Anyone who has been trading the Anchor Strategy over the past few months should be extremely happy with its performance. Now that many have realized how well it performs in down markets, one of the most common questions is “what should I do now?”
Prior to answering that question though, we must revisit what exactly Anchor is, and what it is not. The Anchor Strategy is a hedging Many investors have been puzzled as to why Anchor has not been going up with the market over the past week (as SPY has gone from around 220 to 260, Anchor accounts have either remained flat or even gone down slightly). That is to be expected from how the strategy is designed
For example, if you opened the Anchor Strategy when SPY was at 300, using the 285 puts, and the market crashes ten percent or more, you should expect your account to stay approximately the same as when the account was opened. We saw this occur when the markets dropped 30% or more and the Anchor accounts actually went up slightly in value. However, as the markets start going back up toward the 300 level when your account was opened, Anchor will not go up in value
This frustrates many investors. Everyone loves the 30% outperformance on the way down, but hates the 20% under performance on the way back up. But remember, the strategy is a year to year hedging strategynotnew highs
Quite a few investors though are not happy with this result. They want the protection in down markets, but also to gaindroppedin value to $124,847, a drop of 11.88% in a week. This places Anchor down 8.3% on the year (down 5.4% in the first quarter) and the market down 18.75% (320 to 260). Given that Anchor’s hedge doesn’t even kick in until a 5% drop in the market, this result is exactly in line with what is expected. However, no investor in Anchor is happy at the 11.88% loss in a week as investors mistakenlynot
So how is an investor to profit as markets rebound? The only way to do this is to adjust/reset the Anchor Strategy. However, as noted numerous times, “resetting” or opening a new Anchor account after a large decline is quite expensive and sets investors up for underperformance. So what are investors to do? Below is a brief analysis of the four different options available:
Option 1 – Do Nothing
I am not an advocate of changing strategy mid-flight. The Anchor Strategy is a capital preservation strategy and it is doing that spectacularly. If an investor were to take either of the below options, and the market declines further, they would be in a significantly worse position than if they did nothing, thereby losing some capital.
If you reset the position, to a lower hedge (a) the cost of the hedge is much higher, which will act as a drag on the portfolio as paying for the hedge is more difficult and (b) if the market drops further, the account will
Secondly, the SPY long call position currently has a delta of around 0.7. This means if the market drops $1, the investor’s account will only drop $0.70. If the position is reset to a call of close to one, then if the market drops $1, the investor’s account will also drop $1.
If the investor is in a capital preservation mode, and does not want to increase risk, the best option is to simply continue to manage the strategy as designed.
Option 2 – Reset the Position
Many investors though want (or expect) gains to come from investments when the market is going up, even if they have greatly outperformed over the past 30-60 days. The thought process normally goes like this:
A. I beat the market by 25% last month;
B. I will be very frustrated if next month the market goes up 20% and I go up 0%;
C. I am ok if the market goes down 10% and my account goes down 10% because I am still outperforming the market on the year by 25%;
D. I don’t need my investments right now for expenses; and
E. I would rather take on additional risk to try to grow my account as the market goes back up (if it goes back up).
If this fits your profile, closing out the existing Anchor position and “resetting” it to a new position would not be a bad decision. (I am strongly leaning toward this in my personal account. But I do not need the money to live on, I have decades left before retirement, and I would rather take the chance to gain even more and take on the risk of losing 10% -- but that is not the case for everyone – each investor needs to take their own situation into account).
