Diversified portfolio on 2 times leverage

Discussion in 'Trading' started by Tomaz26, May 19, 2008.

  1. Tomaz26



    I am thinking about constructing a diversified porftolio with 2x leverage. I would put 70 % of my capital in this portfolio and leave 30 % for option, cfd,.. short term swing trading.

    Is it a good idea to use leverage on investment portfolio if it is well diversified?
    It would consist of USA indices, EU indices(STOXX 600),, EM indices, REITS and commodities. I dont think large drawdowns can happen in that type of portfolio, so I guess 2x leverage would be
    OK to boost the return, would you agree?
    If not, why not? Should I add bonds or 20 % cash position to lower the volatility?
    I also plan to add some OTM put option for protection if one large drawdown would occur.

    Please give me any comments.

    thanks for help


  2. 1) Regarding the concept of "diversification", you should have long-positions AND short-positions, not long positions only.

    2) You have to take into account that we seem to be in a liquidity-driven environment right now, i.e. everything is moving up and down together in phase. You can experience big drawdowns if you only have leverged long-positions on your account statement.

    3) Regarding the use of out-of-the-money puts for protection, wait until August, September and October for that.
  3. Tomaz26


    Thanks for reply. Can you please explain part 3? Why should I wait until august for OTM put options? you think prices will be lower because of low IV?

    Regarding long/short positions, I was thinking about that also. I just dont know what to choose to go short. Maybe some sectors? I think banks and housing sectors wont fall any more,.

    I agree, there is a high correlation between those things, especialy EU, USA and EM. So how does one make a diversified portfolio? Any ideas would be welcome.


  4. The problem is that in times of wide-spread market stress (fall 1998, fall 2002, spring 2004, summer 2006, spring 2008 etc.) correlations tend to break down as market players head for the exits or receive margin calls. A panic in stocks usually has repercussions on other markets (bonds/commodities/currencies) and vice versa.

    You have to make sure you don't get blown out of the market in those situations thanks to leverage.

    I suggest you backtest your strategies with a 'bucket' strategy. You have one (or more) stock strategies, a currency strategy, a commodity strategy etc.

    Allocate capital and leverage to them in your simulation and see what what have happened historically. Rebalance the buckets once a quarter or once a year.

    I perform all such simulations in Excel.

    While this is no guarantee to survive future market turmoil while leveraged at least this exercise can you a little confidence.
  5. 1) Regarding Part-3, those months tend to be the most bearish.

    2) Instead of diversifying, give more thought to concentrating the portfolio. Diversification tends to lead to mediocre returns and unnecessary stress.

    3) You could consider using sector-related ETF's for diversification. You can buy strong ones and short-sell the weaker ones. You can avoid unnecessary "overlap" that general-market funds would have with other types of general market funds.