Hedging for FastTrack Users June 29, 2004

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Hedging for FastTrack Users June 29, 2004

• Bob Krishfield
• bobkrish_at_socal.rr.com
• Home.socal.rr.com/bobkrish/cainvestor.html

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Agenda

• Hedging Discussion
• Automating the Process
• Results Analysis
• Summary Conclusions
• Options for Improvement

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What is Hedging?

• Combining a Long Fund such as ARGFX - Ariel, with
  an Short Fund, like URPIX ProFunds Ultra Bear
• To reduce volatility
• To improve risk adjusted return
• Example
• You have 80,000 of ARGFX in your portfolio
• You buy 20,000 of URPIX to create a Hedged
  Position ( 80 long and 20 short)
• You now hold both a long and a short position

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Need for Hedging

• Fund Trading Systems Developed in the 90s
  Outdated
• Markets No Longer in a Long Term Up Trend
• Buy Hold may result in excessive DrawDowns
• Lack of a Defensive Strategy may result in an
  emotional Sell (usually after a significant
  loss)
• Mutual Funds Now Have Many Restrictions to
  Discourage Frequent Trading
• Selling a favorite fund during downtrends may be
  a problem
• Redemption fees now typically 2 if redeemed
  under 90 days
• Rules may prevent you from buying fund back later
• You may become flagged as a frequent trader and
  banned from fund
• Hedging Reduces DrawDown (of Combined Position)
  to Make it Acceptable to Hold onto Primary Fund
• Short Fund Offsets Dip in Primary Fund
• Trys to Reduce the Large Dips - not the Little
  Ones

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Effect of A Hedge
ARGFX(Black)
No Hedge
80 ARGFX20URPIX (Pink)
70 ARGFX 30URPIX (Blue)
URPIX (Black)
Rel Strength ARGFX/URPIX
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Hedging Options

• Static Hedge
• Buy Leveraged Inverse Fund and Hold it
• Optimize Returns by testing various percentages
• Timed Hedge
• Buy Leverage Inverse Fund during Down Swings
• Sell During Up Periods
• Augmented Timed Hedge
• Buy Leverage Inverse Fund during Down Swings
• Sell During Up Periods and Buy Positive Leveraged
  Funds during up periods (augments Main Fund)

The Augmented Timed Hedge Usually Offers a
Greater Return
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Red - 70/30 ARGFX, UAPIX (Long Fund) Green -
75/25 ARGFX, URPIX (Short Fund) Yellow - ARGFX
Fund (BH Fund)
Yellow/Green Line - Augmented Timed Hedge Gain
190 Ann49
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Hedging Process - Simplified

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Key Tools Used in the Process
Use FastTracks SS to Pick Funds w/ High Returns,
Low SD or UI, High UPI
What Primary Funds are Good Candidates to be
Hedged?

• Use ShortHedgeTime2a to
• Pick ShortAug Funds,
• Compute Ratios Combined Funds,
• Make Reports FNUs of Results

Which Short Fund to Pair with Primary Fund?
Which Long Fund to Augment? What Ratios to use?

