After a hiatus of a year from writing articles for anyone, I recently had the good fortune of getting re-acquainted with some long-time readers of these pages.
A new reader was less than welcoming and had some serious questions about performance, which included the use of non-standard metrics, with a particular emphasis on the impact of tax rates.
I'm all about non-traditional, but I bristled a bit when considering the thought of being compared to a standard that no one else was using or to try and normalize individual considerations, such as trading in a tax-deferred account versus a taxable account or using a discount brokerage versus a more costly one.
Over the years, I've been far more interested in the generation of a return in excess of what the market could offer and was always happy to pay taxes on any good fortune or to take advantage of existing tax laws and benefit from the use of strategic losses.
For me, having retired from a pretty lucrative profession at a relatively early age, "return" was a very tangible concept and not a paper construct.
I wanted and I needed cash. I also wanted and needed it in a reasonably reliable stream.
Okay, maybe "happy" isn't exactly the right word, but taxes are simply the costs of doing business and in my world of executing many trades, rather than sitting back with a buy-and-hold portfolio, trading volume was an important way in which to create an income stream in excess of what might ordinarily be expected to be generated through passivity.
With stock trading being my new profession, taxes and commissions were simply the cost of goods and by historical standards, the cost of those goods was actually pretty low.
Pretty low was also a good characterization of my own expectations for an investment strategy. I always looked at what the impact of return at the margins would have on the amount of time necessary to double one's money.
Or in a more pragmatic consideration, how much more quickly could that additional 1%, 2% or 3% each year get me to retirement?
From a very simple perspective, going from an annual rate of return of 7% to 8% reduces the amount of time to double assets by about a year.
I'll take that.
In fact, I did take that.
With an aim of generating a 1% ROI for what would typically be anticipated as a week-long holding of a new position would occasionally have cynics question whether I had proof of a 50% annual ROI.
Of course, I never dealt with annualized returns unless I had a stock, whose multiple periods of holding, approached or exceeded 365 days. Otherwise, annualized returns was one of those metrics that I really had no use for and were so frequently misleading or created unrealistic expectations.
Instead, for years, I reported ROI for each specific holding and then compared it to the ROI for the S&P 500 for the precise time period of each and every holding.
In my ideal world, those specific holdings would very often be of the same universe of stock, over and over again. Sometimes there would be overlapping lots of shares and other times there would be individual lots, but with each lot of shares having its ROI considered on an individual basis, even as the cumulative performance of a specific stock would also be considered.
In a recent article I reported on a trade that I was pleased with, even as it underperformed the S&P 500 for the week of its holding. The week-long holding returned 2.2% during a week that the S&P 500 returned an astonishing 3.5%.
Of course, there is a cynic in every crowd, although that same cynic can perhaps frequent many crowds. In this case, the underperformance for the week, which had me actually pretty happy, could easily be proof positive for a failed investment approach to someone in that crowd.
Ultimately, a point in time is not necessarily reflective of a pattern nor a trend, although, just as with annualized returns, some are more willing to project on the basis of scant data than are others.
I happen to like lots of data points.
As an example of creating data points, Friday I had shares of that same stock once again assigned, after having re-purchased that position two weeks after the initial position was assigned and having held those new shares for three weeks.
This time around, those shares of General Motors (GM) returned 2.0%, while the S&P 500 lost 5.4% for that same time period.
In other words, from the beginning of that brief odyssey with General Motors, I owned shares twice and generated a realized return of approximately 4.2%.
I suppose from the cynic's perspective, or at least if there is consistency in the application of logic, the past trade validates the approach, but that's an issue for some other time.
In the meantime, the S&P 500, during this heightened period of volatility, which is an absolutely perfect time to be a seller of options, lost 3.2%.
While I wouldn't use that single experience to validate a specific trading philosophy, nor would I have used the experience of the initial holding of General Motors to invalidate a philosophical approach to investing, particularly as the objective may differ from some other philosophy.
For example, asset accumulation as one goal as compared to income generation.
