Patrick Ceresna (Build Your Own DRAGON PORTFOLIO: How To Go Long Vol)
What this covers
Patrick Ceresna and I reveal 👉 HOW YOU CAN GO LONG VOL 👈 and build your own DRAGON PORTFOLIO!! This is The Rebel Capitalist Show educational series!! You've heard about it everywhere, Chris Cole's amazing dragon portfolio consists of 5 main parts, equities, bonds, gold, long volatility, and commodities trend following. Most people understand the first 3 but they have no idea how to use the last two so Patrick and I are going to reveal the secrets in this 2 part educational series! This is PART 1 of 2.
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Retail investors can implement Chris Cole's 'dragon portfolio' concept by using accessible options strategies like ratio call spreads to gain long volatility and gamma exposure without excessive negative carry costs, creating a portfolio that hedges against both inflationary and deflationary tail events.
- Traditional long options have prohibitive negative carry that drags portfolio performance; ratio spreads like call back spreads can achieve similar gamma exposure at near-zero cost
- Being long volatility through gamma (directional optionality) differs fundamentally from speculating on VIX levels; the former provides portfolio insurance that compounds returns during regime shifts
- A properly constructed dragon portfolio with long volatility components via options strategies protects against both inflationary and deflationary secular changes with modest maximum loss in calm markets
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Active management through rolling ratio call spreads every 3 months (closing and reopening) ensures you never experience the maximum loss point because time value remains in the long calls, making this risk management strategy superior to holding to expiration.
“one of the more interesting things about being along a ratio back spread like this or a call back spread in this case is is that by closing it early let's say I bought six months and I was rolling it every three months right so every three months I would close it and buy another one that's six months out you will never actually experience the great loss at that V point because because there will always be time value on the long calls against the short call and therefore you may be down but you will never be experiencing max loss”
Buying VIX ETFs or tracking volatility directly is not an effective long volatility strategy for portfolios because these products suffer from contango roll costs (often 5-10% per month) and do not hedge directional asset moves.
“when you buy car insurance on balance the vast majority of us are net net losers on car insurance which is we are not the ones that need to pay off now if you're unfortunate that you actually needed the pay off it's because you were having a bad accident or had massive liabilities because of it and you turn to the insurance policy for the for the to cash it in and and get the pay off but for the majority of us we're losers on the insurance because we never end up having to crash our cars or do anything and and we're our contribution to the insurance was helping the other person and that's like the mutual life so it's you in the first place Patrick yeah there you go and and and so on balance in the same way always buying insurance on the stock market perpetually is a losing proposition that drags your performance right if yeah it's and and this is where Chris Cole spends so much time trying to say how do we go long volatility without all of this big negative carry in a portfolio construction”
Long call options have negative carry because even if the stock stays flat or rises slightly, the option loses money due to time decay, and the buyer must beat the capital outlay through sufficient stock price appreciation.
“there's a negative carry in other words even if the stock stays the same or even goes down goes up just a little you are still in a position of losing money with a call option your a call option payoff is that you have to beat the capital you out late for the call option on the up side of the market”
Most retail investors find it straightforward to gain exposure to equities, bonds, and gold through simple index purchases or bullion, but struggle with trend-following and volatility strategies that require options market access.
“almost every investor knows how to do the first three which is all buys an SP 500 index or a basket of equities I know how to buy a Minoo some sort of bond basket or I know how to buy a gold bullion but then we get to trying to following and volatility strategies and this is where most people's heads start spinning”
Because rolling ratio spreads reduces actual risk exposure, you can size the position larger than if you held to expiration, allowing you to accumulate more gamma exposure at lower cost.
“and so this is a one of the really fascinating things about owning that option then the the the second thing is that because you structurally have less risk you can actually size your position even larger so if you turn around and you even that max risk point is a fraction of its size because you never hold till it's maturity you can actually increase your sizing of of the spread and have a even more gamma”
The 60/40 portfolio (stocks and bonds) and risk parity portfolio perform well during the standard market expansion cycle but perform poorly during secular changes and system resets.
“the typical 60/40 portfolio that most of my viewers probably have the risk parity portfolio does very well when we go into the next cycle it it doesn't do well at all”
If the underlying security experiences an extraordinary big move upward, the ratio call spread has a huge payoff because the long calls appreciate significantly while the short call loss is capped.
“at the same time if you had an extraordinarily big move to the upside it has a huge payoff so if we saw a call back spread on the stock market would be an inflationary impulse”
The dragon portfolio is structured with roughly equal weightings in equities, bonds, gold, commodity trend-following, and long volatility to perform well in both deflationary and inflationary regime changes.
“he basically came to the conclusion that he was going to build this dragon portfolio that had roughly equal weightings into equities bonds gold commodity trend-following and long volatility”
Chris Cole describes cycle resets as having two possible paths: a deflationary path or an inflationary path, referred to as the 'two wings of the hawk'.
