From the October 01, 2012 issue of Futures Magazine • Subscribe!

Hot New CTAs: Not your father’s option traders

Tang: Automating volatility arbitrage

Ziqiang (Chon) Tang, founder of Junzi Capital Engineering, has a résumé that screams quantitative trader. Tang worked as vice president of engineering for a provider of industrial automation solutions for a decade after earning a Master’s in Computer Science and Electrical Engineering from the Massachusetts Institute of Technology, and degrees in Computer Science and Electrical Engineering from UC Berkeley.

In 2009 he launched Sacramento, Cal.-based Junzi. “I would describe it as pattern recognition-based volatility arbitrage,” Tang says. “It is definitely not normal premium collection. If you were collecting premium, you don’t want a big move. Some of our worst days come when prices don’t go anywhere.”

Tang actually has two programs that work closely together, although one uses discretion and the other is completely systematic and automated. He starts out by selling strips of near-the-money options in a diverse group of markets in the energy, metals, grains, livestock and softs sectors that have an attractive level of implied volatility. He is looking for an exploitable gap between implied and realized volatility. 

“Say crude oil is at $100. I will buy a bunch of calls all the way up to $110 and sell puts down to $90,” Tang says. Then he turns on his automated “glass box” strategy. “If crude goes to $101, I would buy a future to hedge calls,” he adds.  

The automated system continues to do this as the market moves up and down. 

“It is a very traditional delta hedging program,” Tang says. “Every futures contract that I trade and close, I will be closing for a loss.” 

Tang says he is attempting to execute “delta hedging trades in a more intelligent way, in a more [robust] way and a quicker way than the rest of the market. By doing that more effectively than the rest of the market, I claim that profit. That is why it is truly an arbitrage.”

He usually will hold his short options to expiration and when they expire in-the-money, the automated system should have bought enough futures to cover all the in-the-money calls. 

In fact, he often makes money on the long futures as well as all his puts in that scenario. 

“There are some months where prices don’t go anywhere. The options side will show profits because there will be no hedges against them and they all expire worthless,” Tang says. “If crude goes to $120, the options side gets killed. Hopefully, if the strategy works the way we designed, the futures side has a nice big profit.”

As opposed to traditional options sellers, he does not want the risk of low probability price spikes. “I am very careful to sell options within one standard deviation of the current price because I don’t want exposure to extreme events,” Tangs says. “I don’t really like the optionality of options. I want to trade on volatility, not on option value.”

He says, “There are two things that will cause me to lose. One is a gap move: If my program can’t trade, I am in trouble. Number two is when realized volatility is very high.”

Because of this, his automated hedge strategy runs nearly 24 hours. He even has a technology team in China monitoring the health of the program overnight. 

But at its core, Junzi is trading the difference between implied and historical volatility. “There will be some months where the profits come from the options side and there are some months where the profits come from the futures side. It is like a pairs trade,” Tang says. “I do need profits from the futures side. Figuring out the right balance is part of what makes it hard.”

It may be hard as well as complex, but so far Tang is succeeding with a CAR of 23.72% and a worst drawdown of 9.11% over three years.

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