Vol of Vol Practical thoughts on trading volatility as a distinct - - PowerPoint PPT Presentation

Vol of Vol

Practical thoughts on trading volatility as a distinct asset class

Michael Fagan Chairman Levitas Capital

Vol of Vol: 2015 some extraordinary happenings

• In 2015 the events of August represent

an extraordinary example of the ferocity

• f vol of vol
• This plot shows the percentage change

in implied vol of VIX options against a change in the term structure of the futures

• The rise in the implied vol is

accompanied by some of the steepest

• bservations of the futures curves we’ve

seen since the inception of the product group

• No other financial product can capture

the velocity of the moves that we have so far observed

2015

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The Volatility Dichotomy

Volatility as a Hedge

• Protect against macro or unforeseen

events

• Allows managers to “stick” to core

holdings

• Positive convexity is comforting
• Extreme situations force abnormal

performance results

• Cost of protection acts as a drag on

performance in good times

• Picking individual volatility winners is

cheaper, but difficult for most fund managers to achieve

Volatility as an Asset Class

• Agnostic to the noise of the market
• Use statistical analysis of behavioral

patterns in volatility product groups

• Positioning independent of bottom-up

analysis

• Acknowledge the power of volatility over

direction in certain circumstance

• Scale volatility exposure by recognizing

the various tools available to the investor

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VIX: The Opportunity of negative correlation

The VIX and its associated derivatives provide the opportunity to capture negative correlated returns

R² = 0.5644

• 50.00%
• 40.00%
• 30.00%
• 20.00%
• 10.00%

0.00% 10.00% 20.00% 30.00% 40.00% 50.00%

• 15.00%
• 10.00%
• 5.00%

0.00% 5.00% 10.00% 15.00%

VIX Relationships 2008 to 2015

SPX ASX200 FTSE Eurostoxx N225 Linear (SPX) Linear (ASX200) Linear (FTSE) Linear (Eurostoxx) Linear (N225)

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Vol of Vol: What does it look like to a trader?

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• 2008 and we enter into the

Lehmans phase of the financial crisis

• What works better? VIX options or

SPX puts?

• The initial move shows the extreme

reaction of vol of vol to the events,

• utperforming an equivalent SPX

put by a factor of 4

• Here you can see the way the Vol of

Vol (represented here via the VVIX) rising, reflecting the price action we see in the VIX calls

Largest monthly SPX fall since 2007

(Chart utilzes the nearest OTM options; buying second expiry month holding over 1 calendar month of interest.)

Vol of Vol: What does it look like to a trader?

6

• 2009 and Central Banks are

injecting capital in response to the credit crisis

• Equity markets decline, but VVIX

declines with them

• Note that the VIX and the VIX

Futures remain elevated

• Here you can see the way the SPX

puts now out perform in response to the one way nature of the S&P 500’s movement

Second largest monthly SPX fall since 2007

(Chart utilzes the nearest OTM options; buying second expiry month holding over 1 calendar month of interest.)

SPX Puts vs VIX Calls – Is there a difference?

7

• In “normal markets” VIX calls act very

much like S&P puts, i.e. excluding major market disrupTons ρ = 1.00

• At the start of the ’09 recovery Vol of

Vol had to normalize, you couldn’t hold and ride the delta, you had to trade to capture the outperformance

• Equity hedgers will want to concentrate
• n the extreme events
• In event of extreme outliers, VIX calls

grossly outperform S&P puts

(Analysis 2007-2015, utilzing the nearest OTM options; buying second expiry month holding over 1 calendar month of interest.)


SPX Puts & VIX Calls – P&L Distribution

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• Timing remains key
• Systematic buying of options (SPX puts or VIX calls) is unprofitable
• Losses for > 90% of the time
• Ave Put Losses = -25% of premium
• Ave Call Losses = -12% of premium

(Analysis 2007-2015, utilzing the nearest OTM options; buying second expiry month holding over 1 calendar month of interest.)


Vol of Vol

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• VIX options are ultra sensitive to market inflexion points, more so than standard Vol

instruments (e.g. SPX puts)

• The market overpays for insurance for the outlier events because of this sensitivity

(more on that later)

• Systemic buying of options in itself produces significant drag on the portfolio of a

hedger because you’re mostly losing

• A trading mentality that separates the normal and the abnormal coupled with timing is

a better path

• Vol of Vol is more tactical than strategic

PnL ($ per contract) Statistics <19 >19 <75 >75 <9 >9 Average 42.6 75.2 23.7 94.0 36.4 81.4 Median 90.0 175.0 90.0 155.0 125.0 115.0 STD 247.2 496.0 407.2 372.5 487.4 261.3 SKEW

• 3.9
• 5.0
• 5.9
• 4.9
• 5.1
• 3.4

% Positve 89.1 87.8 88.3 88.7 87.5 89.5 AVE/STD 0.17 0.15 0.06 0.25 0.07 0.31 Implied Volatility (%) Term Structure (%) VIX Index PnL ($ per contract) Statistics Low/Low High/High low/Low High/High Average

• 20.6

138.7

• 0.8

118.2 Median 90.0 190.0 90.0 160.0 STD 475.0 261.5 477.8 268.4 SKEW

• 5.2
• 3.6
• 5.2
• 3.4

% Positve 85.3 91.6 87.8 89.2 AVE/STD

• 0.04

0.53 0.00 0.44 Index/Term Structure Term Structure/Implied Volatility

VIX Strategy: Selling Volatility via Short Calls

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This analysis shows the P&L per contract by selling OTM calls in the front month up to 2 weeks till expiry, after which point selling the second month with positions held to expiry.

VIX: Using Vol of Vol like an Actuary

• By using statistical analysis of VIX Cash levels, Implied Vol and Term Structure to

determine option positioning. We believe a successful quantitative strategy is possible with an agnostic view of price movement.

