MarketsMuse Strike Price curators are always looking for smart perspectives on how to bring more asset managers and institutional investors to better understand and embrace the use of options in a responsible manner. According to Todd Hawthorne, lead portfolio manager of Boston Partners, volatility [which some immediately and sometimes, misguidedly associate with the CBOE VIX Index], has created a new asset class for institutional and retail investors, and like all other asset classes, there are opportunities to harvest returns. In this case, the tools to implement volatility strategies are found via the use of options contracts.
In a recent submission to Pensions & Investments, Hawthorne writes, “These volatility strategies, when viewed as their own discrete asset class, are designed with the goal of delivering returns that are in line with historical assumptions for equities while maintaining a far narrower range of performance (i.e., a substantially higher Sharpe ratio) and downside protection that can limit losses. Moreover, in a market in which yield has become difficult to find, the construct of equity buy/writes, coupled with bottom-up fundamental analysis, can create a synthetic yield instrument that delivers uncorrelated returns and manages to capitalize on volatility rather than being subjected to it.”
Adds Hawthorne, “Traditionally, when retail investors discuss “low volatility” strategies, they are referring to an approach that combines diversification with systematic and regular rebalancing. These more traditional approaches — be it Shannon’s Demon, the Kelly Criterion, or other variations — are more about circumventing volatility than actually capitalizing on it with true downside protection and improved return profiles…
However, other strategies that combine both equities and equity call options — or buy/write securities — can more effectively “harvest” returns out of swings in sentiment, while providing more predictable, and often better, performance even as volatility ramps up. The concept of creating synthetic yield isn’t necessarily new, as portfolio managers will often invest in buy/writes on a basket of stocks tied to an index as a way to generate returns that are in line with the market over time, but at slightly reduced volatility and with the added benefit of options income..”
Professional Investment Community Cries Out in Agony and They Don’t Yet Know Exactly Why
MarketsMuse Strike Price and Global Macro curators voted the Oct 5 edition of global macro advisory firm Rareview Macro’s Sight Beyond Sight the best read of the week. Yes, its only Monday, but those who follow this newsletter as we do (along with a discrete universe of savvy investment managers and hedge fund traders) have discovered that a certain degree of prescience can be contagious when trade ideas are presented with a pragmatic, transparent and easy to understand thesis.. Below are the lead-in topics and followed by selected excerpts…
A Great Disturbance in the Force – Oil, Materials, & Momentum Strategies
Portfolio Overlay – Two Inexpensive Ways to Add Downside Convexity
New Trade – Short 2-Year US Treasuries via Put Options
For those of you who still have to make up your mind on whether we can help you or not with your daily investment process, today’s edition of Sight Beyond Sight is a good example of what makes us different. The majority of the morning notes you have received today all center on the “bad news is now good news” meme or how lower interest rates for longer will be supportive for risk assets. Of course, none of them have highlighted that financial conditions have been tightening all year long so despite the call for lower interest rates for longer the real world is not buying that unless credit spreads tighten. Instead, we will give you a rareview into how risk takers are faring across various strategies. Additionally, we provide three new trade ideas.
In the 1977 iconic movie Star Wars: Episode IV-A New Hope, following the scene where the Death Star destroys the planet Alderaan, the Jedi Knight, Obi-Wan Kenobi, said: “I felt a great disturbance in the Force, as if millions of voices suddenly cried out in terror and were suddenly silenced. I fear something terrible has happened.”
I have started with that quote because it seems the best way to describe the Start of the new week for the professional investment community. Take a look at the below observations and it will be easier to understand why risk takers are “crying out in terror” and for many of them “something terrible has happened”.
If you are a global macro fund, then liquidity is not going to be your friend today as you defend core strategies that are deeply entrenched. For those who have been living on a deserted island the remaining long US dollar positioning is mostly versus emerging market FX and G10 commodity currencies, rather than other reserve currencies such as the euro, Japanese yen, Pound sterling, and the Swiss franc.
If you are a long/short strategy, you already know what is happening because it started well over a week ago.
