Bank Of America Portfolio: Halftime Report - Bank of America Corporation (NYSE:BAC)

This portfolio was designed to last six months. Here, I show how it has performed at its halfway point.

So far, it is up 2.84%, within 27 basis points of SPY, despite being hedged against a greater than 16% decline.

Bank of America celebrates Pride Month (photo via Bank of America News's Twitter page).

Last August, I wrote about the performance of a bulletproof, or hedged, portfolio built around a position in AT&T (T) in 2017 and presented a new one, which completed in February (each portfolio lasts for six months). Following that, I began presenting hedged portfolios built around other stocks, including Bank of America (BAC) in April. Let's see how our BAC portfolio is doing three months in, given the performance of the stock, and the market, in general, since then. First, a reminder of how the portfolio was constructed and what it consisted of.

We used the Hedged Portfolio Method to build a concentrated portfolio around BAC in April, starting with these premises:

These were the steps involved for those who wanted to do this manually (your returns would obviously have varied based on which approach you used).

The goal of this step was to find names that had the potential to generate high total returns to include alongside BAC. My site, Portfolio Armor, calculates its own potential returns by analyzing adjusted price history (which takes into account dividends) and options market sentiment, but you could have derived yours from Wall Street price targets or the price targets given by Seeking Alpha contributors you follow. Your initial universe could have been as big as Portfolio Armor's (the ~4,500 stocks and exchange-traded products with options traded on them in the U.S.) or something smaller, such as the Dow 30.

Since you were going to hedge, gross potential returns were less important to you than potential returns net of hedging costs. To figure those out, you needed to figure out the optimal, or least expensive, way to hedge each name. We wrote about how to find optimal hedges here. For this example, you would have been looking for the cost of hedging against declines of 16% or greater. The lower the decline you were looking to hedge against, the narrower the list of names you would have been able to use.

For each of the names in your initial universe that had a positive potential return, you would have subtracted the hedging cost you calculated in Step 2 to get a net potential return.

Here, you would simply have bought and hedged a handful of names that had the highest potential returns net of hedging costs. The automated approach we'll show below included a fine-tuning step to minimize your cash and another fine-tuning step to decide whether to hedge with puts or collars, but those four steps were the basics.

Using the process outlined above, this was what Portfolio Armor's automated hedged portfolio construction tool presented us with:

In addition to BAC, the site selected Cadence Design Systems (CDNS), MarketAxess (MKTX), Nexstar Media (NXST), VMware (VMW), and Xilinx (XLNX) as primary securities, based on their net potential returns when hedged against >16% declines. The site attempted to allocate roughly equal dollar amounts to each of those names, but rounded down the dollar amounts to make sure it had round lots of each stock.

In its fine-tuning step, it selected Wayfair (W) to absorb cash left over from the process of rounding down the primary securities. Wayfair is hedged with an optimal, or least expensive, collar with a cap set at the current seven-day (annual) yield of the Fidelity Government Cash Reserves money market fund (FDRXX). The hedging cost of this is negative: The idea here is to get a shot at a higher return than cash while lowering the overall hedging cost of the portfolio and limiting your downside risk in accordance with your risk tolerance (to a drawdown of no more than 16%).

This is how the underlying securities in the hedged portfolio have performed since, unhedged:

BAC was in the middle of the pack here, down about 1.78% since. Assuming, for simplicity's sake, your portfolio was equally weighted and you held each position from April 16th until Wednesday's close, you'd be up 3.57% so far.

Here's how the hedged portfolio has performed so far:

The hedged portfolio was up 2.84% so far, while the SPDR S&P 500 Trust ETF (SPY) was up 3.11%, as both started to converge this week.

So far, this portfolio is within 27 basis points of SPY's performance, despite being hedged against a >16% drawdown, it is not on pace to meet its 8.49% 6-month expected return. Let's check back in a few months and see if our BAC portfolio from April has managed to close the gaps with SPY and its expected return.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Seekingalpha.com

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