What to buy in this recession

Just a quick thought - the last recession saw many financial institutions pulled under. But they were too important to the system, and so many never actually went away. Similarly in this crisis, perhaps we should be looking at the hardest hit sectors and ask: are their share prices reflecting the long term prospects accurately? I will be looking out for 'systemically important' hospitality / travel related companies that have been dragged down too much. It's only a matter of time before consumer demand, air travel, and mass events return. Like banks, they can never go away - they are too important, at least for this era.

Similarly, it would be interesting to see a repeat of 2008 in another sector - i.e. a major hospitality company fails and triggers bankruptcies and selloffs in other related companies and then spread to other less related companies.

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: https://www.fintrinity.com/marketview/trading-the-inverted-yield-curve-2/

Seasonality in indices can still be traded: https://www.fintrinity.com/blog/january-effect-idea-nov-2019/

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.

Opportunities in the Outbreak

While it's certainly no good thing that outbreaks occur time to time, the volatility that it induces in the markets produces opportunities that are quite rare (thankfully).

The first phase is an asymmetric play - to buy the medical / healthcare stocks. They may suffer a bit if the outbreak is less contagious than expected, but they may be lifted by the more general relief going back into the broader stock market.

The thing with exponential growth is that we hardly grasp / estimate it well - we are usually shocked by the numbers when it materializes. Hopefully (and it is my personal view that it won't) materialize as per the trend.

I do expect the trend to buck soon, and when it does, then phase 2 of the plan will be to exit phase 1 and get exposure in the beaten down stocks e.g. airlines, hospitality etc. probably by selling puts, trying to catch a falling knife with the hopes that the signal above is a strong enough and reliable one that we are about to turn the corner.

But above all I do hope for the safety and health of people. It's one of those things you don't mind losing money in a trade for.

Update on 19 Feb

The asymmetric trade in phase 1 did not play out - so that's a small loss, but I went in a bit early on phase 2 and managed to buy some things cheaper. Of note was some stocks which had very high implied vols, and I shorted some puts.

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)