20% annual returns over 40 years...interested?

[Kbg]

I was going to post this earlier but didn't have access to my backesting system.

An equal weighted SPXL, TMF, UGLD portfolio annually rebalanced has returned 17.2 CAGR/-31.05 MaxDD since 2012.

[Kbg]

I was looking at my historical spreadsheet and it definitely pays to be in the PP after a negative year. Pretty much a blow out positive return the following year. Thus far this year is tracking for a repeat.

[Kbg]

I can't remember/too lazy to search for it but in a recent post someone suggested shorting a similar future against a long future to narrow down the total cash commitment required to do a PP with futures...so hat nod to "someone."

In any event, I did the basic math on this to see what such a portfolio would look like using current prices and margin rates.

Future Contracts used (long/short contract)

Stock: ES/YM
LTTs: UB/ZB
Gold: MGC

Net long: 44,438.50 (1 contract each)
Initial Margin: 20,875
Maintenance Margin: 16,700

Another 3,800 required to equalize positions (GLD +2750, TLT +1150)

So roughly 1.8 - 2.66x leverage depending on if you use initial or mx margin as your basis and how you want to consider GLD and TLT additions. What I don't know is if your brokerage would offset the margin equirements for ES/YM and UB/ZB since the long position is hedged. If so that could put the total margin down to around $2300. This would be interesting because it would provide one an enormous cash reservoir.

In terms of expectations, MGC will do whatever gold is going to do. UB/ZB will profit relatively more when LTTs are appreciating and one will be less hedged/exposure to LTTs will grow in a decline. There also may be possible yield curve issues at the far end of the spectrum one will have to watch. Overall, the mechanics of LTTs are straightforward and can be dealt with by regulating TLT. The main concern for me is the stock component, as correlation and performance could vary thereby screwing returns up. A more precise match than ES and YM would by RYO and ES, but the difference is only 9,600 and the spread is $50 for RYO.

[Kbg]

Interesting...I executed the above in my broker's paper trading account and it only used 3,850 in margin. 1000 of that is for the equity portion and 2850 is for the futures portion. I'm going to continue this paper trading experiment, but with only 3850 used in margin and an estimated trading cost of .9% or less per year, this is suddenly getting very interesting to me. I will add the paper account results to my monthly report. For those of you who may not be tracking why this is interesting, it means that one can get a PP 4x the size of the cash they put down and ride out PP's worst ever draw down.

[iwealth]

Interesting...I executed the above in my broker's paper trading account and it only used 3,850 in margin. 1000 of that is for the equity portion and 2850 is for the futures portion. I'm going to continue this paper trading experiment, but with only 3850 used in margin and an estimated trading cost of .9% or less per year, this is suddenly getting very interesting to me. I will add the paper account results to my monthly report. For those of you who may not be tracking why this is interesting, it means that one can get a PP 4x the size of the cash they put down and ride out PP's worst ever draw down.

How does the margin call process work? If you maintain a large cash position in the account and there's a portfolio drawdown that drops you below maintenence requirements, do they keep your positions open and take your cash? I'm trying to reconcile this with using the leveraged ETF version where there's a very defined amount of money at risk.

[Kbg]

FYI: Overnight margin bumped up to 6,365.

Futures do what is called mark to market on a daily basis. So for example, if you are long the ES futures contract (SPX) which trades at $50 per point and the ES goes up 10 points your broker deposits 500 in your account and if down 10 points they subtract 500 from your cash balance. Today (day 1) in this paper portfolio ES lost us $150 while the Dow (YM) gave us $28 for a net of - 132. The LTTs are the big value contracts in our little experiment and today UB gave us 780 while ZB lost us 660 for a net of 120. Overall, up $20 today. So every single day the market is open your broker will take money or deposit money accordingly. Let's say ES went down 10% over 3 months, well your broker over that 3 months would take 10% of the contract's value from your cash account. Using today's price that would be a subtraction of around 10,700. Because we are hedged, every day the stock futures and LTTs are cancelling each other out to a degree so the net is substantially less. Gold is not hedged and the MGC (mini gold) is $10 per point.

