I’m Starting My Own Hedge Fund

Update: I got my ass kicked and underperformed the market by 50% over the course of 1 year.  See the update here where I talk about pulling my Roth IRA out and buying an affiliate website with the remaining balance.

I'll leave this post up as a warning to anyone who thinks they can casually invest and beat the market.  Don't bother, just buy $VFIFX.

I’m Creating My Own Hedge Fund: AFI Capital

I’ve always been an index investor.  401k and Roth IRAs all set to autopilot, adding up and growing over time into well diversified funds with low expense ratios.  That’s all been going well but once you get it setup it’s kind of boring.  After all the basic steps to the early retirement game are:

  1. Save Money
  2. Repeat
  3. Wait
  4. Retire

So in the interest of making life a little more exciting, learning a new hobby/skill/talent, and possibly beating the market (blasphemy!!!!!!), I’m going to start my own fudge.  That’s probably an exaggeration;  what I’m really doing is setting aside 10k for trading options.  My total retirement nest egg right now is at 110k.  80k in a 401k, 10k in my Vanguard Roth, 10k in Optionshouse, and 4k in Mrs. AFIs Roth.

How to Tell if I Can Beat the Market?

My 10k in the Vanguard Roth IRA will be left alone and invested in VFIFX.  Unfortunately (for this experiment) my Roth IRA gets contributions every week so I can’t just measure the account balance.  My plan is to use the paper trading portion of my OptionsHouse Roth IRA to buy roughly 10k worth of VFIFX to simulate ‘the market’.  This will make it easy for me to quickly check the balance of both accounts and easily see which one is accumulating more gains.

But Options are Risky!

Options can be very risky.  There are a lot of stories out there of people who lost a lot of money on options but also stories of those who mad enormous amounts as well.  Take for instance the highly suspicious and highly profitable trade that happened recently on LinkedIn (LNKD).


Somebody new that LinkedIn was about to be bought so they purchased a ton of call options at a $175 strike price.  These were insanely cheap because the odds of LinkedIn taking a random walk and ending up above $175 were incredibly small.  So once Microsoft announced they were going to buy LNKD and the share price soared up to $196, the value of those options went from $135,100 to $2,000,000.

Now obviously my plan is NOT to start insider trading and really this isn’t even a hedge fund.  Just a small, <10%, portion of my portfolio that I’m going to use to try to outperform the market and see how it goes.  With proper risk management I think my worst case scenario in this experiment is a $3k-$5k loss which is roughly 3-5% of my portfolio.  However, I’m taking steps to ensure that doesn’t happen.

How I’m Learning to Trade Options

One of my favorite podcasts is Smart Passive Income by Pat Flynn.  One of the episodes I listened to recently was an interview with a guy from a website named Option Alpha. The guy who runs Option Alpha is named Kirk Du Plessis and his strategy for trading options is very sound.

Before I get into any more of this I just want to say this post will not be covering the basics of options trading.  This can easily be found elsewhere and it will be written by people who are much better teachers than I am.

So back to Kirk’s strategy.  Find stocks with high implied volatility compared to their historical averages.  This high volatility means the value of the options will be higher than normal so it will be advantageous to sell these options.  You look for trades that have a high probability, greater than 70% or so, and structure the options trade such that the payoff makes sense.

So if you’re 70% likely to win, you can keep placing those trades with the same probability over and over again and in the long run you will gain money, much like a casino that uses a small edge, maybe just a few percent, times a HUGE number of bets with it’s customers and over time the casino comes away with the money.

Kirk has a lot of free content on the website and right now I’m soaking all of that in to learn the trading strategies.  I’ve done a little research in the past on options trading and I’ve mostly just been confused.  I’ve been enjoying Kirk’s free content so far and it is very easy to understand.  I’m looking forward to understanding more about options so I can finally actually begin trading them.

Progress So Far

I hope to update this monthly with how I’m progressing and how my personal fund is doing vs the market.  As of right now I have mostly abstained from any trading as I learn the ropes.  But that doesn’t mean the contest hasn’t started.  The market is at an all time high so my account is sitting in cash.  This is a pretty timid way of ‘shorting’ the market by sitting on the sideline but it is an opportunity cost.  This money could be sitting in VFIFX right now picking up dividends, appreciate in value, etc so I think any underperformance from my learning curve should be accounted for in the cost.

AFI Capital: $10,069

Holdings: $9,994 in cash

25 $MSTX Oct 16 2.5 calls @0.05 each (this is just a speculative gamble, unrelated to any actual, legitimate strategies from Kirck.  It only cost $10)

The Market: $9,944

Holdings: VFIFX

Some links on this website may earn me a small commission if you click on them at no extra cost to you. For more information please click this text to see the full affiliate disclosure.

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    1. I was stupid. Shouldn’t have done it but couldn’t resist the gamble. They had some drug trials going and if they passed, their stock would have skyrockted and the options would have been worth much more. I’ve gotten more disciplined now, staying away from speculative gambles.

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