• One would assume that due to VIX Cash mean reversion characteristics, selling VIX

when it is high would be a successful trade. However, on an Average/Standard Deviation basis, there is no clear trade based purely on the VIX Cash level.

• Positioning based on the Term Structure alone (which is often when the cash is at its

lowest levels) results in double the success based on the Average/Standard Deviation

• f the VIX Cash level.
• Combining high VIX Cash and high Term Structure achieves near double again the

Average/Standard Deviation of the Term Structure alone.

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VIX Futures Term Structure Realized Volatility - 
 Hold on at the short end

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VIX Cash & Futures Term Structure: August 2015

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VXX VX1 VX2 VX3 0.00 5.00 10.00 15.00 20.00 25.00 30.00 35.00 40.00 45.00 03-Aug-15 04-Aug-15 05-Aug-15 06-Aug-15 07-Aug-15 10-Aug-15 11-Aug-15 12-Aug-15 13-Aug-15 14-Aug-15 17-Aug-15 18-Aug-15 19-Aug-15 20-Aug-15 21-Aug-15 24-Aug-15 25-Aug-15 26-Aug-15 27-Aug-15 28-Aug-15 31-Aug-15 40.00-45.00 35.00-40.00 30.00-35.00 25.00-30.00 20.00-25.00 15.00-20.00 10.00-15.00 5.00-10.00 0.00-5.00

VIX Cash & Futures Term Structure: 08 v 15

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5 10 15 20 25 30 02-Jan-15 22-Jan-15 10-Feb-15 02-Mar-15 19-Mar-15 08-Apr-15 27-Apr-15 14-May-15 03-Jun-15 22-Jun-15 10-Jul-15 29-Jul-15 17-Aug-15 03-Sep-15 23-Sep-15 12-Oct-15

2015

10 20 30 40 50 60 70 02-Jan-08 23-Jan-08 12-Feb-08 04-Mar-08 25-Mar-08 14-Apr-08 02-May-08 22-May-08 12-Jun-08 02-Jul-08 23-Jul-08 12-Aug-08 02-Sep-08 22-Sep-08 10-Oct-08 30-Oct-08 19-Nov-08 10-Dec-08 31-Dec-08

2008

• Compare the realized 1M vol of VXX (rolling 30-day VIX futures) with its

corresponding implied vol derived from its option price confirms similar distribution of risk premium and the same median of 11% with a negative skew of -1.2.

• Compare the realized 1M vol of SPX with the VIX Index shows a more

centred distribution and lower risk premium of 4% with larger negative skew

• f -2.3
• The greater risk premium in the VoV is justified by the great

dispersion of daily returns found in underling Vol instrument compared equity cash.

• The higher risk premium combined with a lower negative

skew suggests selling vol of vol is superior to selling vol

Vol of Vol vs Vol Risk Premium Distribution

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Returning to our first slide - Vol of Vol: 2008 v. 2015

• Which was a tougher environment for

investment decisions, Lehmans ‘08 or 2015?

• In 2015 (orange dots) the VIX market

has arguably been more “dangerous” than 2008

• The three largest moves in vol of vol

measured by the shift in VIX futures term structure and change in implied vol

• f the options there on, have taken

place this year.

• No other financial product can capture

the velocity of the moves that we have so far observed

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24/10/08 S&P gapped down -8.3% and closed the day down -5.1%. VIX 67.8 VVIX 121 (starting from high vol levels) 24/08/15 S&P gapped down -5.4% and closed the day down -4.1% VIX 28 VVIX 138 (starting from low vol levels)

VIX: Options and context

• VIX options represent the purest form of

leverage to the velocity of market moves

• 2015 was less expected by the markets

than what occurred during 2008 as volatility was at a much lower absolute level

• The gradient of the line of best fit for 2015

is as a series far stepper than that in 2008, indicating a significantly higher level

• f “surprise”
• What we saw in August this year was a

release of stored energy as multiple macro factors shook markets

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24/10/08 S&P gapped down -8.3% and closed the day down -5.1%. VIX 67.8 VVIX 121 (starting from high vol levels) 24/08/15 S&P gapped down -5.4% and closed the day down -4.1% VIX 28 VVIX 138 (starting from low vol levels)

Vol of Vol Summary

The mean reverting nature of the product means that a long vol of vol has to be traded Vol of Vol is hyper-sensitive to market inflexion points Systematic buying of volatility rarely beats selling in the simple sense of win / loss

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Levitas Capital

About Us:

Levitas Capital was founded in 2013 as an Asset Manager and is based in Sydney, Australia. We currently service clients in Australia, Singapore and Hong Kong. We are leading managers of volatility as an asset class with a quantitative investment process and advanced risk management models. In addition we offer active portfolio

• solutions. Interested investors can contact through our website: http://levitascapital.com.au/contact/

Disclaimer:

Levitas Capital is the trading name of Volatility Funds Management Pty Ltd (ACN: 165 110 476) that is a Corporate Authorised Representative (CAR No. 448549) of HLK Group Pty Ltd (ACN: 161 284 500) which holds an Australian Financial Services Licence (AFSL no. 435746). Any information or advice contained in this presentation is general in nature and has been prepared without taking into account your objectives, financial situation or needs. All securities and financial products or instruments transactions involve risks. Please remember that the past performance results are not necessarily indicative of future

• results. Trading derivatives carries a high level of risk to your capital and you should only trade with money you can

afford to lose. Trading derivatives may not be suitable for all investors, so please ensure that you fully understand the risks involved, and seek independent advice if necessary.

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Levitas Capital info@levitascapital.com.au Level 5, 120 Sussex Street Sydney NSW Australia 20