How would this be accomplished? Simple…liquidate the current Anchor Strategy and simply re-enter. As noted above, the current model portfolio is valued at a few dollars under $125,000. If an investor were to launch a new Levered Anchor Position on $125,000, it would look like:
1. Buy to open 8 contracts June 18, 2021 170 Calls for $94.85 (about 66% leverage, 7 contracts would give 45% leverage, 9 contracts 87% leverage) – Total cost: $75,880
2. Sell to open 8 contracts March 19, 2021 Puts for $25.81 (Use the June 2021 calls to ensure long term capital gains while using the March 2021 puts as its closest to 365 days and if the markets move up quickly and the hedge has to be adjusted, it is cheaper and investors have the ability to roll up and out as well) – Total cost: $20,648;
3. Buy to open 4 contracts of the March 19, 2021 260 puts for $31.04 (to hedge the short puts) – Total cost: $12,416;
4. Sell to open 4 contracts of the April 22, 2020 262 puts for $14.36 – Total credit: $5,744;
5. Buy 230 shares of BIL for $91.62 – Total cost: $21,072.60; and
6. Hold $727.40 in cash.
If an investor were to use 9 long calls, to increase the leverage, then that investor should also increase the short hedge and short contracts to 5. All investors should remember, over time, Anchor tries to target needing a short credit of $0.80/contract/week when initializing the position. The above requires double
I would not expect to be able to pay for the above hedge over the next year, particularly if it has to be rolled up as markets go up. Howeverwill lagshould
Option 3 - Sell Puts that are Deeper in the Money
Traditionally Anchor sells puts that are around a .55 delta (1-2 strikes in the money), 24 days out, and rolls such puts once the strategy has captured most of the time value of the short puts. Investors could profit some more by selling puts that are further in the money. For instance, instead of selling the 262 puts, an investor may sell the 280 put. If the markets rise swiftly, having sold further in the money will be more profitable than aggressively rolling the short puts.
The risks to such strategy include:
1. With a higher delta, if the market declines, the short puts will decline in value faster than a position closer to at the money;
2. Selling puts further in the money requires higher margin and cash requirements, particularly in IRAs; and
3. If the markets are slowly increasing, it may be more profitable to roll short puts at the money.
Option 4 (Most Risky) – Temporarily go Long
The biggest drag on option II above is the cost of the hedge. Several investors have expressed a desire to take on more risk and not hedge
A. I beat the market by 25% last month;
B. I will be very frustrated if next month the market goes up 20% and I go up 0%, or worse;
C. I am ok if the market goes down 10% and my account goes down 10% because I am still outperforming the market on the year by 25%;
D. I am ok if the market goes down 25% and my account goes down 25% because I’m still beating the market on the year;
E. I don’t need my investments right now for expenses; and
F. I would rather take on additional risk to try to grow my account as the market goes back up (if it goes back up).
How would this decision be accomplished? Similar to above, liquidate the current Anchor Strategy and simply re-enter the long positions without purchasing the hedge. As noted above, the current model portfolio is valued at a few dollars under $125,000. If an investor were to launch a new Levered Anchor Position on $125,000, it would look like:
1. Buy to open 8 contracts June 18, 2021 170 Calls for $94.85 (about 66% leverage, 7 contracts would give 45% leverage, 9 contracts 87% leverage) – Total cost: $75,880
2. Buy 530 shares of BIL for $91.62 – Total cost: $48,558.60; and
3. Hold $561.40 in cash.
There is substantial riskto the above. If the markets drop from 260 to 220, investors should expect their long calls to decline to $60.50 (approximately), a drop in their portfolio of over 21% -- more
Another risk to keep in mind is that in the event of a large market drop (below SPY 170), the investor’s account could be looking at 50% total losses.
To combat such risks, an investor could temporarily eliminate leverage and buy SPY shares. Or the investor could implement a partial hedge. Even a 50% hedge would help alleviate some of the risk. Further, when volatility drops, and the long hedge becomes more affordable, long puts should be purchased.
If an investor was in the Anchor Strategy to preserve capital, switching to a long only position to try to “gain” when the markets gains is not a smart decision
Another common question is “when should I make the decision to re-structure Anchor? The proper answer is “at the bottom tick of the market.” Of course, if an investor knows when the bottom is going to hit, there are much better ways to take advantage of the situation.
