Exploit U.S. Stock Market Dips with Margin?
December 22, 2022 - Equity Premium, Strategic Allocation, Volatility Effects
A subscriber requested evaluation of a strategy that seeks to exploit U.S stock market reversion after dips by temporarily applying margin. Specifically, the strategy:
- At all times holds the U.S. stock market.
- When the stock market closes down more than 7% from its high over the past year, augments stock market holdings by applying 50% margin.
- Closes each margin position after two months.
To investigate, we assume:
- The S&P 500 Index represents the U.S. stock market for calculating drawdown over the past year (252 trading days).
- SPDR S&P 500 (SPY) represents the market from a portfolio perspective.
- We start a margin augmentation at the same daily close as the drawdown signal by slightly anticipating the drawdown at the close.
- 50% margin is set at the opening of each augmentation and there is no rebalancing to maintain 50% margin during the two months (42 trading days) it is open.
- If S&P 500 Index drawdown over the past year is still greater than 7% after ending a margin augmentation, we start a new margin augmentation at the next close.
- Baseline margin interest is U.S. Treasury bill (T-bill) yield plus 1%, debited daily.
- Baseline one-way trading frictions for starting and ending margin augmentations are 0.1% of margin account value.
- There are no tax implications of trading.
We use buying and holding SPY without margin augmentation as a benchmark. Using daily levels of the S&P 500 Index, daily dividend-adjusted SPY prices and daily T-bill yields from the end of January 1993 (limited by SPY) through November 2022, we find that: Keep Reading