Tag Archives: etfs

Identifying Alpha With The Capital Asset Pricing Model: An Example In Dr Pepper Snapple

The Capital Asset Pricing Model (CAPM) is a tool that can be used to identify whether a stock can potentially generate alpha based on its risk-return characteristics relative to the market index. For instance, suppose that we have a stock that returns 5 percent annually where the market index returns 7 percent. Given a high risk in terms of beta (discussed further below), the CAPM would argue that this stock is a non-alpha stock; since the return generated does not compensate an investor for the given risk. On the other hand, suppose that the stock now returns 10 percent while the market index returns 7 percent. Additionally, the stock has very low risk meaning that the risk of a lower return is, well, very low. This type of stock is said to generate alpha returns – it compensates an investor above and beyond that which they should be entitled given the risk and return on the market index. Parameters Average Daily Return vs. Expected Return: The average daily return shows the actual percentage daily return of each company over the given time period; this is the benchmark that we use against the expected return (the return that the CAPM says we should receive for holding the stock) to determine if a stock is undervalued or overvalued. The expected return is defined as the risk-free rate plus the product of the company’s beta and the average daily market return, i.e. Risk-free rate + ß(Average Daily Market Return) = Expected Return. If the stock lies above the Security Market Line, it is undervalued. If it lies below, it is overvalued. Beta: This figure tells us how volatile a company’s price is relative to its market index. In this case, a company with a beta of less than 1 is less volatile than the S&P 500 Index; a company with a beta of greater than 1 is more volatile than the S&P 500 Index. R-Squared: The R-Squared figure indicates the degree of the company’s returns that can be explained by the market return, e.g. a company with an R-Squared of 100% means that 100% of the company’s returns are “explained” by the market. Conversely, a company with an R-Squared of 0% means that none of the company’s returns can be explained by the market return. Jensen’s Alpha: Jensen’s alpha indicates the excess return generated by a stock over its expected return according to the CAPM. If a company has an average daily return greater than the expected return, then the excess return is defined as Jensen’s alpha. An Example of Dr Pepper Snapple Group ( DPS ) Companies Coca-Cola PepsiCo Dr Pepper Market Daily Return -0.04% -0.04% -0.04% Company Daily Return -0.04% -0.02% 0.06% Beta 0.64 0.75 0.74 R-Squared 45.39% 56.29% 39.66% Intercept -0.00018 0.00006 0.00082 Expected Return 0.02% 0.01% 0.01% Jensen’s Alpha -0.06% -0.03% 0.04% Valuation Non-Alpha Non-Alpha Alpha With data run over a one-year period (November 2014 to November 2015), we see that of the three companies, only Dr. Pepper shows alpha returns of 0.04%. This means that the average daily return of the company is 0.04% higher than what is required to compensate the investor for the risk of holding the stock. Moreover, we see that the company has the lowest R-Squared of the three companies, which means that only 39.66% of the company’s returns are attributable to the returns on the market index; the rest are unrelated to the market. Additionally, with a beta below 1, Dr. Pepper could be considered an ideal low-risk alpha stock on the basis of its past returns. Conclusion An obvious limitation of the Capital Asset Pricing Model is that it is backward looking and cannot predict the future. Nevertheless, it is extremely useful in the sense that it allows us to analyse other fundamental factors taking past returns into account. While past returns cannot predict future returns, understanding a stock’s return characteristics allows for a very handy guide in making investment decisions. Original source .

