The Cost of Caution

Dear Investors,

For five months the crop came in. May is the first month it cost us something to keep the field insured.

We finished May with an average realized return of approximately -0.79% across the accounts we manage. Since inception, the accounts we manage are up approximately +16.13% on average. It is our first negative month, and it came from a single line in the book: the cost of the hedge we carry in every market, calm or not.

Because we manage capital in separate accounts rather than a pooled fund, each account can differ slightly based on size, cash flows, timing, fees, and execution.

The Strategy Breathes

The core has never moved. We sell insurance on businesses we would be happy to own, well below the current price, short-dated, and we let time decay the option in our favor. If a stock is put to us, we own a company we wanted and sell calls against it. Quality is the soil. Theta is the engine. That is the whole of it.

Around that core, the book breathes with the weather. Through the early months of the year, the scanner found fewer short-term setups worth taking, so we rotated some capital into longer-dated puts on the highest-quality names, where two years of room is a wider margin for error than forty-five days. When the Strait of Hormuz seized up in March, we added a defined-risk oil position, an asymmetric macro bet that moved on its own schedule and cared nothing for what semiconductors were doing. We reported both as we made them. Both did their job.

By May, the longer-dated puts had already been harvested over the prior months, their marks recovered from the March selloff. The oil position was the last special situation to close. In early May the market moved on diplomacy headlines while the physical reality did not change: a reported framework to negotiate with Iran and reopen the Strait over time sent crude lower on deal optimism, even though Hormuz itself stayed shut, as it remains today. The disorder in oil had not gone away. The edge for that expiration had, so we closed the position. With the special situations behind us, capital came home to where it belongs in an ordinary market: short-dated puts on quality companies. Three weeks, not two years.

The engine never changes. What changes is how much weight sits beside it. In a loud market the book widens into asymmetry and protection. In a quiet one it contracts back to short theta. May was the quiet one, and the book is simpler for it.

The Rally We Did Not Chase

You will have seen that the market went up, and not by a little. From the late-March lows the broad market rallied hard and fast, the S&P by double digits and the Nasdaq deeper into the teens, and we did not catch most of it. The gap between a soaring market and a slightly negative month is the obvious question, and it deserves a direct answer.

We were positioned for the opposite of what happened. After the March shock we expected more downside, so we carried protection and we held back from opening aggressive new positions into a rally we did not yet trust. The market climbed against that caution. We were early to fear and slow to chase, and a strong tape largely passed us by.

That is a real cost, and I will not dress it up. It is also the strategy doing exactly what it is built to do, and the reason is worth your time.

Our upside is capped by design. We sell insurance, so the most any position pays us is the premium we collect. A good month is a row of small, repeatable wins, never a windfall. We do not own the rocket ships and we do not catch full rallies, because catching them is not our trade. A strategy whose gains are limited cannot afford losses that are not. The arithmetic only holds if we refuse to risk a deep, lasting drawdown for the sake of a few capped percent.

So the question through April was never how much we might make if the run continued. It was what the book would suffer if we chased the run and the market turned. Fully deployed into a reversal, we would have given back far more than the rally would ever have added. At our very best, leaning all the way in might have earned five or six percent across these months. That is not a trade worth the whole book. I would rather hand you a quiet, durable number than a loud, fragile one.

We left money on the table, in May and in the weeks before it. We did it on purpose. Limited upside is the price of limited risk, and limited risk is the entire promise of this strategy.

The Cost of Insurance

The realized loss came from the hedge, and the hedge is doing exactly what we built it to do.

We carry permanent portfolio insurance on the broad market: a defined cost, a defined payoff zone, cash settlement. It exists for the month when individual company quality stops mattering because everything falls together. May was not that month. The market stayed calm, the protection lost value as it is built to in quiet conditions, and we closed it and rolled the coverage forward into a more capital-efficient structure. That is the arithmetic of insurance. You pay the premium in the still months so the policy is in force during the storm.

Everything beside the hedge worked. The core premium engine was positive. Idle cash kept earning interest, a quiet and dependable contributor while rates stay high. The oil position came out roughly flat across the accounts we manage. The hedge cost more than all of it combined, and the month closed slightly below the line.

A farmer who insures his fields does not regret the premium in a year without hail. He pays it again the next year. We will pay it again next month.

The Numbers

May's average managed account return was approximately -0.79%. Since inception, the accounts we manage are up approximately +16.13% on average.

Returns are calculated on realized profit and loss, not on changes in net liquidation value. We count money we have actually made or spent, never paper marks on open positions. By that conservative measure, May cost us a fraction of a percent, almost all of it the price of staying insured.

We sell fear on companies we understand and buy it on the market we cannot. The first pays us most months. The second costs a little until the month it pays for everything.

May was quiet, and against a roaring tape it looked quieter still. The book is sharper, the protection is in force, the engine is back to the patient, repeatable work it does best, and we did not bet the firm to chase a rally we could not size safely. Thank you for your continued trust.