The next best time to enter is at the same time as an investor would enter the Anchor Strategy normally – namely after one or more up days in a row, when volatility has declined. In the model account, we are taking the following steps:
1. Stay particularly aggressive in rolling the short puts up as the market moves up;
2. Not change the positions until more economic news comes out – there is significant uncertainty on unemployment numbers, production, the length of time the economy will be shut down, how lenders and financing will be impacted, etc., which means sacrificing downside protection right now doesn’t make much sense;
3. If there’s another major downtick (back down to below SPY 230) then look to perhaps implement item II above, or a blend of II and III.
Remember the purpose of Anchor – capital preservation and positive returns as the market goes above
Christopher Welsh is a licensed investment advisor and president of LorintineCapital, LPCERTIFIED FINANCIAL PLANNER™
What Is SteadyOptions?
Full Trading Plan
Complete Portfolio Approach
Diversified Options Strategies
Exclusive Community Forum
Steady And Consistent Gains
High Quality Education
Risk Management, Portfolio Size
Performance based on real fills
Non-directional Options Strategies
10-15 trade Ideas Per Month
Targets 5-7% Monthly Net Return
Recent Articles
Articles
Pricing Models and Volatility Problems
Most traders are aware of the volatility-related problem with the best-known option pricing model, Black-Scholes. The assumption under this model is that volatility remains constant over the entire remaining life of the option.
By Michael C. Thomsett, August 16
- Added byMichael C. Thomsett
- August 16
Option Arbitrage Risks
Options traders dealing in arbitrage might not appreciate the forms of risk they face. The typical arbitrage position is found in synthetic long or short stock. In these positions, the combined options act exactly like the underlying. This creates the arbitrage.
By Michael C. Thomsett, August 7
- Added byMichael C. Thomsett
- August 7
Why Haven't You Started Investing Yet?
You are probably aware that investment opportunities are great for building wealth. Whether you opt for stocks and shares, precious metals, forex trading, or something else besides, you could afford yourself financial freedom. But if you haven't dipped your toes into the world of investing yet, we have to ask ourselves why.
By Kim, August 7
- Added byKim
- August 7
Historical Drawdowns for Global Equity Portfolios
Globally diversified equity portfolios typically hold thousands of stocks across dozens of countries. This degree of diversification minimizes the risk of a single company, country, or sector. Because of this diversification, investors should be cautious about confusing temporary declines with permanent loss of capital like with single stocks.
By Jesse, August 6
- Added byJesse
- August 6
Types of Volatility
Are most options traders aware of five different types of volatility? Probably not. Most only deal with two types, historical and implied. All five types (historical, implied, future, forecast and seasonal), deserve some explanation and study.
By Michael C. Thomsett, August 1
- Added byMichael C. Thomsett
- August 1
The Performance Gap Between Large Growth and Small Value Stocks
Academic research suggests there are differences in expected returns among stocks over the long-term. Small companies with low fundamental valuations (Small Cap Value) have higher expected returns than big companies with high valuations (Large Cap Growth).
By Jesse, July 21
- Added byJesse
- July 21
How New Traders Can Use Trade Psychology To Succeed
People have been trying to figure out just what makes humans tick for hundreds of years. In some respects, we’ve come a long way, in others, we’ve barely scratched the surface. Like it or not, many industries take advantage of this knowledge to influence our behaviour and buying patterns.
- Added byKim
- July 21
A Reliable Reversal Signal
Options traders struggle constantly with the quest for reliable
By Michael C. Thomsett, July 20
- Added byMichael C. Thomsett
- July 20
Premium at Risk
Should options traders consider “premium at risk” when entering strategies? Most traders focus on calculated maximum profit or loss and breakeven price levels. But inefficiencies in option behavior, especially when close to expiration, make these basic calculations limited in value, and at times misleading.
By Michael C. Thomsett, July 13
- Added byMichael C. Thomsett
- July 13
Diversified Leveraged Anchor Performance
In our continued efforts to improve the Anchor strategy, in April of this year we began tracking a Diversified Leveraged Anchor strategy, under the theory that, over time, a diversified portfolio performs better than an undiversified portfolio in numerous metrics. Not only does overall performance tend to increase, but volatility and drawdowns tend to decrease: