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Summary Hedged Exposure to S&P 500 currently protecting investors’ capital. Delta approaches zero as market drops. New investors in with a -8.33% floor and a 18.95% cap. The recent volatility in the equity markets was a fun test for an investment I introduced upon its launch last April, which is the Exceed Structured Shield Fund (MUTF: SHIEX ). The fund has indeed shielded investor capital as the market plummeted. A detailed description of the mechanics of this fund can be found in my previous article , but as a refresher of the highlights: Passive, synthetic exposure to the S&P 500 via OCC cleared options 1:1 up and down, i.e. no leverage Protection level of -12.5%, or better if market execution allows Ceiling of approximately +15% The fund opened for business on 16 April 2015 and marked at $10 on close of market that day. For several months we were in a relatively sideways market, with SHIEX closely tracking the SPDR S&P 500 ETF Trust ETF (NYSEARCA: SPY ), so there were not any real opportunities to begin to highlight the performance success of an options-based hedge. We were able to observe the success of the 1-to-1 tracking, as SHIEX paralleled SPY. The following chart is the first four months of SHIEX, which is right before the market started cratering. (click to enlarge) At the lowest point, SPY was only down -2.79%. You can see that SHIEX was preserving capital at that point, since it was only down -1.89%. As measured from inception to that low-point, SHIEX had a 0.68 downside capture ratio. That means that for every $1 that SPY lost, SHIEX lost only $0.68. You can also see that SHIEX lagged slightly when SPY turned positive. I wanted to show you the mundane first, in order to set the stage for a stressed, falling market. Let us extend our view to include the most recent market activity. (click to enlarge) As the S&P 500 heads further south, we can see more clearly the impact of the hedge I call a “floor.” Recall that Exceed achieves this by being long (owning) a Put that is out of the money (OTM) by -12.5% or better. For small losses one can hardly notice the effect of this Put. But as the underlying security approaches being at the money (ATM), the delta decreases, approaching 0, and you can see that reflected in the pricing of the fund. The following table will help demonstrate that. The “change” column for both SHIEX and SPY relates to the launch date of 16 April 2015. The second row demonstrates that slight lag I mentioned earlier. The third row, 8/24/2015, is demonstrating the effect of the hedge starting to come into play. While the market has -9.92%, SHIEX has only captured 72.6% of that drop, with a -7.2% drop. But, as the market tanks for a second day, pushing SHIEX closer to its floor, the downside capture ratio shrinks to 66.5%. You can see that clearly in the bottom row. Imagine it like the “ground effect” in aviation. As one gets closer to the ground, the ground (floor) starts “pushing” back. SPY lost -1.18% in the next day of the sell-off, but SHIEX only shed -0.11%. In other words, as the floor was approached, the downside capture ratio sank to 9.3%. That means SHIEX only lost less than a dime for every dollar SPY dropped. Indeed, if SPY continues to drop, you will see the downside capture ratio also continue to drop. The chart for SHIEX will likely look like an invisible Atlas is supporting the fund price. There is nothing mythical about the mechanics, though. This is merely a hedge doing exactly what it is supposed to do: saving investor capital. If the markets continue to correct down, will we see a point where SHIEX will absolutely stop and drop no further? I can’t answer that forward statement, because there are too many variables at play. Recall that there are four, consecutive, 1-year collars being employed at every moment in the fund. Each one expires within a different quarter of the year. The 12.5% floor is set on each collar at a different strike point. The collar that initiated when the S&P 500 was at its lowest will also have the lowest floor, so that will be the critical path to reaching the bottom. But options do not price merely on Delta. Other factors such as volatility, time to expiration, and interest rates also weigh on the value of this synthetic exposure. Also remember that there is a large fixed-income portfolio of investment grade bonds collateralizing the fund, which will have a small impact on the pricing. But, as we have seen demonstrated, the downside capture ratio will continue to shrink towards zero (i.e. an absolute floor)as the long Put approaches being at-the-money. All the historical test data, and mathematical proofs, support this: NASDAQ Exceed Structured Protection Index (EXPROT). Further, they indicate that as the lowest Put goes in-the-money, the hedge will hold solid. (click to enlarge) For every one of the four collars that expires while the market is below the -12.5% or worse, the floor is absolute. The reason is Delta is at 0 (zero). Where is the Fund at this time? Exceed sent out an update on the current state of their collars as of 8/24/2015. This is an average of all four collars currently at-work in the fund: Floor: -8.33% Cap: 18.95% These are the levels that an investor would realize if they invested at the close yesterday. I noted in my introduction piece that the -12.5% floor was a minimum requirement. As you can see, they have exceeded the minimum requirement, and are executing a superior hedge. Further, for those concerned about missing a runaway bull-market, the cap has increased to +18.95%. That is the defined-outcome range of SHIEX as of the most recent, quarterly collar-roll. In this market, by most subjective projections, that is a highly desirable range of outcomes. Unfortunately, the fund has only managed to raise around $7MM assets, which I find disappointing. Disappointing, that is, for all the investors that are losing billions of dollars in this down market with their unhedged, long, domestic, passive and active, large cap investments. I attribute this to a few factors: Lack of awareness of this solution, which I hope to address with articles like this. Misinformation about bundled option strategies propagated by for-profit competitors. Reticence to trust a theoretical strategy; instead preferring to see if it really does work. The numbers are in, and the strategy is working as engineered. Only Schwab and Pershing clients have been able to take advantage of this fund’s strategy. The fund is not yet approved on the TD Ameritrade and Fidelity platforms, but it is my understanding that TD and Fidelity clients will have access within a month. I see little reason to have unhedged exposure to the S&P 500 when this solution is available. The Exceed Structured Shield Index Strategy Fund was just put the test, and it scored. Disclosure: I am/we are long SHIEX. (More…) 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. Scalper1 News
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