Of significant note: Taxes happen the same way. At the end up the year you will get a form that says if you are up or down on the year and how much. If you are up, then you will pay 60% at your long term rate and 40% at your short term rate regardless if you bought and sold in a single day or held the entire time. The reverse will occur for losses. This is actually a WAY good deal in taxable accounts normally.

[iwealth]

Thanks for that explanation. I had to read it twice but it's very clear.

Maybe I'm still totally off here but bear with me if you don't mind. If you hold nothing but futures contracts in your account, you don't own anything but cash and the rights to the cash gain or losses associated with the futures. If you dip below maintenance margin requirements and don't deposit more cash, they'd liquidate some/all of your futures contracts. So to mimic the defined risk of using 3x ETFs, your total futures account balance can't be larger than whatever you'd be comfortable having invested in those ETFs, is that correct?

[Kbg]

Thanks for that explanation. I had to read it twice but it's very clear.

Maybe I'm still totally off here but bear with me if you don't mind. If you hold nothing but futures contracts in your account, you don't own anything but cash and the rights to the cash gain or losses associated with the futures. If you dip below maintenance margin requirements and don't deposit more cash, they'd liquidate some/all of your futures contracts. So to mimic the defined risk of using 3x ETFs, your total futures account balance can't be larger than whatever you'd be comfortable having invested in those ETFs, is that correct?

Correct. However, the technically correct answer is it depends on the type of contract, For example, in agriculture (and other futures) a future means you have a contract to deliver (short) or accept (long) the standard amount of whatever the physical base of the contract is on expiration. In the case of UB and ZB futures you actually have to deliver long treasury bills of the required duration/time remaining to expiration. In reality, for normal investors/traders cash mark to market is used to make sure you can "deliver" when required and depending on your broker they will automatically close the contract at a certain time before it expires so you don't have to deliver or accept the physical. Other contracts, like stock indexes, are "cash settled" which means daily mark to market and a final mark when the contract expires.

In any event, with futures you have to pay attention to expiration dates and "roll the contracts forward" before the current one expires to avoid any potential problems with physical deliveries. Normally the current contract's volume begins to decrease 1-2 weeks out from expiration as folks do their rolling forward. And for sure don't even think about this until you fully educate yourself on the mechanics and workings of futures contracts as well as your brokers policies regarding this stuff.

[Kbg]

Summary post on our paper futures PP.

We are net long ~16k for each asset for a 48K portfolio. Margin is ~6400. To absorb a 25% DD we would need 12K in cash and to absorb a 30% DD we would need 16K. So let's be conservative and go with 22.4K as our minimum cash amount which will put us at 2.14x leverage. I won't track it but if we had high interest rates it would be a very big deal...and that is putting some of our cash in 90 day T Bills. How much to put in T Bill vs straight cash would take some figuring out. Again, we won't do it but take something like the 1970s-1980s this would be a significant advantage for using futures.

[clacy]

My only concern with the futures strategy of ES-YM would be that while the Dow and S&P generally move in the same direction, there can be a moderate diversion in terms of momentum.

Over time, months to years, it would wash out but you would have some occasions where your short Dow position lost as much as you gained from your long S&P position, even though both markets were up (Dow gained more relative to S&P and you were short Dow).

Would it be a better fit to go Long EMD (S&P Midcap 400 futures contract), which has a notional value of $154,090 (using yesterday's closing price) and shorting ES which had a notional value of $107,279 leaving you net long approximately $46,800?

Either way, that is another way to creatively trade stocks via futures. Same principle as looking at 30 yr vs 10 yr as another alternative to UB-ZB, depending on account size.

You could also long 1 EMD + long 1 YM and short ES x 2 which would leave you net long $30,852. And 1 midcap 400 contract plus 1 Dow 30 contract might average very closely to step for step for how the S&P moves.

