Approximately 12 months ago I started a series of posts to follow the performance of 2 portfolios that used simple In-The-Money (ITM) Call Options to build portfolios that might mirror the performance of conventional portfolios allocating funds to selected ETFs from the 10-asset Rutherford Portfolio List (VTI, VEA, VWO, TLT, TIP, PCY, VNQ, RWX, GLD and DBC). These were not “real” portfolios in that funds were not actually used to invest in the portfolios – however, they are true “forward test” examples of expected performance (with no backtest bias) that can be compared with the performance of the “conventional” Rutherford portfolio described and reviewed in regular monthly posts on this site.
The “real/live” Rutherford Portfolio had a balance of $109,073 on 18 March, 2016, the date the “Options” portfolios were set up. The value of this “real” portfolio, as of yesterday’s close, was $110,725 for a gain of $1,652 or ~1.6%.
The simplest Option portfolio would have invested equally in equivalent underlying vehicles that would represent equal weighting in the top 2 ranked assets (as determined through use of the Kipling spreadsheet). This represents a rather aggressive strategy since it would effectively be fully invested in only 2 assets at all times. Performance of this portfolio is illustrated in the figure below:
This portfolio would have returned a loss of $2,638 over the test period (~2.6% on a nominal $100k account) with a Maximum Drawdown (July-October) of ~12%. The average investment (maximum risk) over this period was only ~15% – Naked Long Options are “self-hedged” with respect to maximum risk.
Using the Tranche SS and the recommended multi-tranche allocations with risk limitation the second portfolio generated the following performance:
The portfolio generated a profit of $1,615 with a maximum drawdown of ~7%. Average monthly investments (max risk) were less than ~10% of a nominal $100k portfolio value.
Over the 12 month test period the (second) more conservative/diversified portfolio would have performed better than the (first) aggressive portfolio – however it is difficult to draw meaningful conclusions from this since, under different market conditions, this might not be the case. Maximum value of the first portfolio reached $5,200 whereas the maximum reached in the second portfolio was only $3,500. Similar differences are observed to the downside with the first portfolio showing a minimum value of $6,600 below the starting level and the second portfolio a more modest drop of only $3,800. Obviously, volatility of the more aggressive strategy is significantly higher than that of the more conservative diversified strategy.
It is interesting to note that the 12 month return of the second strategy is very close to the return generated in the “real” conventional portfolio that also used the tranche/risk management strategy. Although review dates were not identical for each portfolio it is comforting to confirm that a “simple” option portfolio can mirror the performance of a conventional portfolio using essentially the same strategy. At the same time, the use of Options does not require active risk management (through the use of stop orders) since maximum risk is defined by the Option premium paid to acquire the Options.
I will not be continuing this particular (paper) study but I might consider allocating funds to a “real” Option portfolio sometime in the future.