1. Tactical Trading Strategies Using ETFs
Marvin Appel, MD, PhD
CEO, Signalert Asset Management Corp.
Great Neck, NY
QWAFAFEW NYC, 10/24/2017

2. For my presentation today I’ll be reading the PowerPoint slides word for word

3. Outline—Oct 2017 Option writing strategies with ETFs
Covered calls
Cash-secured puts
VIX as market timing filter to switch between BXM and SPY or PUT and SPY
Covered call writing– Not all ETFs are created equal.
Update from last year: EFA vs SPY, EEM vs SPY

4. Covered call position
Buy 100 shares of stock and sell one option on the stock.
Gain is likely to occur, but is limited.
Losses are relatively unlimited, but in a losing month writing a covered call always reduces losses compared to owning the shares alone.

5. Stock + dividends = call – put + cash
Put-Call parity
Stock + dividends = call – put + cash
(cash earns risk-free interest)
As a result,
Stock – call = cash – put
In theory, covered call writing should return the same as cash-secured put writing.

6. Risk measure: worst drawdown
Note: different if you use monthly versus daily data.

7. Total Returns 1988-2017 Index Annual return Worst Drawdown
Bottom line: put writing better on absolute and risk-adjusted basis, covered calls better on risk-adjusted basis.
Index
Annual return
Worst Drawdown
Covered call (BXM)
9.2%
-40%
S&P 500 total return
10.3%
-55%
Put writing (PUT)
10.4%
-37%

8. Implied volatility and VIX
“Implied volatility” is the level of volatility that a stock must demonstrate between now and expiration to make its stock options fairly priced.
VIX is an index that measures the average level of implied volatility (annualized) over the next 30 days built into S&P 500 Index options (puts and calls) expiring between 23 and 37 days from now. Its average value has been 19.5%.
The higher the level of implied volatility, the more expensive the same level of option protection.
Just because options are cheap (low VIX) doesn’t mean that they are a bargain.

9. Market returns under high versus low volatility

10. Take advantage of VIX to guide your strategy: write options when VIX > 19

11. These are not conservative strategies

12. Poor risk management during market crashes
Max DD: 29% for BXM. The only defense against a potential market crash is to have a strategy to be in cash when conditions are potentially risky, as we do.

13. There are other covered call indexes available from CBOE
Dow Jones Industrial Average (BXD, )
Russell 2000 Index (BXR, )
Nasdaq 100 Index (BXN, )
Beware: Not all ETF covered call strategies are created equal.

14. Covered calls and DJIA, 1997-2017
Bottom line: DJIA options have not been as profitable as SPX during the same period. DJIA outperformed SP500, but BXD lagged BXM.
Index (total return)
Annual Return
Worst Drawdown
DJIA
7.8%
-52%
BXD
5.9%
-36%
S&P 500
6.9%
-55%
BXM
6.3%
-40%

15. Covered calls and Russell 2000
Bad to write covered calls on RU2000: Lose 1/3 of profit, but less than 20% of risk.
Index (total return)
Annual Return
Worst Drawdown
Russell 2000 Index
8.2%
-59%
BXR
5.7%
-51%
S&P 500
5.9%
-55%
BXM
4.5%
-40%

16. Covered calls and Nasdaq 100
Index (total return)
Annual Return
Worst Drawdown
Nasdaq 100 Index
12.6%
-83%
BXN
8.0%
-57%
S&P 500 Index
9.8%
-55%
BXM
-40%

17. From the FED: A New Era of Higher VIX?

18. Relative Strength Models
Foreign vs. U.S Equity
Relative Strength Models

19. Concept of relative strength
Divide index1 by index2. These indexes may reflect price or total return.
Rising ratio means index1 (numerator) is stronger.
Falling ratio means index2 (denominator) is stronger.
Relative strength leadership does not tell you whether either or both indexes are showing profits or losses.

