Introduction
Suppose we have a way to select good stocks for the long term, e.g. as in my post A Cloud & AI strategy.
Unfortunately, even if we are right, if crisis hits, as in 2008, we will experience a large draw-down.
As suggested in the book, "Stocks for the Long Run", by Jeremy Siegel, shorting SPY, or selling your SPY might be
a way out.
Here I wish to explore if shorting SPY actually helps during crisis to reduce the draw-down.
The answer is YES, it does.
Note: There is also an answer to the post A Cloud & AI strategy that shows that the use of leverage and shorting can boost the returns and reduce draw-down. The current post was also inspired by this answer in addition to the cited book.
Details
- The baseline strategy re-balances on average every 6 months between a fixed predefined set of stocks. Those are Cloud & AI stocks, that in hindsight, as we know, have fared very well
- We use the SPY 1 year average return. If this value drop below 0, we short SPY, causing a leverage of maximum 2.
Does Shorting Help?
As it can be seen from the table below, shorting SPY based on leverage, reduced draw-down from -0.54 to -0.28, while
it did not affect the returns.
| Metric | No Shorting (Original) | Shorting (Current) |
|---|---|---|
| Total Returns | 13.92 | 13.26 |
| Alpha | 0.11 | 0.14 |
| Beta | 1.09 | 0.61 |
| Max Draw-down | -0.54 | -0.28 |
| Volatility | 0.24 | 0.20 |
| Max Leverage | 1.0 | 2.0 |
Caveats
- See the original post
- Additionally, we may not be able to short stocks. Then keeping 50% in SPY and selling it during crisis might work, but this has not been investigated here.
Disclaimer
This presentation is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation for any security; nor does it constitute an offer to provide investment advisory or other services by the author or anyone else. Nothing contained herein constitutes investment advice or offers any opinion with respect to the suitability of any security, and any views expressed herein should not be taken as advice to buy, sell, or hold any security or as an endorsement of any security or company. This disclaimer was adapted from Quantopian's own disclaimer.
