UIS 3x Leveraged – Black Swan event planning

[StefanM]

Reading several threads on the 3x UIS performance, some comments were made about using a small portion of this strategy to improve the performance of a more vanilla strategy. The logic was posited that the strategy would be vulnerable to a Black Swan event.

My interpretation of that comment is where SPY crashes by 30%, SPXL would go down by 100%, and thus be terminated, thereby losing your entire investment in SPXL.

Given that 3xUIS has a maximum exposure of 60%, and assuming the hedges (UGLD and TMF) continue their negative correlations to SPXL, would not the maximum loss of this strategy be 60% (i.e. 3 x (60%-40%)) and not 100%?

This assumes that the hedges continue to respond quickly. Such an assumption might be safe as it would be logical to assume that most market-moving hedge trades are algorithmically-driven by large hedge funds and institutions, and thus responding potentially in seconds to a market crash.

The other variable is the kind crash, for example:
• a flash-crash (occurring during one day, where the market recovers that day),
• a 1987-type crash where the DJIA fell 22% in one day,
• a more elongated 2007-9 crash.
I think the 1987 crash would be the one to pose most risk to 3xUIS. (sidebar: has anyone modelled 3xUIS during the 1987 crash?)

The other assumption is that the negative hedge correlation continues. I seem to recall that there was a correlation heat map on the main LI website, however I think it has been removed. Is there a way to measure the current levels of ‘hedgy-ness’ in a heat map form?

The key questions I would appreciate feedback from forum members are:
• Is 60% the maximum potential loss of the 3xUIS strategy?
• Would the hedges (continue) to respond quickly in various crash scenarios?
• What is the riskiest type of crash to the 3xUIS strategy?
• Where could we find up-to-date hedge heat maps (or generate our own) that would provide comfort that the hedges are working over various timeframes?

Thanks

[ikoskela2]

My modified UIS 3x Leveraged strategy trades weekly. This could help in a black swan situation. I also trade it within a larger strategy of strategies that itself only allows a single strategy to be 60%; so at most SPXL is going to be 36% of my portfolio.

[Richard McKamie]

I’m curious: How did your strategy work this week? What are the signals for next week? What type of performance has it had long term? Is it vulnerable to quick market drops with quick reversals? I will look at modeling something like that, too. Thanks for any input you have on this.

[ikoskela2]

Well, these past few weeks are about as Black Swan as you can get. It did not perform well at all. I’m using SPXL and #CASH as the equities and TMF and UUP as the Hedge. Not sure why it didn’t go to #CASH. It’s still sitting at 40/60 SPXL/TMF. Fortunately, my strategy of strategies removed it at month end. Also, fortunately, I am still evaluating Logical Invest and wasn’t trading it with actual money.

[Frank1 Grossmann]

Still working with leveraged ETFs can reduce your total risk considerably if you invest only 1/3 of your money and keep 2/3 as cash. The 3xleveraged strategy lost 21% because of the bad performance of the safe havens Gold and Treasuries. Translated in a 1x leveraged investment this is only 7% down.
If you want your strategy go to cash because of volatility use the volatility limiter in Quanttrader.

[Frank1 Grossmann]

A good property of 3x leveraged strategies is that they automatically reduce equity exposure during such a black swan event. The 3x leveraged SPXL lost about 72% this month but the 3x leveraged TMF is still about 15% up. Starting this month you had 60%Treasuries, 30%Equity. At the moment your allocation is 16% Equity, 69% Treasury. At the start your Treasury/Equity ratio was 2/1 now it is more than 4/1. This means that at the moment you have a very defensive allocation. If the correction continues and equity goes down and Treasuries up, you will make much more money on the Treasury side while your downside on equity is limited. It could well be that the strategy manages to pare the previous losses until end of the month.

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