Let's say I've developed a strategy that always outperforms the S&P-500, let call it the "magic strategy".
Now I should be golden. All I need is to always have the S&P shorted with the same amount as I have in the magic strategy, and my outcome is bound to be positive.
But how much better does my strategy have to be? Let's say that while the S&P returns 10% per year and my strategy returns 11% in the same period, then my set-up return would look like this:
- 50% of my money invested in S&P shorts becomes 45.45% of the starting value
- 50% of my money in the Magic Strategy becomes 55.5% of the starting value
making my collected results 1%.
In a world where everything is free, I could just leverage this 1:99 and the result would be 100%, not bad?
But what would be the cost of this sort of strategy in the real world? How much do I have to outperform something in order to make a "A outperforms B" sort of bet?
When I read papers they often show how this or that approach, outperforms some index -- how much do you need to outperform something to be able to make a hedged bet?