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random musings on finding an "alpha"

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March 19, 2009 – Comments (2)

All week I've been slowly trimming shares and selling covered calls (a great tactic in my opinion) on my portfolio and bracing myself for a downturn.  And I have bought some puts on select indexes, ETFs, and securities. 

In my view we WILL have a downturn sometime between now and the beginning of the next great bull market, and I've become cognizant in the last 3 months about how far ahead one would become if you avoided the big steps back.  And so I've begun experimenting with hedges. 

Today my portfolio actually inched every so slightly forward, but on the next day we get a big dip we'll see if the hedging strategies help to ease the pain. 

I'm the cat that curiosity keeps trying to kill, and the more i learn about the market and the tools it offers the more convinced I become that an "alpha" exists.  There is a way to ensure gains without extraordinary prescience, and I'm going to find that sucker eventually.

Julian Robertson is maybe the most successful long term investor in market history and he once quipped

""Our mandate is to find the 200 best companies in the world and invest in them, and find the 200 worst companies in the world and go short on them. If the 200 best don't do better than the 200 worst, you should probably be in another business."

And maybe this kind of long/short strategy is appropriate.  Maybe long/short based on assumptions of movements in different sectors, maybe long/short based on Zacks rank or some other system that one can come up with.  Maybe long stocks you think will outperform and short the market. 

Maybe long with an appropriate hedging strategy.  Along those lines the covered call is quite an interesting tactic.  It works like this:  if you own 100 shares of, say, RCL, you can sell a $10 call ending april 17th for $0.40 today.  So that means that you have two possible outcomes

1.  you sell the shares for $10.40 in a month, a considerable profit from todays prices

2.  you get 40 free cents, or about a 5% return on the shares you bought today (provided you bought them today).  If one did this consistently over time you could in essence create dividends for yourself (and quite healthy dividends at that) OR sell shares at very favorable prices that you pre-determine. 

The covered call is a nice hedge against downward movements and a potential income strategy.  And its literally no risk as long as you pick an exit price you'd be happy to exit at. 

Today I don't have answers, but the beauty of this is the endless complexity and impossibility of doing everything right.  But I know there's a better way than I've found so far, and I'm hell bent on finding. 

2 Comments – Post Your Own

#1) On March 20, 2009 at 7:59 AM, icuryy4me (< 20) wrote:

Well I'm the first to admit to be rather ignorant when it comes to options and I know this stategy is a popular one but I just don't get it.

  The way I look at it is that in return for gving away all the upside potential you get a little less than 4%and yet are still exposed to all the dowside risk. You could sell the stock as it starts to fall and hope to buy back later to reduce that loss but at the penalty of commision charges.

  I think this is why so many dual option stategies have developed. These can limit risk given certain expecteced maket conditions, e.g. "Iron Condor" for flat markets and so on.

I look forward to being illuminated by those who know better...!

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#2) On March 23, 2009 at 1:01 PM, checklist34 (99.69) wrote:

well the reason that I like the sale of the covered call, over short time horizons (say out to april) is that it creates one of two possible outcomes

1.  the stock goes up to a price you pre-selected, is called away from you, and you make money. 

2.  you get free money from the call expiring worthless

So for me selling calls on shares I own today is a win/win.  If i sell a $12.50 call on 1/2 of my RCL that pays $0.50 and expires in June of 2009 there are two possible outcomes.

1.  the stock falls or rises to $12.49 or less by june 19th, in which case I get about a 8% return on my initial investment (I bought for around $6 on average) and the stock may well be up higher than $6 or higher than today

2.  the stock rises to $12.51 or higher by june 19th.  In that case I sold some percentage of my $6 shares for 2.1 times my money.

Its a shelter against market voaltility (the value of the calls drops dramatically when the market turns negative, especially if they are calls applicable to the current month, which partially counters the losses in your portfolio) to some extent, its an income strategy (like making your own dividends), OR if the shares are called away from you, that means you amde alot of money. 

Imagine a situation where the stock dropped and you lost confidence in the company.

Then just close out the calls (buy them back) at a profit and dump the shares. 

The only way it can backfire is in the case of a rapid wild rise in share price, like JAVA.  I owned some JAVA and had sold calls on 25% of my shares.  When IBM offered to buy JAVA and it went fro $4 to $8 in a day, I dumped 75% of my shares for more than double my money, but 25% of my shares I'm sitting at a $5.50 price or so ($5 call plus the premium I got).

So i lost mone yfor selling those calls, but who cares?  I still made money and thats the important part.

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