“there are two ways and least Chris Cole describes those two ways of that cycle resetting and it calls it the two wings of the hawk right it could be an deflationary path or it could be an inflationary path from which this occurs”
Professional managers like Chris Cole continuously analyze markets to identify which assets have lower volatility regimes but are correlated to equities, allowing them to place ratio spreads at lower cost with better payoffs than placing them directly on stocks.
“if the volatility is high in equities there are other assets that are correlated to equities that don't have the same high volatility so why don't we put this ratio spread on in some other asset that is going to move when equities move as well but we're able to open it at a much lower vol premium and a much easier carry cost like this is what they're doing there are analyzing the markets all the time and saying where can we put these long volatility trades on for the best payoffs and the lowest lowest risk and at least carry and all these different things that's why they're professionals”
If an inflationary impulse manifests and ratios spreads purchased to hedge a deflationary impulse expire with zero loss, an investor still has low-cost insurance that did not drag performance during the wrong scenario.
“for instance let's say an inflationary impulse leads to huge asset price inflation and in fact commodities and so trend-following commodities and and all the equities start actually appreciating in a period where the dilution of money is occurring at such a rapid pace so the denominators being hammered on on money and and so in that period if you were just buying let's say back spreads to insure a deflationary impulse well they're going to expire no loss to you in other words you had the the insurance for a deflationary impulse but the inflation everyone was the one that manifested itself and in doing so now you didn't really lose for having that insurance”
Fed expansion of its balance sheet in historic terms during the COVID-19 crisis creates conditions where one of the 'wings of the hawk' (inflationary or deflationary secular changes) could materialize, making this an optimal time to implement long volatility hedges.
“and I I can't think of a crazier time in the market than now where we had the Fed basically have to expand its balance sheet in in historic terms in order to fight this this economic recession that was induced from the corona and and so now we have a scenario where one of the Hawks of the wing is the wings of the hawk could actually start to materialize maybe a major secular change maiya be afoot”
The dragon portfolio works as a diversifier in a balanced portfolio, complementing long equities and bonds like cranberry sauce at Thanksgiving—not essential but beneficial when included
“Chris Cole was talking about this as a component of a portfolio in other words we're not buying this call back spread because we think that this is going to be an extraordinary performer we actually are buying it just in case [ __ ] hits the fan and some some event is occurring and suddenly we're taking a big losses on other parts of the portfolio and this like an insurance policy pays off in a big way on the wing and so we have for a balanced portfolio this is playing a diversifier role”
An inflationary impulse leads to asset price inflation in equities and commodities as the money supply expands, whereas a deflationary impulse causes bond prices to rise and interest rates to fall as central banks ease.
“an inflationary impulse leads to huge asset price inflation and in fact commodities and so trend-following commodities and and all the equities start actually appreciating in a period where the dilution of money is occurring at such a rapid pace”
Dragon portfolio ratio spreads on bonds, particularly Treasury bonds (TLT), paid off extraordinarily during the 2020 market crash because both bond prices rose (gamma profit from declining interest rates) and volatility expanded (vega profit)
“we had one open on the TLT on Treasury bonds during the last crash and the market just blasted off to the upside in this extraordinary way at least Treasury bonds did in return for the fact that interest rates were declining”
Delta is the slope of an option's payoff curve, and gamma is the rate at which that slope is changing (steepening or flattening), together describing how an option's behavior changes as the underlying price moves.
“this slope is change is the Delta of the option and the rate of which that slope is steepening or flattening it's steepening or flattening at the rate of gamma”
A ratio call spread is constructed by selling one call option and buying multiple call options at higher strikes with the same expiration, often achievable at near-zero net debit to create gamma exposure without negative carry.
“what this involves is a combination like a spread trade of selling a call option and subsequently buying to higher strike price to call options against it with the same expiration on the same underlying security and the goal is to try to actually open this at a net zero cost”
A delta one position (like buying stock directly) is a 45-degree angle payoff profile where every dollar the security moves up or down results in an identical dollar gain or loss.
“what we want to do is I want to just start off with what is the traditional payoff profile of a long stock position it's it's called a delta one position which is a 45-degree angle and it's the very binary relationship of if every dollar the stock or security goes down you lose a dollar and every dollar it goes up you make a dollar”
Over the last 30-40 years, markets have operated within a standard market cycle founded on fundamental growth in normal economic conditions, reaching a peak with large amounts of leverage and debt expansion, after which a secular change occurs to reset the system.
“we have over the last you know 30 40 years been in what's called the standard market cycle which is I found founded on fundamental growth and very normal conditions and in the economy is expanding and then it reaches a point where the cycle is ending with a huge amounts of leverage and debt expansion in the system”
Future sessions with Patrick will cover commodity trend-following strategies and potentially a live webinar showing step-by-step implementation of options trades within the dragon portfolio
“for us to do kind of the same broad overview of this commodity trend following yes and then if we come to some sort of idea of how we can make this live webinar work to walk people through this process step-by-step then we'll go ahead and announce that next week”