Description:

After reading Leverage For The Long Run by Gayed and Bilello, I was inspired to build my own systematic trading strategy using 200SMA as a buy/sell signal for SSO (2x daily leveraged S&P 500). I'm not reinventing the wheel here, the 200SMA cross is a well established trend following strategy, but I wanted to develop my own strategy and determine an effective implementation. I've opted to use long duration US Treasuries as the risk off asset instead of cash which I'll explain in more detail later. I also ran some sequence of return stress tests that I thought I'd share.

Strategy:

Use SPY's 5 day SMA crossing SPY's 200 day SMA as the buy/sell signal. When SPY's 5 day SMA is above SPY's 200 day SMA->Buy SS), when below->Sell SSO and buy EDV.

No intraday trading, only sell when signal is triggered at market close. Trade the next day at market open.

Use TradingView for signal notification (you'll need to pay $15/month).

Methodology:

As explained in Leverage For the Long Run, historically when the S&P 500 is under it's 200 day SMA, volatility is much higher. Avoiding being investing in the S&P 500 when it's under it's 200 day SMA has proven to lower volatility and improve Sharpe Ratios. Volatility is the death of LETFs so staying out of the market when under the 200SMA has historically been very beneficial to returns. Read the paper if you want more convincing.

The 5 day SMA is chosen over the raw price of S&P 500 because it slightly reduces whipsaw as it's a slower signal. It's not chosen for increased returns or CAGR, just for reducing # of trades. It's an average of a full week of trading which will weed out some larger daily bumps that may not be a true signal. One day, 2 day or even 10 day SMA all yield fairly similar results, but 5 day feels like a solid middle of the road choice. Other ways to manage this would be some kind of % threshold above or below 200SMA. Both work, I just prefer fast SMA cross slow SMA.

More generally, the S&P 500 is chosen for it's broader diversification. You could chose Nasdaq 100 (QQQ) and implement a similar strategy, but that is a sector/growth bet. Clearly QQQ has been the better asset for the past 20 odd years, however, I don't have the foresight to know that outperformance will continue. If you have the crystal ball, go for it. The 200 SMA should work almost as well for QQQ (just not as much research or backtest data for it).

As of the risk off asset, cash is the obvious choice, but I think there are large potential benefits to long duration US treasuries. They are extremely rate sensitive which can be a pro or con depending on the current macro environment. In a deflationary crash like 2000s and 2008, they would have performed exceptionally well. In a inflationary crash like 1976 and 2022 they would have been crushed. Inflationary crashes occur far less often than deflationary crashes, so I'm inclined to take the additional risk for more return and stick with EDV. People will say we are entering a higher inflation environment which may be true, but higher inflation isn't what crushes long duration US Treasuries, it's fast and unexpected rate increases; not prolonged above average inflation. I won't even go down the rabbit hole that the US debt bubble will burst so US treasuries are a terrible investment, if the US treasury market implodes so does our entire financial system. The difference in CAGR between cash and EDV is significant (EDV adds almost 1.9% CAGR), but I do recognize that bonds have been on a 40 year bull market, at least until 2022.

Security Selection

ProShares's SSO is seeks daily investment results, before fees and expenses, that correspond to two times (2x) the daily performance of the S&P 500. Has ~$7.3B in AUM and has ~5M average trading vol (3M). SPUU is another option with a lower ER, but has much less AUM and less volume. In an exit scenario during market turbulence, the extra liquidity and tighter spreads is worth it.

Vanguard's EDV Seeks to track the performance of the Bloomberg U.S. Treasury STRIPS 20–30 Year Equal Par Bond Index. Avg duration of 24 years, lots of volume and AUM. Alternative would be ZROZ, but EDV has lower ER and more AUM/liquidity.

Backtests:

Testfol.io allowed backtests to go back to 1962 (about 64 years) due to limitations of data on EDV (used ZROZSIM with adjusted ER). While US data goes much farther back than 64 years, it's a fairly large amount of market history.

Historical backtest SSO/EDV LRS ($10k starting value)

• $52.4M ending value vs SPY's $6.2M — 8.5x the terminal wealth.
• 14.24% CAGR after costs, vs 10.51% for SPY.
• -58.93% max drawdown, -15.36% average, 6.04y longest.
• 27.70% volatility — roughly 1.7x SPY.
• Sharpe 0.46 / Sortino 0.65 / Calmar 0.24
• Ulcer Index 19.19 / UPI 0.67
• 75% SSO / 25% EDV ~1.5 switches per leg per year.

Not the craziest CAGR compared to a TQQQ or SOXL strat, but 14.24% CAGR with only 58% drawdown over 64 years is pretty damn good. You end up holding SSO ~75% of the time, so this strat is almost a buy and hold, just avoiding the times of extreme stress. Volatility is of course higher than the non-leveraged SPY.

Now backtesting has one large issue: overfitting. To try and test for this, I've run 25 scenarios with shuffled return blocks. I used BL=120 (6 months) as the minimum block size, and BH=250 (1 year) as the maximum block size. The software then shuffles these blocks of actual return data around which creates an entirely new return path. This isn't a perfect science, but it does show how the strategy performs with different sequences of return.

Here is the summary: ($10k starting value)

• Median CAGR of 13.76%, ranging from 9.79% to 17.51%
• Median ending value ~$36M, ranging from $3.8M to $284M
• Outperformed SPY on CAGR in every single scenario
• Max drawdown ranged from -56.91% to -89.02%
• Sharpe ranged from 0.32 to 0.56
• Worst-case drawdown meaningfully deeper than SPY's worst of -66.53%

This shows that over the strategy robustly outperforms standard buy and hold SPY. It is however still path dependent, with large drawdowns being the main risk. The median CAGR of 13.76% is likely the best indicator of the strategy will perform in the future.

Conclusion:

This is a strategy with high volatility and potential risk but it also has a decent chance of outperforming buy and hold S&P 500 in terminal wealth. This will not outperform on a risk adjusted basis, and the drawdowns will be high. Size this position appropriately, maybe 10-30% of your portfolio. Potentially more if you're young.

Lastly, you need to be dispassionate and follow the signal to a tee. It doesn't matter whats going on in the news or the world; when the signal says buy, you buy, if it says sell, you sell. Once of the largest risks of this strat not working is if you fail it. It takes a certain kind of temperament to execute it. Be honest with yourself about what kind of drawdowns you can handle. It's easy to feel like you can take on all the risk/leverage in the world during a bull market like this one, just be prepared for when it does pull back.

Other Considerations/Thoughts

• Due to the large amount of trades, implementing this strategy in a tax deferred account is preferred.
• If folks are interested, I can share some Claude charts of the Testfol.io shuffle data I pulled. I even ran them for UPRO/EDV too.

This is for educational/entertainment purposes only.