Inverse Equity ETFs To Tackle The Slump

The whole of 2015 suffered losses on the market, and the final day of the year was no exception. While the broader market indices like the S&P 500 and Dow Jones Industrial Average were down 0.7% and 2.3%, respectively, in 2015, the closing bell of December 31 also failed to ring in cheer, as both indices lost more or less 1%. A hangover could be felt at the onset of the new year, and if morning shows the day, then 2016 has chances of seeing a weak start. Like 2015, an edgy global market backdrop, acute oil sector worries, the commodity market rout, a soaring greenback and weakening corporate earnings, geopolitical threats related to terror attacks and the influence of the all-important Fed will be replayed in 2016 as well. We are now gearing up for the Q4 2015 earnings season, with the S&P 500 earnings projected to decline 7.3% on 3.3% lower revenues. Barring the finance sector, the numbers are projected to reflect a 10.3% decline in earnings on a 3.1% fall in revenues, as per the Zacks Earnings Trends report issued on December 29, 2015. Per the report, earnings growth lacked luster, as depicted by the negative growth rate for the S&P 500 index in each of the last two earnings seasons. The scenario is expected to remain equally dull, as the present Q4 growth expectations are “the weakest of any other recent period at the comparable stage.” Needless to say, dull earnings will have adverse effects on the bourses. Probably sensing this turbulence in the market, the long-term U.S. treasuries have been behaving in a dovish manner even after the Fed lift-off. Yields on long-term treasuries have hardly budged since then. While these safe-haven bets are always there to pacify investors’ jittery nerves, they can also make short-term plays on the equity markets with the inverse ETFs. For these investors, we highlight the three non-leveraged inverse ETFs that could deliver higher returns if the market remains bearish (see: all the Inverse Equity ETFs here ). As a caveat, investors should note that these products are suitable only for short-term traders, as these are rebalanced on a daily basis. Still, for ETF investors who are bearish on the equity market for the near term, either of the above products could be an interesting choice. ProShares Short S&P 500 ETF (NYSEARCA: SH ) This fund seeks to deliver inverse exposure to the daily performance of the S&P 500 index. It is the most popular and liquid ETF in the inverse equity space, with AUM of nearly $1.63 billion and average daily volume of around 4.8 million shares. The fund charges 90 bps in fees and expenses. Though the product lost 4.3% in 2015, it added about 1% on December 31, 2015. ProShares Short Russell2000 ETF (NYSEARCA: RWM ) This ETF targets the small cap segment of the broad U.S. equity market from a bearish perspective. This is done by tracking the inverse performance of the Russell 2000 index. The fund has amassed $381.1 million and trades in heavy volume of 600,000 shares per day. The expense ratio comes in at 0.95%. RWM was up 0.1% in the last one year, but gained 1.3% on December 31, 2015. ProShares Short Dow 30 ETF (NYSEARCA: DOG ) This product seeks to deliver inverse exposure to the daily performance of the Dow Jones Industrial Average, which includes 30 blue chip companies. The fund has managed $324.2 million in its asset base, while it charges 95 bps in fees and expenses. Volume is moderate, as it exchanges less than 850,000 shares per day, on average. DOG gained more than 1% in on December 31, 2015, but shed about 3% in the last one year. Original Post

Every Single VIX ETP (Long And Short) Lost Money In 2015

Just one month ago, in The Current VIX ETP Landscape , I plotted all twenty-four VIX exchange-traded products with respect to leverage and maturity, using leverage on the Y-axis and maturity on the X-axis. I also included a half dozen VIX strategy ETPs that have no easily discernable point on the leverage-maturity grid. Depending on how finely you wish to split hairs, these twenty-four ETPs cover approximately seventeen unique ways to trade volatility long and short, across various maturities and according to a wide variety of strategic approaches. The big story is that in 2015, not one of those VIX ETPs was profitable. In fact, the mean VIX ETP lost over 21% for the year. This means that in those instances where there are long and inverse pairs – notably the iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA: VXX ) and the V elocityShares Daily Inverse VIX Short-Term ETN (NASDAQ: XIV ) as well as the iPath S&P 500 VIX Mid-Term Futures ETN (NYSEARCA: VXZ ) and the VelocityShares Daily Inverse VIX Medium-Term ETN (NASDAQ: ZIV ) – both the long and short version of the same volatility trading idea lost money. This all happened in a year in which the VIX fell a mere 5.2% from the beginning to the end of the year. While contango was a factor during the course of the year, contango affecting the front month and second month VIX futures averaged a relatively mild 4.3% per month during the year, while contango between the fourth month and seventh month was slightly above average at 1.6% per month. The biggest culprit affecting the declines were the huge moves in volatility, with three one-day VIX spikes of greater than 30% occurring in the space of two months. The large volatility spikes had a considerable impact on end-of-day rebalancing, leading to volatility compounding price decay. One last technical note, with respect to the AccuShares Spot CBOE VIX Up Shares ETF (NASDAQ: VXUP ) and the AccuShares Spot CBOE VIX Down Class Shares ETF (NASDAQ: VXDN ) products, I have yet to see AccuShares or anyone else attempt to calculate the performance of these products for 2015. Given the chaos created by regular, special and corrective distributions, in addition to reverse splits and stock dividends, calculating performance for these two ETPs is not a project I have the inclination to tackle right now. That being said, until I see the calculations, I cannot be 100% sure that VXUP had a losing year in 2015. Consequently, in the event that VXUP did post a gain, this would be a good time for AccuShares to post some performance data and claim at least one public relations victory in this space. To the broader audience, if you happen to be sitting on an idea for a VIX or volatility-based ETP that would have been a winner in 2015, this is an interesting time to consider moving forward with that idea. Looking ahead, I will have a lot more to say about VIX ETP strategies, VIX ETP performance and related subject going forward. [source(s): VIX and More]