bonds, Index Investing, Low-Cost Funds, options

Proprietary Trading Group

It’s official.  Balhiser LLC now contains a proprietary trading group which manages a private fund.   The fund, dubbed Sigma 1 (Σ1), seeks to be a covered-call balanced fund for the benefit of Balhiser LLC shareholders.  Balhiser LLC’s initial investment in the fund is a modest $25,000.  Like the CIA (Crazy Ivan Account) Σ1 is, in part, a test vehicle for trading and investing strategies.  Unlike the CIA, Σ1 is a Balhiser-LLC-owned tool to put my theoretical fund management skills to the test.

As fund manager, I plan to apply more rigor than necessary for an LLC  proprietary trading group.  I plan to draft unaudited quarterly reports.  I have crafted an outline of fund rules and guidelines.

With direct access to markets and exchanges, very low trading costs, and access to futures, options, forex, margin, algorithmic trading, etc.,  Σ1 should allow testing of  trading strategies that were simply not practical before.

Despite the myriad choices available, Σ1’s initial ground rules and objectives will be pretty pedestrian.   Here a some of them for the record:

Conceptual target allocation: 40% bond, 60% stock.

Bond Portion Parameters:

  • Duration 0-7 years.
  • Max. Foreign Exposure:  50%
  • Max. Corporate Exposure: 50%
  • Munis: 50% max
  • Mortgage-backed : 50% max
  • Treasuries/TIPs/Govt:  25% min
  • Bond ETFs:   Yes

Stock Portion Parameters:

  • Foreign: 40% max
  • Any single stock: 20% max
  • Total single stocks: 50% max
  • Diversified (largely index) ETFs: 50% min

Other parameters:

  • Max Overall Stock Exposure: 80%
  • Max Overall Bond Exposure: 60%


  • Never to exceed:
    • 60% of  NPV of holdings
    • 100% of NPV of bond holdings

Stock Options:

  • Covered calls: Yes
  • (Cash/Bond)-Covered puts: Yes
  • Uncovered puts/calls:   only allowed intra-day while closing covered positions.
  • Buying puts/calls:  Yes, not to exceed 5% of NPV of holdings.
  • Paired options (e.g. butterfly):  Yes, VAR not to exceed 5% NPV.

Futures:  TBD

Other Options:

  • interest-rate: TBD  (likely only as bond hedge)
  • currency options: TBD (likely only as foreign-bond hedge)

Stock (ETF) Futures:  TBD


  • Futures:  No
  • Precious metals (ETFs):  Yes,  10% max
    • Covered calls:  Yes
    • Buy puts:  Yes, as hedge
    • Buy calls:  Yes, 2% NPV max.
  • Non-metal:  No

“Uncovered” (value at risk)  Derivative Exposure:

  • Total 5% NPV max (on any trading day).

“Uncovered” Derivative Loss Limits:

  • Not to exceed 10%  in 4 rolling consecutive quarters.  (10% of 4-quarter average starting NPV).
  • How enforced:  If previous 3 (or 2 or 1 or present) quarter(s) uncovered net derivative loss (NDL) is in excess of 5%, max uncovered-derivative VAR cap is lowered to 10%-NDL.


  • TBD, likely only allowed as a hedging technique.

Futures Options:  TBD

That is a brief outline of Σ1.  I will be providing updates as it moves forward.

Disclaimer:  Σ1 is a private proprietary trading account and is not available to the public.   Balhiser LLC is a privately-held company.

funds, money

Exchange-Traded Funds (ETFs)

There are two very different types of funds that are traded on the stock exchange(s).  The dominant form is the open-ended exchange-traded fund, commonly called an ETF.  The smaller cousin of the ETF is the closed-end fund commonly called the CEF.

According to a recent Forbe’s article ETFs currently contain $725 billion in assets and could top $1 trillion in the next two years.  According to this site CEF assets totaled $335 billion in 2007.

Closed-End Funds

The weakness of the CEF is that its assets are bound up in a closed financial package.  In a way a CEF is a bit like a financial black hole — the investments inside are not reachable by the rest of the financial universe outside the event horizon.  The only way that the money is accessed is indirectly through the current price of the CEF and through cash distributions.   To take the analogy further a CEF is a bit like a “white hole” in that the internal assets can slowly radiate out in the form of cash distributions.

Because there is no effective mechanism to keep CEF price in line with NAV (net asset value) they hold they frequently trade at a premium or discount to their NAV.  This yahoo finance chart shows the ever-changing relationship between price (red) and NAV (blue) for S&P 500 covered call CEF.

The price versus NAV tracking-error in CEF pricing is a big con to CEF investments.    It does also present a couple opportunities.  1) Buying CEFs at a steep discount to their NAV is sometimes possible and 2) shorting CEFs that are at a steep premium is another opportunity.  Generally, however, I don’t advice speculating or investing in CEFs, largely because of the superior alternate — the ETF, or exchange-traded fund.

