How will I trade your $100000?

"They say a good chess player can see up to twenty moves deep. That means that in some games, you've calculated every possible move in your head. The game's over before it's even really started”.               –Confidence.

   Let us see if we can come up something close to the above statement, in our field, trading stocks. 

A trading strategy, which can factor every possible scenario! Give us an upper hand to outperform the market.

  One doesn’t need to be a genius to realize the possible outcomes after you buy a stock; stock goes up, stock goes down or remains flat at the same price, depending on your time horizon.  So all we need to do is capture the upside and not loose on the down side. This can be done easily by simply buying puts. But protection is not cheap. If we spend 10% of the underlying position to buy puts, that will protect us for a year and our position does not move more than 10% in that time frame, we have lost money.

If I know, my stock is not going to bankrupt, all I would need is limited protection. If the stock is trading at $100, instead of protection for $100, all I might need is downside protection for first $20 or $30. Only way, I can be confident that my position will not decimate completely is to get into indexes.  What are the chances of SPY or IWM going to zero?

  My ideal portfolio should always maintain cash. If we are fully invested or borrowed on margin, we panic when the market crashes. On the other hand, we will see it as an opportunity to increase our position or open new positions at sale price, if we have cash. At the same time, if the market is on rise, we will underperform the market because we are not fully invested. This can be offset by using options.

  If I am, a portfolio manager or running an insurance company, this is how I would invest your one hundred thousand dollars:

 Inception date: Dec 25, 2011

Symbol	Description	Quantity	Price	Value
IWM	iShares Russell 2000 Index	400	$74.55	$29,820
-iwm130119c75	IWM Jan2013 75 call	5	$8.91	$4,455
-iwm130119c90	IWM Jan2013 90 call	-9	$2.89	-$2,601
-iwm130119p75	IWM Jan2013 75 put	6	$10.81	$6,486
-iwm130119p60	IWM Jan2013 60 put	-10	$5.13	-$5,013
EWZ	iShares MSCI Brazil index	500	$58.33	$29,165
-ewz130119c58	EWZ Jan2013 58 call	6	$7.75	$4,650
-ewz130119c70	EWZ Jan2013 70 call	-11	$3.00	-$3,300
-ewz130119c58	EWZ Jan2013 58 put	8	$8.70	$6,960
-ewz130119c45	EWZ Jan2013 45 put	-13	$3.90	-$5,070
Total				$65,552
Cash Remaining				$34,448
Total portfolio				$100,000

    Now that I have shown the portfolio, let us run few scenarios.

 Market is down: Let us assume both IWM and EWZ are down 15%. IWM would be trading at 

$63.37 and EWZ would be trading at $49.58. IWM position will be worth $25,348 and our 6 puts will be worth $6,708. EWZ position will be worth $24,790 and our 8 puts will be worth   $7,000. Portfolio value will be $98,294 plus the dividends earned. I would be extremely happy at this situation and also increase positions with cash on hand.

 Market is up: Let us assume both IWM and EWZ are up 15%. IWM would be trading at   $85.73 and EWZ would be trading at $67.08. IWM position will be worth $34,292 and our 5 options will be worth $5,590. EWZ position will be   worth $33,540 and our 6 options will be worth $5,250. Portfolio value will be $113,120 plus the dividends earned.

 Market is flat: If both positions are flat, we have to close all options and puts two months before expiration to break even. This was the specific reason, we paired Russell index with Brazil index. 

There was no year, in which both Russell and Brazil index ended in flat line. If the global economy does not end up in recession next year, I would bet two cows and three goats that Brazil index would outperform over the next year.

 Market crashes: If both positions crash 30% our portfolio will be down around 8% and we will be doubling our core positions, waiting for markets to rebound. It will hurt that we are down, but will have the pleasure that our neighbors lost more than us.

   I will be tweaking this portfolio once or twice a year and review the portfolio every Dec 25^th for next four years. You can see how you would have done, if I was your portfolio manager for five years.

   Feel free to leave comments and poke holes in my strategy, to outperform the markets.

  Disclaimer: This article should not be treated as individual advice. Consult your financial adviser to review your risk tolerance and strategy that suits you.

 Source: Yahoo Finance

Disclosure: I have short and long puts in EWZ and do not plan on initiating position in IWM in next 72 hours.