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  • Leapday Quantitative Research Team

2021 mid-year update: Reaction model continues to provide uncorrelated returns


Summary


This report provides a 2021 mid-year update on the performance of the Leapday REACTION signals. In the first half of 2021, a portfolio that used all 3 entry points (t0 open + 60 min, t0 close, and t1 open) with a starting portfolio of $50M per entry point ($150M total) would return 7.2% with a Sharpe ratio of 1.82 and correlation to SPY of 0.10. These portfolio results are inclusive of conservative trading cost assumptions and robust to stock liquidity. In comparison, the same portfolio had an average return of 4.4% with a Sharpe of 1.62 in 2016-2020 H1 and an average return of 7.7% with a Sharpe of 2.81 in 2016-2020 H2.



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Market Recap


In the first half of 2021 U.S. equity markets continued their post-pandemic economic recovery, netting double digit returns across the most popular equity indices. This strong performance was driven by record setting financial results from public companies. In the first quarter of 2021 alone, over 900 companies reported record quarterly revenue. Meanwhile fewer than 100 companies reported record low revenue over the same period. With the stabilization of the economy, more companies began to issue earnings and revenue guidance this year. Leapday’s REACTION model generated signals on 7,446 events in the first half of 2021. The first quarter contained 3,731 of those events while the remaining 3,715 occurred in the second quarter.



Performance Update


We previously constructed market-neutral portfolios using Leapday’s REACTION signals which are generated 60 minutes after the open on the first day of trading after an earnings announcement (t0 open + 60min), just before the close on the first day of trading after an announcement (t0 close), and before the open on the second day of trading after an announcement (t1 open). In the t1 open report we also constructed a combined portfolio that used all 3 entry points. The previous reports evaluated the signals from 2016 through 2020.


This report provides an update of performance for the above portfolios through the first half of 2021. The assumptions we use for these portfolios are the same as those used in our previous reports and are available through the links above and in the Appendix of this report.


Below we present performance from 2016 to 2021 H1 for each of the 3 REACTION entry points, both with and without trading costs.



We also present the performance of the combined portfolio that trades all 3 entry points between 2016 and 2021 H1, also with and without trading costs.



The 2021 H1 performance associated with the charts above are as follows. We present portfolio returns and Sharpe ratio in 2021 H1 and compare these metrics to historical H1 and H2 performance between 2016-2020.



Below is the correlation of each portfolio to SPY and to the other portfolios for 2021 H1.



In the first half of 2021, portfolios built using REACTION signals continued to exhibit uncorrelated returns with equities. The combined portfolio using all 3 entries had a correlation of only 0.10 to SPY. The t0 open + 60m entry point signals surpassed their historical average, with a return of 16.8% inclusive of costs in the first half of 2021 compared to a historical average of 2.3%. Despite the other two entry points lagging their historical average, the combined portfolio trading all 3 entry points outperformed historical metrics for both return and Sharpe ratio. This result emphasizes the value of using multiple entry points.


Historically, H2 outperforms H1 across all three entry point portfolios and the combined portfolio. If results in H2 are close to their historical average, then the REACTION signals will end up with an above average year for 2021.



Conclusion


In this report we provide a 2021 mid-year update on the performance of the Leapday REACTION signals. A portfolio that used all 3 entry points (t0 open + 60 minutes, t0 close, t1 open) with a starting portfolio of $50M per entry point ($150M total) would return 7.2% with a Sharpe ratio of 1.82 during 2021 H1 inclusive of conservative cost assumptions. In comparison, the same portfolio had an average return of 4.4% with a Sharpe ratio of 1.65 in 2016-2020 H1 and an average return of 7.7% with a Sharpe ratio of 2.81 in 2016-2020 H2 indicating strong 2021 H1 performance for the REACTION signals.


The first half of 2021 witnessed U.S. equity markets continue their post-pandemic economic recovery with double digit returns across equity indices. This strong performance was driven by record setting financial results from public companies. Despite being in the midst of a strong bull market, a market-neutral portfolio constructed using REACTION signals performed well in 2021 H1 with returns that remained uncorrelated with equities. These results indicate the robustness of the REACTION signals and their continued value to drive an independent trading strategy or as an input for a model or decision making framework.



 


Appendix - Assumptions used in portfolio construction


We use the strongest one-third of the 3d REACTION signals for each of the three entry points (t0 open + 60 min, t0 close, t1 open) to build a simulated portfolio. Below we present all the assumptions used in the portfolio construction.

  • Enter and exit trades as follows:

    • t0 open + 60min signal: Enter a trade 60 minutes after the open on the first day the market is open subsequent to a company’s earnings announcement (t0 open + 60 minutes) and exit the trade on the close 3 days later (t2 close).

    • t0 close signal: Enter a trade at the market close on the first day the market is open subsequent to a company’s earnings announcement (t0 close) and exit the trade on the close 3 days later (t3 close).

    • t1 open signal: Enter a trade at the open on the second day the market is open subsequent to a company’s earnings announcement (t1 open) and exit the trade on the close 3 days later (t3 close).

  • Create a market-neutral portfolio by hedging trades using an opposite side trade in SPY with a beta-adjusted notional value that offsets the beta risk of the event trade.

  • Starting capital of $50M per entry point ($150M for the combined portfolio of all entry points) and assuming constant capital throughout the portfolio (i.e. - we do not reinvest profits).

  • Portfolio leverage used during periods of high activity.

  • Trade no more than 6 percent of the starting capital per position.

  • Trade no more than 2 percent of a company’s historical average trade value per position for t0 close and t1 open signals. Trade no more than 1.5 percent for the t0 open + 60 min signal. (The historical average trade value is calculated using the trailing 20 day average traded value.)

  • Beyond the two constraints on trade size stated above, trade equal weight.

  • Round-trip trading costs are based on breakpoints for liquidity group as follows:

    • Low (<$3M historical average trade value): 20 bps (40 bps for t0 open + 60 min signals)

    • Mid ($3M-$25M historical average trade value): 10 bps (20 bps for t0 open + 60 min signals)

    • High (>$25M historical average trade value): 5 bps (10 bps for t0 open + 60 min signals)

    • Costs are allocated half on entry and half on exit

    • In the metrics presented below, we assume $0 in hedge costs (for the SPY hedge) and the hedge does not use any equity or margin



 


Disclaimer


This material is solely for informational purposes and is not an offer or solicitation for the purchase or sale of any security, nor is it to be construed as legal or tax advice. References to securities and strategies are for illustrative purposes only and do not constitute buy or sell recommendations. The information in this report should not be used as the basis for any investment decisions. We make no representation or warranty as to the accuracy or completeness of the information contained in this report, including third-party data sources. The views expressed are as of the publication date and subject to change at any time. Hypothetical performance has many significant limitations and no representation is being made that such performance is achievable in the future. Past performance is no guarantee of future performance.



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