Refining Fire

This market downturn has taught me some things.

First, don't do bargain buys in any part of the bull cycle. I had to cut a few of these positions because the downturn was like a refining fire - only the good ones recover - the bad ones keep going down. Bargain buying in a bull cycle is tempting because everything else looks expensive, and there's thing hunt for yield / returns. But it's only a matter of time before the fire burns away the dross, leaving only the pure elements. It's more important to buy strong companies (even if they're expensive) rather than bargain buy weak companies (hoping they will yield a higher % return).

Second, percentage returns for the rallies are misleading - e.g. "oil is up 50% from its lows". It's not uncommon to see severely beaten down stuff rally in double digits, leading you to think you should have bought beaten down stuff. But we often forget we can hardly ever pick the bottom, and so these returns are only relevant to the minority who did catch the bottom. For the rest of us, we are likely to have endured some double digit drawdown, before seeing some double digit rally (from the bottom), leaving our position pretty much near breakevent.

Third, think carefully and clearly on the next steps. This is a WIP as I consider whether I should bet big on a down move, or start putting money back into equities. We have to give ourselves the leeway to be wrong about things. Some decisions are psychologically more difficult than others (e.g. make a bear call while it's rallying, and missing a once-in-a-decade opportunity to buy), but I have to weigh things out as I best can, and make the mental decision and not waver. Rigour is not always rewarded - accept that. Be content that you've made your best decision, regardless of outcome.

Covid19 Marketview

I'm taking the opportunity to think about the future and while I may not be the most qualified / knowledgeable, I think it's good practice to think about such things and pen them down anyway.

TLDR: I think the worst is still ahead of us, and currently the market is not pricing in the full potential effect of this crisis on the economy.


22 Mar 2020


  • Buy US equities later, prices expected to drop further
  • Buy those with a previous strong run, dominance in space, established, but haven taken a good hit
  • EM like India = Hold, China = Hold
  • Oil exposure ok to hold


Will US lose its dominance?

Considering the possibilities of a world power shift.

China is in a good position because they have had the backdrop of having that economic clout, and now they are recovering faster than US. But the world system is still quite entrenched, so I think it will take more than just this slowdown and who is faster to the recovery race to overthrow US. It will take a really crippling thing to happen to the US which renders their systems unusable and forcing the incumbent ‘clients’ to switch. Similar to how UK lost its dominance in WW2, US fortuitously gained. It was nothing UK could do. But that alone didn’t do it – it required a surge of innovation in the US to propel it forward.

So maybe this crisis is not enough. But it could be the start of something.

Maybe China will gain grounds it would never have the chance to gain until now. Not sure where though. It could further consolidate its power in being the engines of the world economy by looking to replace other links in supply chains that are now closed (because they were in Europe). Availability in a desperate time is valuable. It’s just too difficult to predict how, where, and to what magnitude this will happen.

Back to the question, I don’t think it will lose its dominance in the tech space nor will its stock market be left in the doldrums as the rest of the world accelerates. I do believe that the main indices will recover and make new ATHs in a matter of 5 years. That’s because this virus changes economic demand, and that is a temporary thing. It is not paradigm-altering. Consumer demand remains the same – people will still buy the same things after the crisis and use the same services.

I don’t think it will lose its dominance, though I do think that China will close the gap.


What are the prospects for emerging countries?

A year or a few years back, it was still a good thing to have because everything else in developed markets were expensive – i.e. both stocks and bonds, and we were hungry for yield. We have been since 2016 actually, leading to things like VIX apocalypse.

But now why would we bother with emerging economies when the developed ones are on discount? Looking at India vs US, both are down about 30% and so the relative value goes to US in terms of risk-reward. I doubt India can recover faster than the US.

China looks good given the above reasons, but it has only declined about 12% throughout this crisis, so in comparison to US it’s less of a priority.

I’m just going to keep IN and CN on a hold for now.


What’s the plan for loading up?

I expect this downturn to go further because the curve is just starting for US and probably in the middle or about 35% for Europe. Meaning there’s still some way to go which will really put a dampener on consumer demand and prices should reflect that accordingly.

It seems so far that the way the infection spreads is quite uniform in terms of trend in countries, so it’s not unreasonable to expect the same waves to occur in Europe then US.

Depending on how forward-looking the market is, these could have ALREADY been priced in at this -30% level. But only time will tell as the waves materialize whether the above is true i.e. if it’s not priced in then we’ll see further declines as the infections materialize. If it is already priced in, I expect to see some form of a bottom being carved out. Seeing a bounce in the midst of the wave could be something else (random optimism or some behaviour I really can’t explain) because I’ve yet to see a market so efficiently forward-looking.

Again, many market moves cannot be fully explained – I’ve been stumped quite a few times post-move even with the benefit of hindsight and a plethora of news attempting to explain things i.e. the explanations don’t make sense but more commonly no explanation is given “stocks move higher despite XXX” kind of rubbish headlines.


