Financial Risk Management in Denver | IPS Strategic Capital

Everyone is asking the same question, “Where is the market going and what should I do?” The financial markets at home and abroad are a disaster, and the financial community says the same thing.   “Diversify, buy value, buy tech, buy the dip, don’t buy the dip, go to cash, hold for the long term yada, yada, yada.” In the end, everyone has an opinion, and you know what they say about opinions.

The truth is that nobody knows what the market will do, so let’s do this. Invest most of our portfolio in one-year U.S. Treasury Bills and use the future interest today to buy index options giving you 60 to 70 percent of the market upside. If the markets drop another 20% from current levels in a year, you would be protected. Wait!!! What??? I have explained this to many of my clients and what I usually get is a blank stare.

Its Simple Arithmetic

Let’s assume you want to invest one million dollars in a one-year T- bill, which recently was trading at over 2%, in light of the fact that you can buy a T-bill at a discount from par. You would be guaranteed one million dollars in a year if you invested $980,392.16 today. We are talking about a U.S. Bill, so the million dollars in a year is guaranteed unless you think Uncle Sam will default.  

If you put $980,392.16 in a T-bill, you would still have $19,607.84 to invest from your million. ($980,392.16 + $19,607= $1,000,000). So, let’s invest your $19,607 in exchange-traded options. What??? Wait!!! Options are risky, and I can’t put money in options. Exchange-traded options have never defaulted, and options define your risk today for tomorrow. Options are mathematically defined if held to maturity, and they will deliver exactly the profit/loss you define today in a year.

So, let’s look at the P/L I recently built for a client using U.S Treasuries and options:      

The first thing investors say is, what does 70% of the upside mean?

What 70% of the upside means is that if the market is up 20% in the next year, you will make 14%. If the market is up 50% in the next year, you will be up 35%. The first comment I get from investors is that if I invested in the S&P 500 directly, I would get 100%, not 70%. Why would I do this? What is missing is that the average investor puts their money in some type of diversified portfolio, most commonly a 60/40 stock-bond mix. Historically a 60/40 stock-bond mix doesn’t come close to capturing 70% of the S&P 500 upside. The chart below shows that when the market was up in 2009, the 60/40 only captured 44% of the upside.          

The other point that investors are missing is that a 60/40 stock-bond mix year-to-date has been an unmitigated disaster. Bonds are down big, and stocks are down big. During the financial crisis of 2008, a 60/40 Stock bond mix captures 50% of the loss. (see chart below)

The T-bill strategy is mathematically defined. If the market drops 20% from current levels, you will be fully protected. The financial markets are down between 15% to 40%, which means the market would have to be down 35% to 60% from here for the investor to start losing money.

The particular U.S. Treasury investment strategy shown above was built with a 1% negative carry cost. What that means to you is that if the market is down 20% from current levels, the investor would be down 1%; if the market was down 22% from current levels, the investors would be down 3% in a year. However, if the market was up 22% from current levels in a year, the investor would be up 14.4% (70% of 22% =15.4% -1% carry cost = 14.4%). These investments can be tailored to an investor’s desired outcome, no carry, positive carry, more downside protection with less upside participation, or more upside with less downside protection. In the end, as my mom used to say, it all comes down to arithmetic. (see was a 30-year high school math teacher)        

In today’s uncertain market environment, everybody would want to put certainty back in their investment portfolio. You can’t get more certainty than U.S. Treasuries and exchange-traded options to deliver the peace of mind we all want.

Since 1996, IPS Strategic Capital has grown and protected wealth by generating consistent, non-volatile returns regardless of market conditions. We rely on mathematics, not speculation. We firmly believe there is a better, safter way to invest through the conservative use of options to define tomorrow’s risk, today.

Disclaimer: The information in this article should not be misconstrued as an offer, nor a solicitation, to buy or sell securities. Any past performance of any investment(s) does not necessarily indicate the future performance of any investment(s). No client, current or prospective, should assume the future performance of their investments will be profitable based on historical performance. Any backtest charts and data presented are purely hypothetical and do not represent the performance of accounts managed by IPS Strategic Capital. The results were obtained by applying a rules-based investment process to historical data. All investments have the potential for profit and the potential risk of loss. Changes in investment strategies, contributions, or withdrawals may cause the performance results of one’s portfolio to differ materially from the reported composite performance. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client’s portfolio. One should always consult an investment advisor before making any investment decisions.

One should always consult an investment advisor before making any investment decisions as well as consider the investment’s objectives, risks, charges, and expenses carefully before investing or sending money. This and other important information about the Strategy is available upon request.

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