Similar to a Covered Call strategy, a Covered or Protective Put works the same way, except its the opposite, but both of these trades actually credits you cash. But when is a good chance to exercise this ? When Investors fear and the more fear the better. Here’s an example:

Looking over a counter called DEER, its a China Company that’s listed on NASDAQ.

1) Fundamental:
There were news and rumors about this company, by a blogger over at Seekingalpha.com. Now this Company is actually suing over that particular guy who wrote about suggested shorting this stock, due to bad earnings.

2) Technical:
Since Mar 21, the stock has been heavy sold/shorted from $9 to $6 +, with a very nice smooth downtrend, suggesting the selling was gradual and controlled, not much panicking here, but people simply don’t know the situation.

Using Slow Stochastic Oscillator (SSTO), the points to short are when it hits above 80-85, and using Bollinger Band, the width of the upper/lower envelope shows the stock price isn’t jumping around randomly but a gradual one, suggesting it isn’t that volatile.

For stock DEER to average $11 for 5 months, drops sharply to $9, and go under $8 in 2 weeks, it means Investors are fearful.

Here’s the trade.

When the stock was around $6.60, 6 Apr 2011, the Options market, particularly the Put options for $7.5 strike, was trading at $1.85. That means that if you short the stock at its current $6.60 (to buy back at $7.50), and write a put at $1.85 (for $7.5 strike), you will be “credited” net at $6.60 – $7.50 + $1.85 per share.

If you decide to trade 500 shares:

Short 500 @ $6.60 = -$3300
Sold 5 Put @ $1.85 = -$925
Total profits (If exercised at $7.5) = ($6.60-$7.50) x 500 + $925
=(-$0.90 x 500) +925
=$475.

If the stock prices shoots up strongly, with news or buy backs, you make a lost on the shorted $6.60, but your $1.85 a share is theoretically enough to cover $7.50 – $1.85 = $5.65.

If the stock prices drops sharply, with more bad news, it doesn’t matter, because you have already covered the shorted stock with a buy back at $7.50 put, because you are a writer, obligated to buy the shares from the put option buyer. You are bound to lose 90 cents, but your $1.85 would be nice enough to cover that.

Files under Hedging strategies | 1 Comment | 1 Comment »

I have switched from Alpha measuring metrics to Sharpe Ratio for my portfolio. Hopefully this would help me adjust my risk according to my returns, and measure my performance peg against other mutual/hedge funds.

How to calculate Sharpe Ratio:

1. Use Excel
2. Use a professional software
3. Get a professional Fund Administration services Company

The obvious is to use Option 1.

The formula is as shown:

Average daily / monthly PnL returns % – 3/6/12 months Treasury Risk free rates

___________________________________________________________

Standard Deviation of Average daily / monthly PnL returns %

Ok, enough of the jokingly display of serious stuff here but in essence(with Excel formula):

(AVERAGE(A1:A10) – 0.0007) / STDEV (A1:A10)

If A1:A10 is the AUM PnL returns based on either in Days or Months, and the Risk free rates for 3 months is 0.07%, then this formula would apply.

With my Daily AUM updated base on the actual value of my portfolio (After using margin/leverage, negative cash, the actual value, realized/not realized) from my Brokers daily reports, I am able to record down the daily movements. With these data, I simply plug the figure into my excel spread sheets, using opening and closing AUM to get the daily PnL %, to calculate the monthly Sharpe ratio, Monthly PnL, Cumulative PnL% and even Annualized Figures. With these daily I’ll introduced another metric called Impact Ratio:

How to calculate Impact Ratio:

Another important metric introduced was the Impact ratio. Since I do trade “often” perhaps 10-50 trades a month with good movements and volatility or opportunities, or just simply 2 trades a month, the Impact Ratio measure how fast (slow) / how volatile you took to realized profits (loss).

1) Take each day’s Closing AUM and deduct the Opening AUM
2) Derive how much PnL made for the day, be it realized or unrealized.
3) Derive a daily data for a month of profits and losses.
4) Sum up all daily Profits for the month
5) Sum up all daily Losses for the month
6) Take the profits over losses. That will be your Impact Ratio

The reason to use this ratio is calculate how well you manage your portfolio’s profits and losses. Obviously if its a negative value, you may be experiencing a bad month, and a higher negative value means you are “slow” to stop the bleeding or “volatile” loss for the month.

Say your End of Month Impact Ratio is 2, which comes from having $2000 / $1000. This data would  be better off than another portfolio say Impact Ratio 1.5, with a $150/$100. The latter has lower Impact Ratio (Worst) than the former (Better), with its total Profits over losses for the entire trading days much lower.

Now say we combine the Sharpe Ratio and Impact Ratio, and what do we have ? With the exam of $2000/$1000, and $130/$100, we never know how Example 1 obtained the profits of $2000 and a loss of $1000, versus the 130/100.

Simply by using Sharpe Ratio, we can determine the rewards with risk in 2000/1000, and one with 150/100. Maybe the 2000/1000 was obtain with great risk. Maybe the 150/100 had too little risk to reward.

Summary:

By combining my other metrics such as calculating Monthly PnL, Trade % wins, replacing the old Alpha calculation with Sharpe Ratio and Impact Ratio, I hope to measure and improve my portfolio performance any, of course, my skill in managing investments and portfolios.

Files under Monthly Fund performance | 2 Comments | 2 Comments »