Crash Protection Option (B)
Risk hedging options with market data
Last updated
Risk hedging options with market data
Last updated
There are times when extraordinary economic events occur. When that happens, all sorts of economic data go haywire. We have been thinking for a while about how to avoid these turbulent periods. If you're writing a buy-and-hold strategy or a static strategy, you're going to have some of these periods over the long term. If you can avoid one or two of them, your long-term performance will be greatly enhanced.
However, there is also the risk that you will miss a good buying opportunity when the market crashes as a result. There have been many occasions when there has been a huge opportunity to make huge profits when the price correction was ridiculous because everyone thought it was a big crisis (e.g. when prices plummeted due to the coronavirus crisis).
So this option should be used very carefully. While it's important to be risk-averse, missing out on huge profit opportunities can be very damaging in the long run. Indeed, if you look at the return windows that contribute to long-term performance, the post-crisis period is at the top of the list.
So we're trying to make sure that we've got all our cases in order so that this option is applied to a very short window wherever possible. For example, instead of applying it immediately when the economic data we provide is well outside the average range, we study past cases and apply it after a certain point, and also consider the direction of the break, not just the level of the number. So we are continuously collecting these cases and using machine learning techniques to find the optimal solution based on the number of cases. And in the future, this option will continue to evolve as we continue to update the data (because there is a difference between the level of the indicator in the past and the level of the indicator in the present, and there is a difference in how to interpret it, how to apply it, when to apply it, when to de-risk it, etc.).
In fact, we've found that more often than not we get hurt by being too complacent or failing to act on known red flags, so this option is more about helping us to do that mechanically.
The unemployment rate is one of the most important indicators in the US economy. In the virtuous cycle of the economy, unemployment directly leads to lower consumption, which in turn reduces the productivity of companies and pushes the entire economy into a vicious circle. The unemployment rate is therefore one of the most influential indicators for adjusting US economic policy.
Reversals in short- and long-term interest rate differentials are very rare. However, when they do occur, the probability of a recession is very high. When the long term rate (interest rate) is below the short term rate (interest rate), it means that money is moving to a very conservative place and there is not much money in the market.
Higher dividend yields tend to indicate that stocks in general are oversold, while lower dividend yields tend to indicate that stocks are overbought. When the dividend yield on the S&P500 falls below a certain level, this option views the market as overheated and triggers a risk-averse option to invest in defensive assets.
Used in the Growth-Ternd Timing - UE Rate (GTT-UE Rate) strategy, which calculates the 12-month average unemployment rate and identifies a recession when the previous month's unemployment rate is above average. It also takes into account the 10-month absolute momentum of the SPY ETF and is used in the Buy and Hold SPY strategy the rest of the time, holding cash only when there is a recession signal and negative absolute momentum.