20. Hypothetical ideal relative strength switching model

21. Recognizing new trends in relative strength—moving average
whipsaw
Index 1 / Index 2
Rising: Index 1 stronger
Falling: Index 2 stronger

22. Moving average calculations
Simple N-period moving average
Average of most recent N data points, each equally weighted
N-period exponential moving average (EMA)
New EMA = (1-k)*(previous EMA) + k*(newest data point)
K= 2/(N+1)
More weight to recent data

23. Comparison of Simple and Exponential Moving Averages

24. Foreign (developed country) versus U.S. stock model
Use MSCI EAFE Index as the benchmark for foreign stocks and S&P 500 Index as the U.S. benchmark.
Calculate the ratio of MSCI EAFE / S&P 500 (total return) on the last day of each month.
A new trend is defined by a crossing a 19-month exponential moving average.
Can use ETFs (EFA and SPY)

25. EAFE vs S&P 500 history
Exponential MA

26. History of EAFE / U.S. switch model

27. MSCI EAFE vs S&P 500 EAFE: 9.3%/year with 56% DD; S&P 500:
Switch:
11.7%/year with 54% DD
System loses a lot of ground during bear markets (eg: , , ), model currently in EAFE but perhaps not for long. Can improve results with a bear market filter such as 10-month simple moving average on MSCI US Index.
Source: Mutual Fund Expert as of 6/30/2016

28. MSCI EAFE vs S&P 500, update
Switch: 8.5%/year, 52% max dd; SPY 7%/year, 51% max dd; EFA 5.6%/year, 57% max dd; in SPY 60% of the time; based on monthly closing total return data

29. EFA / SPY model is very close to switching to EFA (first since 2013)

30. Monthly switching model: Emerging markets vs. U.S.
On the last trading day of each month update total return indexes for MSCI EM and for U.S.
Calculate the ratio (emerging markets divided by U.S.) and update its 10-month simple moving average.
If the ratio is above its moving average, be in emerging markets for the coming month. Otherwise, be in U.S. equities. (Model is in EM as of 3/31/2017).
Can use ETFs: EEM or VWO, and SPY

31. MSCI Emerging Markets and U.S. Indexes (total return, $), 1988-2016
Source: accessed Oct. 2016

32. History of EM vs US
MSCI gross total return US dollar indexes

33. Results of switching: Emerging markets vs. US equities
MSCI EM:
9.8%/year with 61% DD;
MSCI US:
10.2%/year with 51% DD;
Switch:
16.1%/year with 53% DD
Gross total return USD index data
Source:

34. Update on emerging markets vs. U.S. equities
: switch equity 11.9%/year, 54% max dd; EEM equity 8.5%/year, 60% maxdd; SPY equity 8.2%/year, 51% max dd; half EEM and half SPY 8.6%/year, 56% max dd; 49% in EEM and 51% in SPY, based on monthly closing total return data.

35. Conclusions
Cash-secured put writing and covered call writing with S&P 500 Index options have outperformed the S&P 500 Index on a risk-adjusted basis
In recent years, low option implied volatility has hindered these strategies.
The unwinding of quantitative easing may create opportunities for option sellers.

36. Conclusions (continued)
Simple moving-average based trading systems using the relative strength between U.S. and foreign equity ETFs can keep you on the right side of major long-term trends.
Emerging markets have been favored since early this year.
EFA is close to getting its first relative strength buy (versus S&P 500) since 2013.

37. Disclaimers Past results do not guarantee any future performance.
Results are based on data and calculations believed reliable, but are not audited or guaranteed.
Results are hypothetical. They are not the experience of any actual client.
Transaction costs, trading delays, taxes and other expenses are not accounted for.
The strategies presented here may not be suitable for every investor.
Index data from Investors FastTrack, Steele Mutual Fund Expert.

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39. For a copy of these slides, email me: Marvin Appel mappel@signalert
For a copy of these slides, me: Marvin Appel Signalert Asset Management 525 Northern Boulevard, Suite 210 Great Neck, NY