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Author: Dwdonhoff Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75335  
Subject: Re: Distributions of S&P500 returns Date: 4/1/2013 12:04 PM
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Well, since there is at least 3 of us foraging of into the weeds, let me take the risk of focusing a spotlight on what might already be obvious;

The table merely answers the question, "So, how often did the historical returns fall into these various buckets, anyway? Just how many times were capped off?"

'How often' is irrelevant from a P&L perspective. The old trader's mantra applies; A system works when the average of all winning trades is greater than the average of all losers, minus the ability to survive the worst statistical drawdown.

In my prior 'Traders A/B' example, trader B lost on 100% of the rallies, yet still blew away trader A. Of course, a mere 2-trade market history is hardly sufficient to illustrate anything near reality... but as we proceed with our comparison illustrations, the clouds will begin to clear and I predict you'll see that this is the functional result in the overwhelming majority of market periods.

The IUL industry has coined the phrase "Zero is your Hero" (and I am sure that rankles some of the political hardcores... LOL!) but from a strategic trading perspective, it really does pan out.

Of course, you are absolutely right in that blocking or repositioning risk comes at costs... and in order to 'buy' the elimination of annual downside risks you have to give up some measure of upside risks.

The trader's/investor's question then, again, boils down to;
'At what trade structure will my cost (average trade losses) be less than my average gains?'

A 12% S&P hurdle (as I pointed out previously) is somewhat daunting... but more complex index blends (which take advantage of lower option spreading costs) push that "average gains" hurdle (via higher caps) to 17%-21%

At that level the trade is simply a no brainer... at least for the trade structure, on its mathematical face. Of course, then all the other factors have to be double checked (short term versus long term costs, liquidity, systemic risk exposures, etc.)

Dave Donhoff
Leverage Planner
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