The possibilities are endless, but the more contracts involved, obviously the more you are paying in commissions and bid/ask spreads.

[Kbg]

The possibilities are endless, but the more contracts involved, obviously the more you are paying in commissions and bid/ask spreads.

For sure.

Looking at correlations to other indexes the best stock futures contract match is the Russell 1000 to the S&P 500.
But I already mentioned why that pair could be problematic. Options could be different/optimal based on account size as well. There absolutely isn't going to be a perfect match unless your account is big enough to do it precisely the same as the normal instruments in the correct percentages. The paper portfolio was primarily designed to be the smallest possible with good correlation between the hedged parts. This one is 16K per position while going the EMD route means portfolio size and cash requirements are tripled. Not a problem in and of itself, just a constraint on cash required. If someone wants to build their own recipe and post results that would be awesome.

Just in one day's price action the first thing I've noticed is the impact of contract size on maintaining portfolio balance. In the current mix the daily results are going to be heavily influenced by the LTT contracts. No big surprise here, but the practical implication is that one is going to have to actively rebalance the LTT component to keep it in alignment. Yesterday gold and LTTs were balanced almost perfectly and today there is almost an $1100 difference. To deal with this we will need to either roll profits to the other components or increase the short end of our hedge. I will need to do some thinking on the best way to adjust.

[MachineGhost]

Don't forget the hassles of rolling and the negative roll yield.

If the leverage is no higher than the 2x-3x ETFs, I really don't see the point in using futures.

[Kbg]

Yep more work for sure. These three futures are extremely efficient. If there's a difference between them and spot you can be sure the same factors are playing out in the ETFs and probably the physicals when you account for the cash balance differences/interest and dividends. The real issue is can you trade for less than leveraged ETF fees? On this small example port, maybe. It will be close.

[clacy]

Yep more work for sure. These three futures are extremely efficient. If there's a difference between them and spot you can be sure the same factors are playing out in the ETFs and probably the physicals when you account for the cash balance differences/interest and dividends. The real issue is can you trade for less than leveraged ETF fees? On this small example port, maybe. It will be close.

If nothing else it gives you an option if leveraged ETF's, and in particular, the more liquid 3x ETF's are made illegal.

Secondly, for the right account size, it would be a great way to only risk 10 or 15% of your funds in a futures account, and have the rest earning interest in TIP's or something.

The remaining 85-90% of your funds could be placed into a total return bond fund or a 5 year treasury ladder.

[Kbg]

If nothing else it gives you an option if leveraged ETF's, and in particular, the more liquid 3x ETF's are made illegal.

Secondly, for the right account size, it would be a great way to only risk 10 or 15% of your funds in a futures account, and have the rest earning interest in TIP's or something.

The remaining 85-90% of your funds could be placed into a total return bond fund or a 5 year treasury ladder.

I agree which is the reason why I started looking into futures. I want a large cash balance and if we only end up with 2x ETFs that narrows the cash cushion more than I personally would prefer. I need to do some studying/searching to see how CTAs manage their cash portion. It is broker specific, but 90 day T-Bills (so I hear) are considered cash for margin purposes in an account but they will still charge you margin interest if you get marked for more than your actual free cash balance. Thus, no margin call but paying interest to your broker. And of course their interest rate is going to be more than a ST T-bill. As a minimum that would require some pure cash for normal day to day volatility and then the remaining cash could be deployed in other instruments. Anyone want to help with researching cash options?

[MachineGhost]

What do you mean?

[Kbg]

What do you mean?

Figuring out how CTAs technically manage their cash vis a vis their futures positions. My guess is some of it proprietary and varies but I would think there is something out there where one could get a sense of how it is done and a range of what is considered standard practice. Things like how they invest their cash, are they subject to the same margin rules with regard to T-Bills and straight cash. What are their average leverage ratios. Stuff like that.

[iwealth]

In my brokerage's paper trading account, going net long approximately $245-250k each asset has a projected overnight initial margin of $43k.

