a return generating component of the strategy by capturing the contango which exists (on average) in mid-term VIX futures. What's fascinating about ZIV is that it is a mechanism to be short gamma and collect premium synthetically through contango (when the term structure is in contango), but with closed-end risk, instead of the open-end risk inherent in selling options.
This effect is incredibly important over time, since contango capture is extremely profitable.
UPRO is a 3x leveraged S&P 500 ETP. It is a return generating component of the strategy which gives leveraged stock market exposure.
TMF is a partially hedging component of the strategy through a 3X leveraged long duration government bond exposure. Statistically, often but not always, this instrument moves inversely to stocks, thereby providing an imperfect hedge.
This simple three-instrument index trounces the U.S. stock market, without any stock picking required. This index is a multi-asset class (inverse volatility, equity, and fixed income) and is easily rebalanced.
Most interestingly, it trounces the performance of most stock-picking hedge funds through an excellent correlation profile to the broader market, and more importantly, through the capture of contango, a robust phenomenon.
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Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown; in fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk of actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points, which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program, which cannot be fully accounted for in the preparation of hypothetical performance results and all which can adversely affect trading results.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.