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Monday, May 10, 2021

$ SPY and $ QQQ Market Neutral Structures

By Century Financial in 'Investment Insights'

$ SPY and $ QQQ Market Neutral Structures
$ SPY and $ QQQ Market Neutral Structures

*Trading in financial markets carries risk and can result in loss of capital

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The product and investment ideas do not consider the risk profile and financial position of the recipient and may not be suitable for everyone. Trading in financial markets and use of margin involves a significant risk of loss, which can exceed deposits. Please read the complete disclaimer carefully.

Risks & Assumptions
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Option prices and the corresponding pay-off are as of expiry & for representative purpose only. Going ahead, as the ETF moves in either direction, final pay-off will change accordingly.
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The assumption of receipt of initial coupon or the initial debit cost is based on the option premiums available at the time of structure creation. This may vary at the time of actual execution depending on the corresponding option prices and implied volatility.
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Numbers given below for the P & L are on gross basis (without considering any transaction charges.)
Rationale

US stock markets CAPE ratio (Cyclically Adjusted Price/ Earnings) ratio now stands at one of the highest levels in the world. As an example, for SPX index, the ratio currently stands near 36.6 levels, 98% higher than its monthly readings since 1981. For Nasdaq Index, the ratio currently stands near 53 levels, again higher than its long term average. While these rich valuations are being supported by surplus liquidity on back of various fiscal & monetary policy measures, markets are also forward looking towards the recovery theme aspect of the US economy.

Going ahead, current rise in COVID – 19 cases across Asian countries & Indian subcontinent will likely keep markets on a jittery edge. The structures provide a convenient way to trade on the future 2 month directions on SPX & Nasdaq 100 Index using options of their respective ETF's. The structures are designed to be market neutral with client having the flexibility to choose from either of these based on his view of the expected market volatility.

Expected View & Return Profile

Yield Earners

With the Yield Earners, there can be potential yields of 6.03% & 10.73% over the duration for the SPY & QQQ structures respectively. This is based on the view that both the indices will be range bound between the levels as mentioned in the table below. However, should the market turn out against the view & instead trend in a volatile manner, losses will start accumulating up to the potential max capped loss of - $43,975.

Volatility Plays

With Volatility Plays, there can be potential max profit $43,975 & $29,450 for SPY & QQQ structures respectively. These gains occur when indices break beyond the levels as mentioned below. The max loss over here is potentially limited to the initial debit cost for entering the structures: -$6,025 & -$8,050 for SPY & QQQ respectively.

Structure Leg 1 - Buy Put Strike Leg 2 - Sell Put Strike Leg 3 - Buy Call Strike Leg 4 - Sell Call Strike
$ SPY Yield Earner 86% 91% 113% 108%
$ SPY Volatility Play 91% 86% 108% 113%
$ QQQ Yield Earner 86% 91% 113% 108%
$ QQQ Volatility Play 91% 86% 108% 113%
Summary & Statistics

Sr No Structure CMP considered Duration - 2 Months | Expiry Underlying Strategy Expected Volatility Direction Expected Trend Direction Total Exposure - Each Leg ( in Lots) Total IM + MM Net Premium Recived/Paid Yield ( As % of IM) Max Profit (Capped) Max Loss (Capped) Suitability Break Even Points Max Profitability
1 SPY Yield Earner $416.50 16th July,2021 Iron Condor Low to Neutral Neutral 25 $100,000 $6,025 6.03% $6,025 $43,975 When the view is rangebound /sideways without expectations of any major movement $377.59 & $ 425.41 Between the Break Even Points
2 SPY Volatility Play $416.50 16th July,2021 Reverse Iron Condor High Neutral 25 - $(6,025) - $43,975 $(6,025) When the view is volatile with sharp movement expected across either sides of the markets $377.59 & $ 425.41 Beyond Break Even Points
3 QQQ Yield Earner $332.75 16th July,2021 Iron Condor Low to Neutral Neutral 25 $75,000 $8,050 10.73% $8,050 $(29,450) When the view is rangebound /sideways without expectations of any major movement $296.61 & $363.39 Between the Break Even Points
4 QQQ Volatility Play $332.75 16th July,2021 Reverse Iron Condor High Neutral 25 - $(8,050) - $29,450 $(8,050) When the view is volatile with sharp movement expected across either sides of the markets $296.61 & $363.39 Beyond Break Even Points
Payoff

Risks and Assumptions for Back-tested trading strategies
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The risks and assumptions listed here are not intended to be an exhaustive summary of all the risks and assumptions involved.
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The strategy might suffer from look-ahead bias which occurs due to the use of information or data in a study or simulation that would not have been known or available during the period being analyzed. This can lead to inaccurate results in the study or simulation.
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Future price movements may not be exactly the same as the historical price movements and this could lead to variation in performance.
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Testing can sometimes lead to over-optimization. This is a condition where performance results are tuned so high to the past they are no longer as accurate in the future.
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The model assumes no slippages in trading. Slippage refers to the difference between the expected price of a trade and the price at which the trade is actually executed.
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Drawdowns in actual trading can be higher than the tested system and losses could be significant in the event of leverage.
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Unforeseen events can lead to variation in performance from the tested trading strategy.
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The tested result has been computed with price feeds available from Bloomberg.
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The testing environment has not considered transaction or any other costs.
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Trading indicators used for the purpose of testing has been provided by Bloomberg.
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The strategy might suffer from data mining fallacy, selection bias and backfill bias.

Data Source: Bloomberg
Data & Prices as of: 05/05/2021 – US Market Open

Arun Leslie John
Chief Market Analyst

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