Exchange-Traded Funds (ETF)

The ETF is a really great financial innovation.  ETFs excel over CEFs because they build in a financial arbitrage mechanism that minimizes price/NAV tracking error.   The underlying components (stocks, bonds, money, etc) can be be redeemed directly from the ETF issuer in large blocks of ETF shares called creation units.  Typically 50,000 shares of an ETF equals a single creation unit.  If the NAV is greater than the price of the ETF a large investor can buy a creation unit worth of shares and resell the constituent investment pieces for a profit.  This arbitrage mechanism helps to keep ETF prices in very close correlation with the underlying NAV.

The beauty of ETFs is that they incorporate many of the best attributes of stocks, closed-end funds, and mutual funds into an efficient financial package.  ETFs, like CEFs, trade like stocks.  Because they do, they can be bought and sold in virtually any brokerage account just like any other stock.  Additionally, ETFs can do essentially anything a mutual fund can do — provide diversification, passive or active management strategies, invest in foreign or domestic securities, etc.

Often a mutual fund company will offer a particular fund it two different packages– a typical mutual fund or as an ETF.  For example Vanguard offers the Vanguard Total Stock Market fund as a mutual fund under the symbol VTSMX and as an ETF under the ticker VTI.

I have just scratched the surface of the CEF and ETF investment world with this blog article.  Suffice it to say I am a proponent of ETF investing.  Understanding the disadvantages of CEFs helps illustrate the advantages of ETFs.  In fact, I believe ETFs are one the of greatest financial innovations since the index mutual fund.  One passing word of caution.  Please be carefully not to confuse ETFs with the similar-sounding ETN (exchange-traded note).  ETFs are backed by the underlying securities they contain, whereas ETNs are simply senior debt notes that are only as secure the issuer who sells them.  For this reason, I prefer the real McCoy, the EFT.

funds, Investing, money

Investor’s Thanksgiving Thanks

As we reflect on Thanksgiving, here are some personal finance things I am thankful for:

  • Decimal stock pricing. Remember all those pesky fractions?  Decimal pricing is so much easier.  And the spreads are much better too.
  • Online stock trading. I don’t know about you, but I don’t want to talk to a broker.  I want fast quotes and cheap trades without the conversation.
  • Free online financial data. Thank you all you online publishers of stock data.  It’s 2:00 AM and I just have to know the market premium on the BEP closed-end fund — No problem.
  • Index funds. Thanks John Bogle and others for these diversified, tax-efficient, cost-efficient funds.
  • Good financial planning. Thanks, Dad, and others along the way who taught me money management, investing, and financial planning.
  • 401K, IRA, and Roth IRA accounts. These tax advantaged accounts were spectacular ideas, and they work.
  • Good accountants. Thanks for helping me make some sense of the US tax code.
  • Buying opportunities. Every now and again a great investment comes along and a great price.  Doubling my money on PCU comes to mind.  Such opportunities are what make investing fun for me and keep me searching for the next great buy.
  • Dividends. Even when stocks are down, many still pay dividends. A lot of stocks are currently repaying 3% dividend yields. These quarterly dribbles of cash do feel good to receive.

For investors, there is a lot to be thankful for.  Yes, our equity investments are generally down, and our economy is lethargic. Equities have been a wild ride to nowhere in the last decade.  But bonds and, yes, in many places even real estate have fared much better.  And as long-term investor I am excited about the prospects finding buying opportunities.  I wouldn’t say equities are cheap, but I am thankful that they are not all that expensive either.  I am looking forward to the next 10, 20, 30+ years of investing.

funds, Investing, money

Hot Days, Cold Stocks… Cool Logic?

My retirements accounts are down 12.3% and 10.1% YTD (as of 7/11).  The market is down again today so these number are likely to be a shade worse when the YTD return on the website updates later today.

At the same time the weather has been hot.  In the 90’s and flirting with 100 degrees.

Today the S&P closed at 1228. Not much different from where it was 10 years ago at 1177. At less than half a percent appreciation per year plus about 1.5% yield that’s a whooping 2% per year return for a 10-yr investment window.  Taking a look at the chart is unlikely dollar-cost-averaging would have significantly altered the return up or down over that period [hmm… sounds like an analysis for a future blog].

Not exactly a PSA for the merits of stock investing.

So, how’s my personal investment strategy going to change?  Not much.  My “fun” money account has been doing better because I’ve been selling SPY calls high and re-buying to cover low.  This has been a helpful hedge so far and something I may wish to write about further.  My “core” money allocation is unlikely to change… a mix of large/small/international low-cost index funds, some bond funds, and some cash.

Cool logic reflecting on history suggests that over any 20 year period stocks beat bonds… and likely commodities, cash, real-estate, etc.  Perhaps the S&P500 values 1177 and 1228 are some worthwhile data points to start my blog with and to test against over the next ten years.  Maybe these numbers will be part of an unprecedented counter example.  Time will tell — but for now I’m putting much of my money on the bet that stocks will outperform in the end.