AIM UK

[ls7550]

Double Funds

Periodically on the AIM boards a question is asked along the lines of

"If AIM likes volatility, why not use double Funds?"

Double funds simply scale the amount of movement in an Index - typically twice.

Most Double funds however are reviewed on a daily basis. A problem with this is that, taking an extreme example, if the conventional Index is down 10% one day, and then up 10% the next, then the conventional case encounters 0.9 * 1.1 changes over the two days, or a 0.99 overall change factor across both days.

The double fund however encounters a 20% loss the first day and a 20% gain the next and stands at 0.80 * 1.2 = 0.96 over the two days.

From this simple example we see that the double fund lost 4% across the two days, whilst the conventional index was only 1% down over the two days.

A more preferable use for Double funds would be to SELL them, as that way you would benefit from this type of compounding effect. The problem is however its not that easy to place such trades as 'Short the Double Short'.

Consider however that a short is somewhat similar to going into cash. That is if the price does decline, then cash relatively outperforms (makes a relative profit), which is therefore somewhat akin to having bought a short.

A trading sequence that somewhat emulates a Traded Options PUT is to start with a small short position and add to that short as prices decline and reduce the short as prices rise.

If we consider buying cash as similar to going short, then this might be extended to starting with a small amount of cash and adding to cash as prices decline, reducing cash as prices rise.

Taking the complete opposite stance - to SELL the Short of the previous paragraph - amounts to reducing cash (buy stock) as prices decline, add to cash (sell stock) as prices rise - which is exactly what AIM does.

By increasing AIM trade sizes, we increase this effect - which is somewhat similar to Selling the Double Short (Shorting a Double Short).

There are a couple of ways to increase trade sizes, LD-AIM is one such method, Ladder with uplifted Cash reserves is another. In many respects LD-AIM and Ladder are quite similar in this respect.

LD-AIM scales the trade sizes by using virtual shares. As AIM trades are typically sized as a percentage of stock value, then uplifting the amount of stocks with virtual and actual stocks results in larger trade sizes.

With Ladder each Ladder is allocated a total amount of funds, of which part is initially allocated to stocks and the remainder is assigned to cash. Where two Ladders track stocks or funds that typically don't move in the same direction at the same time then we can increase the cash reserves of both Ladders on the assumption that we might borrow some of the other Ladders cash reserves when called upon. Providing both stocks/funds don't dive down and collectively call upon more cash than what is available across the two Ladder accounts then generally this approach will increase the total amount allocated to each individual Ladder - which in turn has the effect of uplifting the trade sizes and hence potential stock price volatility capture gains.

I used the short side in the above examples as that is generally the more difficult one to get-your-head-around. The exact same principles can equally be applied to the long side of doubles with a similar outcome.

So in short ;>) when asked about using Doubles with AIM the answer is that selling Doubles is a lot better than buying doubles due to compounding effects, and as its difficult to Sell Doubles, AIM emulates such selling whenever the trade size is scaled up to above conventional AIM trade size levels - which can be achieved via the likes of Vealies, LD-AIM and/or Ladders that have overlapped cash reserves.