• Use FastTrack to
• Plot FNUs and Make Listing
• Review UPI, MDD

How to Evaluate Results?
Run/Build Various Signals with FastTrack or Trade
What Signals Work Best?
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Selecting Best Primary Funds
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Running ShortTimeHedge2a
Trade TradeFR
FastTrack Database
Signal File
Download from Dex Frenchs Website. Place files
in Trade Directory Run Program as follows
ShortHedgeTime2a Program
Report
FNU Files
Tradefr shorthedgetime2a.inifundstartdatfamil
ysignaloutputs
Program run options
fund - fund to hedge startdat - start date
(mm/dd/yy) family - family for short/long
picks (profunds, rydex, potomac) signal -
trading signal (rutvol2 my favorite) outputs -
detailed options for outputs
Dex French's FastTrack/TRADE page
http//home.earthlink.net/dexf/
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ShortHedgeTime - Text Output 1
Automates Picking Funds based on Correlation with
Primary Fund
CORRELATION AND BETA OF FAMILY RELATIVE TO FUND
CORR
BETA
-------- -------- UAPIX ProFunds INVUltra
SmallCap/01 89.36 2.56 lt--Long Aug
Fund UMPIX ProFunds INVUltra MidCap/011
88.67 2.38 BLPIX ProFunds INVBull/004
83.37 1.12 ULPIX ProFunds INVUltra
Bull/005 83.27 2.25 UEPIX ProFunds
INVEurope 30/002 67.71 1.20 OTPIX
ProFunds INVOTC/040 63.60
1.58 UOPIX ProFunds INVUltra OTC/008
63.39 3.17 UJPIX ProFunds INVUltra Japan
48.23 1.74 USPIX ProFunds INVUltra
Short OTC -64.01 -3.19 BRPIX ProFunds
INVBear -83.01 -1.13 URPIX
ProFunds INVUltra Bear -83.29
-2.27 lt--Short Fund
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ShortHedgeTime Text Output 2
Compute Various Combos Pick Optimal Ratio Based
on Highest UPI
STATIC HEDGE RESULTS LONG SHORT
GAIN MDD UPI
-------- -------- -------- --------
-------- HEDGE 100.00
0.00 47.84 24.39 0.73 HEDGE
95.00 5.00 46.66
20.88 0.83 HEDGE
90.00 10.00 45.13 17.31
0.96 HEDGE 85.00
15.00 43.24 13.77 1.14 HEDGE
80.00 20.00 41.02
10.64 1.41 HEDGE Optimal Static Ratio
75.00 25.00 38.48 7.92 --gt
1.71 HEDGE 70.00
30.00 35.64 7.71 1.38 HEDGE
65.00 35.00 32.52
8.81 0.79 HEDGE
60.00 40.00 29.13 11.47
0.41 HEDGE 55.00
45.00 25.52 16.33 0.20 HEDGE
50.00 50.00 21.68
21.48 0.07 HEDGE
45.00 55.00 17.67 26.57
-0.02 HEDGE 40.00
60.00 13.49 31.50 -0.08 HEDGE
35.00 65.00 9.18
36.21 -0.12 HEDGE
30.00 70.00 4.77 40.68
-0.16 HEDGE 25.00
75.00 0.27 44.95 -0.20 HEDGE
20.00 80.00 -4.28
49.02 -0.23 HEDGE
15.00 85.00 -8.86 52.85
-0.26 HEDGE 10.00
90.00 -13.45 56.45 -0.28 HEDGE
5.00 95.00 -18.02
59.86 -0.31 HEDGE
0.00 100.00 -22.55 63.08 -0.33
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ShortHedgeTime Text Output 3
Process Repeated for Short Long Combos,
Choosing Combo with Max UPI
STATIC HEDGE RESULTS LONG
SHORT GAIN IMPROVE MDD IMPROVE
-------- -------- --------
-------- ------ -------- OPTIMAL_STATIC
75.00 25.00 38.91 -9.51 7.92
16.46 RESULTS OF TRADING FUND AND HEDGE
LONG SHORT
GAIN MDD
-------- -------- --------
-------- TRADE_argfx_HEDGE
75.00 25.00 51.85 11.75 RESULTS OF
TRADING AUGMENTED FUND AND HEDGE
LONG SHORT
GAIN MDD
-------- -------- --------
-------- TRADE_AUG.argfx_HEDGE
70.00 30.00 63.91 14.36
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Output Files Plotted In FastTrack

• HDOPT(zARG1) - The optimal static hedge (Combo of
  Fund Short Fund)
• TRRES(zARG2) - The result of the fund traded with
  its optimal hedge
• ATRES(zARG3) - The result of the augmented fund
  traded with optimal hedge
• ATHDG(zARG5) - The augmented
• long fund traded with the short
• hedge
• ARGFX - The primary fund

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FastTrack S/S Calculates Statistics
3 Year Gain
BH Static Timed Augmented
Details of Performance Obtained from
FastTrack Gain Annualized Gain UPI - 3
yrs Sharpe Ratio Max DrawDown
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AnalyzeResults
Look for 3 X Improvement In Gain, MDD, UPI
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MoreResults
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Visual Check of ARGFX - Ariel
Hedge Flat - Fund Up Signal Too Active
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Plot RelStr of Fund vs Result
Look for Periods Where Hedge is Effective /
In-Effective
Dont Hedge Strong Trend
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HRTVX - Heartland Value
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Summary Conclusions

• Hedging using ShortHedgeTime Has Merits
• Model is Simple and Helps Evaluate a Hedge
• Easy to Run, but Decisions More Complex
• Results Change (maybe call program
  ShortTimeHedge)
• FastTrack very helpful to analyze hedge results
• Know the Risks of a Hedged Position
• Similar to Buying Short
• Success for this system requires timing and
  objective decision making
• Analyze sensitivity of Results to Signals, Market
  Period
• Hedging is a Defensive Strategy
• It Protects your primary investments during
  uncertain periods
• Avoid Use When Not Needed
• When Primary Fund Growth Trend is Strong
• Unless Augmented Hedge Shows Better Results

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Room for Improvements

• Update to Include This Years New Short
  Leveraged Funds
• Inverse Leveraged Dow 2x RYCWX / RYCWX
• UltraShort Leveraged R2K UCPIX / UCPSX
• Improve on Trading Signals
• Recognize Transitions from Strong Trends to
  Trading Ranges
• Use Characteristics of Primary and Hedged funds
• Try hedging a portfolio by making portfolio into
  a combination file (FNU) and determine its hedge
  ratios, etc.
• Develop ideas for a dynamic hedge ratio - change
  amount of short fund based on market risk
  indicator

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Daily Monitoring
RSPFX
RSPFX 80/20
RSPFX 70/30
RSPFX 60/40
Short Fund URPIX -2X SP500