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Trimming The Sails

|Includes: SPDR S&P 500 Trust ETF (SPY)

After giving it some thought last night and this morning, I reduced my positions to raise cash to about 25% of portfolio. Of course, the upward revision on 4th quarter GDP was welcome, and the market is rallying sedately.

Using a ratio of GDP to S&P 500, based on historical averages the market is getting fairly close to a midpoint. If and when the S&P 500 hits 1,400, from my point of view expected returns going forward are about 5% annualized, not a compelling reason to be in equities.

If I use an alternative method, relying on the ratio of GDP to corporate profits, a midpoint of 1,600 would be indicated. There is ongoing concern that margins, which are at historical highs, will be coming under pressure. The alternative method gives a higher indication because margins have been so fat lately.

The portfolio consists almost exclusively of options - diagonal call spreads, long deep in the money LEAPS and short covered calls against them. Computing leverage on a dollar delta basis, I just reduced it from 1.67:1 to 1.36:1. About 1.2:1 would be more appropriate, so I will be looking to reduce exposure further if the market continues to rally.

The point is, there is less reason to use leverage when returns are expected to be modest, and the risk of giving back gains on a correction increases as the market continues to make new highs.