Yesterday’s move was quite a whipsaw.  It’s important to put things in perspective when we see something like this.  First, if we use 30-Day Historical Volatility as our barometer for expected movement, yesterday’s move in SPY was a 9+ standard deviation move.  If the market were truly normally distributed, a 7 standard deviation move should only happen once every 1.5 billion years.  What does this mean?  It is a simple reminder that the normal distribution and recent realized volatility cannot be used as absolute risk metrics.  One needs to incorporate a more complex approach to market forces than this to understand the risk of the portfolio.
This does not mean that those with a leveraged long portfolio are happy to know that this event probably should not have happened.  But it does remind us all of the value of long options as an alternative to stocks.  Not only do we get the leverage to the upside, but we also get the benefit of defined risk.  The key from that point is understanding one’s risk and defining position sizes appropriately.
Remember, at the end of September, the Big League Options portfolio was about 35% in cash and the Home Run Swing portfolio was about 87% cash.  This does not mean that losses cannot happen, and certainly did as both portfolios were biased to the long side of the market, but it means that we have dry powder to buy when the liquidation event concludes and starts to show a new direction.
I can tell you that I have already added one position for Home Run Swing today due to a nice technical signal and a unique situation where one name actually has very cheap Implied Volatility relative to history.  This is my focus for the coming days in Home Run Swing – finding those incredible opportunities to deploy the cash that was kept on the sidelines.
Big League Options will be focused on position management as the portfolio focuses on longer term trends.  This means a few names may be stopped out today or in the coming days and it may also mean that new signals generate on a recovery.
Market dips, breaks, and corrections happen.  The important thing now is to take this move for what it did to the market, find a trading edge, and execute.  That’s how we hit home runs and make big league returns – with patience for the great opportunities.
Feel free to e-mail me with questions or comments at [email protected]
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Keith Harwood
Portfolio Manager, Home Run Swing Trader
Portfolio Manager, Big League Options
Portfolio Manager, Core Commodities