You just did not want to believe it. Not to worry, a further unwinding in the long Financial/healthcare versus short Material/Energy sector strategy will help you finally come to grips with reality. If you are a quantitative fund, up until really last Friday in both Europe and the US, you have had the benefit of being part of the number one factor input and best performing strategy this year –that is, MOMENTUM. Sadly for you, the reversal of that strategy is a lot more violent on the way out then chasing it on the way in. Perhaps you will take back your 15 minutes of old fame from the new guys-Risk Parity and Target Volatility funds?
The conclusion would be that the worst-of-the-worst–energy, materials and bottom 15% of single stock performers–is now in play from the long side for whatever reason –its “go time”, crude oil has bottomed, or gross exposure reduction is not near being completed.
The current price in S&P 500 futures is ~1950. The low on August 24th was 1831. The difference between the two is ~6%.Protecting against a 6% downside move, or 120 S&P 500 points, is an expensive exercise right now, and not one we are interested in. Instead, we are more worried about the second 6%, or the move down to 1720-1700 from 1831, especially the air pocket that is likely to develop once/if the August 24th intra-day low of 1831 is breached.
The problem is that we do not know the short-term direction of the S&P 500 index, including if it will first go to 2000 in the next 30-days but we are highly sensitive to an even larger move on the downside in the fourth quarter than what occurred in the third quarter. So working on these premises, what are the best strategies to deploy right now? We think having a two-tiered approach between the S&P 500 index and equity volatility, as measured by the CBOE VIX Index, is an optimal strategy.
We’ll look to dynamically manage both of these strategies side-by-side in the event that we see another leg lower in US equities. The two strategies we like are and the ones we deployed in the model portfolio late last week and posted via Twitter are…. Continue reading →
What will they think of next? Is trading options with a weekly expiration too long? According to latest news, the newest binary option contract from Nadex, the 20 minute option, might suit some traders’ needs.
The North American Derivatives Exchange (Nadex), a regulated online binary options exchange in the U.S. announced the launch of 20-minute binary options contracts earlier this week.
The new contracts are geared at retail traders who have a short-term speculative focus and want to get involved in the options market. The new 20-minute binary contracts will be listed between the hours of 9:40am and 4pm EST, Monday through Friday and are available on the top U.S. Index products.
Prior to the launch, Nadex options have had hourly, daily and weekly expiration time. Prior to the launch, Nadex options have had hourly, daily and weekly expiration times. Nadex’s new binary contracts will have durations of 20 minutes, with expirations on the hour, at 20 minutes after the hour and 40 minutes after the hour
In just one week, options contracts with an expiration of 20 minutes have become the second most popular offering on trading platform Nadex, as retail investors seek faster and faster gratification. Continue reading →
Trading in equities options is enjoying a resurgence, thanks to recent volatility in underlying cash markets, a burst in IPO activity and heightened hedging action in the stocks of companies such as Apple, Inc. according to reporting by TradersMag. Citing a TABB Group recent study, 0ptions mart trading volume exceeded 1 billion contracts in Q3. The third quarter gains represent a 4.9% increase from the second quarter total and an 8.2% increase from the year-earlier period.
In its latest research, “U.S. Options Market Review: Third Quarter 2014,” Tabb Group also reported that U.S. options volume rebound was driven in part by a 15.8% jump in September’s total as retail fervor around Apple’s new product announcements, the Alibaba IPO and rising volatility brought monthly volume to 365.9 million contracts.
The report, compiled and written by TABB Group principal Andy Nybo, head of derivatives research, also noted that volatility spikes in late July and late September helped push volatility averages up in each month, with the CBOE index averaging 13.5 in both August and September – prompting more trading.
Weeklies trading, Nybo noted, remained strong in the third quarter with volume totaling 270 million contracts, up 7% from the second quarter total and 39% from the year-earlier period.
Noted Matt Gohd, market strategist at WallachBeth Capital, “Aside from volume spikes that typically come with increased volatility, I think there is clearly an increasing trend towards using equity option strategies for opportunistic, alpha capture and hedging purposes on the part of sophisticated investors as well as institutional fund managers.” Added Gohd, “The better news is that an increasing number of fiduciaries recognize that equity option strategies can play a crucial part of their overall approach to managing risk in a responsible way.”