CMG Case Study – Nov 2012

Summary

An Equity Long/Short Portfolio Manager was bearish on Chipotle and had a pre-existing short-stock position. He was considering alternatives to hedge his risk and lever up before an earnings announcement with an options overlay. He used Tradelegs Derivatives Strategist™ to identify an Optimized Strategy that would have reduced his worst-case risk by 50% and outperformed his short position by 214% on a marked-to-market basis through the lifetime of the trade.

Note that the strategy generated using Tradelegs was not executed, but was backtested on the same basis as the original reference strategy.

Background

• CMG – Chipotle Restaurant Group
• Trade Date: Sep 28^th 2012 / Target Date: Nov 17^th 2012
• Chipotle plans to release earnings in October. Most of the street has faith in the company as a whole, but some analysts think the short-term announcement could indicate slowing growth
• The PM expects a big short-term dip for Chipotle, but believes it will rebound shortly after
• Tradelegs identifies an options strategy that, when overlaid on his short position, maximizes expected profit and halves potential loss

PM Prediction and Constraints

Case Study Results

Expected Returns on Trade Date (September 2012)

• The PM wants to halve his risk, so lowers his potential worst-case loss by $5mm
• Despite this lower worst-case risk, the Tradelegs Optimized Strategy is expected to outperform the Reference position by an average of 53%
• The Proposed Strategy is still expected to outperform by an average of 23% even if volatility moves substantially against the trade

P&L Payout Curve

Optimized Strategy Maximizes average expected profit Accelerates the upside Caps the risk
Reference Strategy Lower expected average P&L with much higher capital at risk The worst-case loss is unlimited beyond the max of the Risk Range

Case Study Conclusions Actual Backtest Results (November 2012) The positions were marked-to-market each day until the Target Date, when the Tradelegs Optimized Strategy outperformed the PM’s Reference Strategy by 215% The Best Day for the Optimized Strategy outperformed the Reference Strategy by 254% Throughout the lifetime of the trade the Tradelegs Strategy outperformed the PM Reference Trade on 33 of the 35 days Whether you are an occasional options trader or an experienced options strategist, Tradelegs’ advanced decision-support technology can give you a substantial edge over trading unaided