Investments for the Modern Financial Markets

Dedicated to Holly for inspiring me to do something other than the mundane

The 2013 Carry Trade

The Global Financial marketplace is $212 trillion dollars which can also be written as
$212,000,000,000,000. We are now close to trading at the speed of light, Computers and computer
science has taken over. Automated trading programs leave little work for an individual investor and
investment banks. Arbitrage seemed to be a thing of the past and it was felt that the individual did not
have the means necessary to trade at the levels of institutions. The institutions make the markets and
they set the prices. And with technology more advanced as it has ever been, the prices in china are in
synch with the prices in the United States, roughly speaking. We really cant buy MSFT in Europe and
sell it in the US simultaneously and make a profit, and if we could the price difference would be
fractions of pennies. And yes pennies add up to a lot when we speak of billions of dollars in trades,
but how could a small guy or even a small financial institution, profit greatly from pennies? Well
thankfully I have developed a strategy where we are not talking about pennies but we are talking
about dollars. I am confident that you will find my research very easy to use and very applicable. I
have been searching for pricing discrepancies in the highly evolved and highly intelligent markets,
and trying to find a way to exploit them. After years of failed ideas, I believe I have found the system
of arbitrage that can provide vast wealth to any individual that applies it.
Skepticism is certainly warranted, with the information highway and technology at the best
its ever been, anyone can search for the desired information at little or no cost. Perhaps we believe
that ingenuity within the financial markets is gone. Perhaps we feel that there are no get rich quick
schemes, and rightly so. But genius presents itself through many channels. It would take someone
quite a long time to contemplate how one could take advantage of the global market place. For me it
has been a total of 13 years, I learned about the market during the tech bubble, when computers
became accessible to the average Joe. I studied the marketplace, I read the books. And I think I
understood the mechanics of the markets better than most. But understanding doesnt bring the wealth
and power that the 1% of Americans enjoys. Neither does knowledge. It is where knowledge and
understanding meet, that we gain wisdom. And that is what I have accomplished. Luckily for you I
dont have a penny in my pocket, if I had the investment capital needed, which is a small sum to get
started as we shall see, I have nothing. So I have no choice but to sell my ideas contained here. I am
not intimidated that this will change the availability of these ideas to anyone. It may perhaps change
the market discrepancies if used by the wrong party. I acknowledge that it will be fixed, as market
evolution is constant. But I believe this is a leak which is available to all of us right now. And it will
enable us to get paid by the 1% taking from them what is rightfully ours. This can become a

movement like no others, and in my opinion can become the collapse of the markets as we know it,
and in addition we can break the wealth barrier and overcome the obstacles that stand in front of us.
I would prefer to not get into the definitions and the how to of the investment vehicles that are
being used. It would be pointless really. If you dont know how to make a trade, how derivatives
work, margin, or even how to find quotes, the concepts may seem complex yet I assure you they are
not. Pick up any copy, of investing 101 and option trading 101, all of which is information that is
readily available and scattered all over the internet. Now, hopefully, you are an active investor
already, have a broker, and are familiar with the mechanics of trading, as well as have a bankroll.
This paper will help you immediately and you can begin immediately. Do not let the simplicity of the
trade make you turn and say nonsense. We have no reason to implore an extensive, exhaustive, and
complex trading system using multi legged option strategies, thank god we dont have to do that. One
of my earlier ideas dealt with a strategy that used something like a 12 option combination. Needless
to say, unless we were trading hundreds of contracts our system would be eaten alive by brokers
fees. And yes fees will be discussed later. Admittedly, I do not have the means to extensively back
test this idea. I will leave this task to someone more technologically advanced than myself. Yet I will
present the material in a manner that proves my point.

The Trade
The goal of this trade is to build a synthetic position that mimics each others performance.
This can be done a number of ways. For the purpose of this paper we are using 1x, 2x, and 3x ETFs
leveraging our positions accordingly and buy and selling options between the two.
So, we can take a 2x ETF and adjust it into a 3x ETF simply by buying (1.5)( 2x ETF).
What this means is that we want to hypothetically, build a completely neutral position. We have a 3x
bull fund and a 1x bull fund. If we sell 100 shares of the 3x bull fund and buy 300 shares of the 1x
fund we hypothetically, have a neutral position. At this point we can make a few arguments for why
this would or would not work. Dont worry about this at this point.
Our first concern is to make sure our investments are dollar weighted. That is to say if the
two investment vehicles are different dollar prices, we must be certain that an equal investment is
given for each. The reason for this is because, typically the price between two investments are
different. If we have an Investment (A), which requires an investment of 200 dollars, and we have
an investment ( B) at 100, then even if we carry a neutral position between the two, and one goes up

5% and one down 5% then we may have made 5% on 100 dollars yet lost 5% on 200, which yields
a loss. This is why it is important to adjust the position into a dollar weighted average. Dollar
weighted average as it applies to options. The dollar weighted theory is still applicable when
considering options.
The way we would set up a trade in consideration for dollar weighted adjustment would be
to find the dollar weighted multiplier. We do this as follows.