But that's not where the story ends and this is where it may be useful to think about a really different way to assess performance.
That's because the money that was used to purchase those initial shares of General Motors found some other use after those initial shares were lost to assignment.
In this case, it's not the performance of individual stocks that I'm focused upon, but rather the return upon specific bundles of cash.
As any good criminal investigator will tell you, "Follow the money."
Granted, a mutual fund prospectus may look at the results upon having invested $10,000 over time, but that ends up being a very passive kind of analysis that is well suited to a passive kind of investment.
I'm more interested in an active analysis for an active investment lifestyle, even as I am headed for a return to a more sedate trading life.
For those who remember basic high school or college chemistry lab classes, you may recall the concept of an "aliquot."
You may even remember doing studies with dyes or radioactive elements and then trying to trace those markers as they began to disperse.
So, in an attempt to illustrate this concept, I'd like to introduce Marathon Oil (MRO) into the conversation.
Some of those long-time readers may recall that 2016 was a year that Marathon Oil had me smiling all year long, even as it really didn't do very much in terms of its pricing. What it did do was to trade in a reasonably predictable range and have an option premium that was worthy of pursuit.
In 2016, I owned shares of Marathon Oil on 12 occasions in a 9-month period, while in 2017, I owned shares on an additional 6 occasions.
When that initial lot of shares of General Motors was assigned away from me, that aliquot of cash went back to work the very next Monday and it purchased shares of Marathon Oil with a concurrent sale in the money weekly calls.
Long story short, those shares were assigned and the ROI for the week was 1.2%, during a week that the S&P 500 actually lost 1.2%.
As an aside, volatility is an option seller's best friend and there may be particular advantage to selling in the money options, even occasionally keeping those positions alive by rolling over, rather than accepting their exercise.
So, the Marathon Oil position did fairly well, but unless you keep track of each position and look at them on a cumulative basis, as I do, that 1.2% is pretty meaningless, unless you engage in truly large volume.
What isn't meaningless is the sum total of what that aliquot of cash has been up to.
In this case, however, I didn't roll the Marathon Oil contract over, but did exactly what I had done when those initial General Motors shares were returned to me as cash.
I re-purchased General Motors and sold calls.
To illustrate this point in order to make it very tangible, let's assume that the initial aliquot purchased 1,000 shares of General Motors at the March 6, 2018, price of $37.14.
Subsequently, following the loss of those 1,000 shares of General Motors, the proceeds from the assignment were used to purchase 2,400 shares of Marathon Oil.
For those doing the math, there is a bit of imprecision in the illustration, but the more compulsive of us can make mathematical adjustments, such as considering the return on idle cash, to recognize that the initial aliquot was $37,140 and the subsequent purchase of Marathon Oil required only $36,216 and the final purchase of General Motors required $37,400.
One method for dealing with the imprecision cited is to have each aliquot include some cash that sits available in the event you want to close out a short option position. In the above example, for instance, perhaps the aliquot could have been $40,000, with $2,860 kept in reserve.
If you do like to annualize, the five weeks of work put in by this cash aliquot was pretty good, but you won't hear that from me.
Of course, as portfolios increase in size, you should have multiple aliquots to follow and you can even designate aliquots as having different objectives, just as you can designate different accounts to have differing objectives.
The benefit of doing either of those is that you can better assess performance and you can do so in a systematic and objective fashion.
Long term versus short term approaches; low volatility versus high volatility: dividend generating stocks versus non-dividend generating stocks.
Unfortunately, when all stocks are piled in together, it may be difficult to identify the real winners and losers.
You may be able to identify them on the basis of individual stocks, but that may really not tell you much more than you had poor timing or were occasionally a poor selector of stocks.
It may say little about your overall approach to managing a portfolio, nor which theme is working for you in a consistent manner.
The aliquot approach to analysis is time-consuming, but if you like color-coded spreadsheets, it can be very instructive and can lead toward constructive actions.
Disclosure: I am/we are long MRO.
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.
Additional disclosure: I may purchase shares of GM or MRO.