Investing Ideas...

As I promised earlier, I am going to delve into some details of how we invested in different strategies. Just for a recap, the three strategies that I mentioned in my first blog were:-

1. Creating an efficient portfolio out of ETFs.

2. Trading in mis-priced Options

3. Daily trading based on specialized strategy

The hypothetical situation is this: You are a portfolio manager. You have just received $10 million from your clients, who wants you to maximize risk-adjusted return, has an investment time horizon of two months and is investing same amount with ten other portfolio managers. He will increase his allocation to your fund to a $1 billion if you perform better than everybody else.

When we started thinking about this project, the first thing that came to my mind was to look for arbitrage trades. Arbitrage trades are those that generate a positive return without taking any risk. For example, if I can buy some securities from A and sell those to B at the same time and at a higher price, then I earn a return without taking any risk. The reason that I went for such trades was the whole idea of Sharpe Ratio maximization.