What to buy in US?

Major indices and tech companies. Generally, companies that have been solidly established and have further room to go but have been knocked back by this. Dominating tech companies are good buys to me, at these levels, as these will not be going away anytime soon. They also have the ability to tide through the storm.

Avoid stocks which are discount on discounts – i.e. prices have been falling anyway. A simple filter is to look for 10-year annualized total return and compare that against 1-mth or 2-mth change in price. With filter of some market cap.


What about oil?

I was a bit too hasty in getting into oil when it collapsed. It took one more hit from 30 to low 20s, which is my lower end of my range i.e. I really did not think it would get this bad.  I had underestimated the contango also – meaning I cannot roll over my positions without significant cost.

Though I think oil will rise back to more normal levels of $30, there is no way to play this as it is already priced that way for the Dec contracts.

Date USO WTI chg chg beta
Jun-14 38 106
Feb-16 8 36 -79% -66% 1.20
Sep-18 16 75 100% 108% 0.92
Mar-20 5 23 -69% -69% 0.99


USO looks decent though in riding spot oil. The contango is built in but at least that’s managed for me.

Funny thing about contango is that market is usually pretty correct – after sharp declines, further months are priced to a premium, and at peaks, they are priced to discount.

This is a reliable signal for the F1-F6 premium too.

Where we are at

The market has finally come down a significant bit, sort of finally pricing in the effects of the virus (we can never know for sure to what extent this is a repricing). Again the market defied expectations for a while - I was wondering why the market was shaking off the virus for the past 2 weeks, but from experience there is always this unquantifiable gap between an investment idea and its translation into profits.

Now that the market has come off its highs, I've been positioned for a short rebound as of last Friday (28 Feb) - this is best done using verticals or diagonals so you have limited downside and not have to pay the elevated premiums.

Also try to go for some vol decay alpha if you wish (e.g. sell puts). Again it's about scale - no need to be afraid of catching a falling knife if you only risk a bit of your capital - sometimes I find it hard to answer people why I have long puts and short puts at the same time (different expiries though) - it's just a dynamic adjustment based on situation.

Update on 07 Mar 2020

The rebound did not look too good, but managed to harvest the higher vol. Seeing as to how the rebound did not play out well, I think there's a good chance a major selloff will ensue instead of a rebound. I'll be positioning myself for that, likely using some cheap OTM bear verticals.

Update 20 Mar pre-open

I'm positioned for a slight rebound using SPY calendar spreads at the 255 area - they are very attractive now due to the high vol in the near leg, and the expected low rate of decay for the far leg. This strategy can be continued for a while using weekly expiries (or even shorter) for as long as VIX is expected to remain elevated.

Update 28 Mar

Though I was a little surprised at the rally, in the larger picture it's quite normal, especially given the speed of the fall. I think the economic damage is yet to be properly appreciated, and so we should be in drawdown phase for quite a while more.

Feb 2020 update

Now that much of my research work is done as part of my job, I don't have much time to devote to research on the sidelines. But here's a recap of what's still ongoing:

The yield curve play is still valid:

Seasonality in indices can still be traded:

Trading the outbreak is not the most convincing for me - I did it mainly to push myself to see what opportunities there are in situations like these, but still have not found anything with high conviction.

I've closed a good bit of my long TRY trades (using options to exit), as it keeps crawling lower (and the carry is diminishing) and so the risk reward is less than what it used to be.

As US markets are near ATH, I've taken the chance to add to long Puts and opportunistically selling Calls.

In FX markets, short term opportunities are still present in short USDCAD.

Commodity futures are still a go, riding on my past research, but not having the time to discover new things.

The January Effect – Idea for Nov 2019

Based off the posts from Part 1, the time has come to implement the bullish call for Nov and Dec.

TLDR: Buy 1-month 310 Calls  - you can't beat the index but you can get better Sharpe

One way to do this is to buy calls, especially since now VIX is quite low. The question is which strike to buy? Buying deeper ITM would cost us a lot, but knowing that Nov isn't a particularly high-skew month also means that many OTM calls would likely end up worthless.

Profiling the equity curve of a hypothetical backtest would help. Here the option prices for each strike is taken and simulated through all the years of % change to obtain the option portfolio equity curve. It takes into account the premium paid.

Naturally, the lower the strike, the more it resembles an outright investment in SPY. Further OTM calls have an equity curve that is highly dependent on very good years, but minorly decline in most years.

A very crude way to evaluate this balance of a smoother equity vs lower total profits is the good old Sharpe ratio. The current price of SPY is 306, and the optimal Sharpe is at 309, just at 1% above current price.

Of course, lots of historical assumptions are inbuilt, but at least it's an answer and a starting point.

Reconstructed equity curves for each strike vs SPY equity (in price points)