Assume:
FAS 95
XLF 15

Our first move would be to get our dollar weighted adjustments.

95/15=6.33
So if we have;
FAZ = 95
XLF = (15)(6.33) -> 95
So we would have to then multiply for the 3X Bull which means
(15)(6.33)(3)=285
What this says is that we would have to invest $285 to every 95 invested between the two funds.
Pause for consideration, the market moves 10%?
Market moves 10%
Then FAS 95*.3=28.5
And XLF 15*.1*6.33*3=28.5
So we can see that our dollar weighted adjustment is correct, and the two investments mirror each
other.

Our formula:
U=underlier
L=leveraged
ETF M=multiplier where M=number of dynamic i.e. 1x 2x 3x etf,
D=dollar weighted average multiplier also used to determine number of option contracts

which need to be purchased,

Uo=ATM option for underlie, Lo= ATM option for the leveraged ETF, and our So is the
synthetic option position, Sno is the synthetic price of our option.
So our set (T) includes THE ELEMENTS = {U, L, M, D, Uo, Lo, So, Sno}
Example:
We are searching for our next trade, we notice XLF is trading at 15.16 and FAS, Which is a 3x
leveraged option of XLF, is trading at 96.65. The XLF front month 15 calls are trading at .30, and
the FAS 96 front month call is trading at 4.60. First we identify our Elements:
U=XLF=15.16

L=FAS=96.65 M=3 Uo=.17 and Lo=3.95

Notice that our options are different because we subtracted the in the money value
So as of now we do not know what D is, and we dont even know if this is a tradable situation, what
we first need to look at is to see which vehicle is divisible by the other so we can find D. We
immediately notice that L is divisible by U and we find D
L/U=D [1] -> 96.65/15.16=6.37=D
From here we need to set up our synthetic option trade. Simply we know that Lo is static, this is
because the leveraged option has the higher cost underlier:
Lo=3.95
we look at Uo = .17
we build our So, which is simply (Uo)(M)(D)=Sp -> (.17)(3)(6.37)=3.25=Sno
So Sno should be 3.25, which represents the synthetic price of Lo in Uo to be dollar weighted and
neutral between the two positions. And for a 1 contract position we would have 3.95 bucks for Lo
and Uo would go for 3.25, we would want to sell Lo for 3.95 and buy Uo for 3.25 netting .70
dollars.

If we crunch some numbers, the underlier moves up by 10% then we have

U=XLF=16.68

L=FAS=106.31 M=3 Uo=1.68 and Lo=12.31

There after the loss would be as follows:

U= 16.68*.10=1.68-.17*6.37=9.61 on the Uo and make 12.31-3.95= 8.36 which results in a .99
gain.

Hypothetically the .70 premium we collect at the beginning of the trade are the profits we should be
locking in from start to finish. What can happen to the stocks, and how will our profits be affected by
what occurs? Of course there are different setups and the reader will have to contemplate the price
movements for different scenarios. In this example the trade involves two bullish positions. If the
overall market dumps in this scenario, both option positions will be out of the money and they would
expire worthless. We would net the difference in option prices and collect our full premium. Case
two, involves both vehicles ending ATM. Again, we will be happy! Finally, if both stocks tend
towards infinity, we should show a gain.
Lets look and see what happen if the underlier (U) rises by 30%
U=XLF=19.5

L=FAS=125.64 M=3 Uo=4.5 and Lo=29.64(4.5-.17)*6.37=27.58 on the Uo

and make 29.64-3.95= 25.69 which results in a 1.88 gain

Rate of Return
A precise rate of return will be left to the reader to find. I will give an estimate of the rate of return in
this scenario, options are usually held in a margin account so our margin requirement is as follows:
20% of the underlying stock price minus any out-of-the-money amount plus option
premium, OR 10% of the strike price plus option premium, whichever is greater.
Short option requirements for 3X Leveraged ETFs use 60% and 30%
Short option requirements for 2X Leveraged ETFs use 40% and 20%
Therefore for our given example,
We are selling the leveraged 3x ETF and our requirement is (.10) (96) + (4.60) =14.2, plus our
capital we put up for our purchased options which is .3(3 6.37 or 5.73 and 5.73+14.2)=19.93 in
initial capital So given our initial premium collected of .70 we can .70/19.93 which equals 3.5% or
an annualized return of 42% minus what they charge for margin borrowing which is nominal
compared to this return.