30% DD would be $225k + $43k margin = $268k equity required. That's around 2.75x leverage. Mighty impressive.

[Kbg]

Day 10 of the futures port...down .32% overall. Currently, I haven't seen anything that would make this an unattractive alternative to replacing a leveraged ETFs version. It will take a bit more work and in a taxable account one will need to look at the tax impact for their personal situation. If one were going to pull the trigger the biggest issue encountered thus far is managing one's cash balance. Specifically, how to get the most out of it while leaving room for normal DDs. On the risk side, going with futures contracts eliminates counter-party risk for those who get freaked out about that.

[dragoncar]

How do futures contracts eliminate counterparty risk? What happens if there is a breach of contract?

[Kbg]

How do futures contracts eliminate counterparty risk? What happens if there is a breach of contract?

They are guaranteed by the exchange and your broker and the exchange are on the hook for any contract defaults. Needless to say, if your broker is concerned they are going to close you out involuntarily. Additionally, this is also why you pay/receive mark to market changes in your cash account. In fact, this element of futures contracts causes a far more likely risk to be worried about for the individual trader...an insane swing in prices that eats all your cash balance and closes you out only to snap back minus your cash. If you want to be worried about something, worry about that. However, in our experimental futures account with the offsetting contracts we have this should not be a big worry. First, we have both our stock and LTTs hedged directly, and secondly, anything truly earth shattering for stocks is likely going to send LTTs and gold in the opposite direction.

In terms of instrument risk, futures are safer than ETFs. Your risk in futures is cash management....but if you were totally unleveraged (e.g. cash balance equals sum of all futures at full contract price then there is only the risk of market movements.

[Kbg]

.

[Kbg]

How do futures contracts eliminate counterparty risk? What happens if there is a breach of contract?

They are guaranteed by the exchange and your broker and the exchange/broker are on the hook for any contract defaults. Needless to say, if your broker is concerned they are going to close you out involuntarily. Additionally, this is also why you pay/receive mark to market changes in your cash account on a daily basis...to ensure you have adequate cash on hand to meet your contract's settlement amount. Additionally, the overnight margin per contract is based on what the exchange calculates as a normal extreme daily move which can and will be adjusted up during periods of high volatility. For example, the mini S&P 500 contract's overnight margin right now is equal to about a 5% move.

In fact, this element of futures contracts causes a far more likely risk to be worried about for the individual trader...an insane swing in prices that eats all your cash balance and closes you out only to snap back minus your cash. If you want to be worried about something, worry about that. However, in our experimental futures account with the offsetting contracts we have this should not be a big worry. First, we have both our stock and LTTs hedged directly, and secondly, anything truly earth shattering for stocks is likely going to send LTTs and gold in the opposite direction.

In terms of instrument risk, futures are safer than ETFs. Your risk in futures is cash management....but if you were totally unleveraged (e.g. cash balance equals sum of all futures at full contract price then there is only the risk of market movements.

[dragoncar]

That's amazing. There's still counterparty risk, of course, but I see why it's relatively insignificant

[MachineGhost]

Generally, the rule of thumb is to have an account size 3x to 4x the historical MaxDD (absolute dollars) to be able to survive. That has held up in every situation I recall when backtesting futures trading systems.

Also, I think you're confusing the exchanges/brokers with the clearinghouses which are pre-Federal Reserve-style associations owned by the exchanges. The clearinghouses are who guarantee the derivative contracts. The ruckus about off exchange derivatives being brought on exchange via Frank-Dodd Act after the subprime collapse -- they had no clearinghouses by definition so it was direct counterparty risk with each other. Very, very bad! You simply cannot trust a counterparty, especially investment banks as their whole modus operandi is front-running your trades and ripping your muppet face off.

Another lynchpin of the futures industry is that customer funds may not actually be segregated off the broker's balance sheet as that recent futures brokerage collapse and suicide of its owner indicated... PFG was it? Perengine Financial Group?