New and improved options
As noted in our October 2012 emerging manager feature, there has been a growth in the number and sophistication of options strategies. Most options players are taking a more holistic approach to volatility — buying and selling options as opposed to simply collecting premium.
While this year’s mild environment for volatility — the CBOE Volatility Index peaked in June at 27.73 and spent most of the year in the teens (see “Markets,” page 14) — was an ideal environment for pure premium collectors, option traders have taken more of a value approach to volatility following the 2008 carnage and the August 2011 spike that caused large drawdowns in the space. This change not only has provided protection from the huge sigma events that happen much more often than quantitative risk models would indicate, but also has opened up doors from allocators who dismiss pure premium collection strategies on principle.
LJM Partners (see profile, page 42) transitioned in recent years from a pure premium collection manager to a volatility trading program. Like several other options traders featured recently, LJM has added long options positions to provide some safety to their mainly options writing strategy, and found that long options could be a driver of returns as well as a risk management tool.
“Positions we put on to manage risk ended up adding to our returns,” says Lauren Caine, LJM business development manager and daughter of founder Anthony Caine. “We are managing a portfolio of long and short puts and calls instead of a straight premium gathering program.”
She says volatility as an asset class is on the rise. “It has been a huge difference in being able to sit across the table from a pension fund,” Caine says. “I have heard all the clichés, ‘picking up nickels in front of a steamroller,’ [but] it makes [asset raising] way easier. A lot more people are willing to listen and volatility strategies are doing well this year.”
ITB Capital Management Principal Jeff Dean agrees (see “Black & Dean’s options evolution,” February 2013). “People are starting to look at options a little differently,” he says.
Ziqiang (Chon) Tang, principal of Junzi Capital Engineering, employs a volatility arbitrage strategy that produced a 43.24% return in 2012. Tang says that the more holistic approach to options trading, in addition to bringing more allocators to the table, gives him more confidence in writing options. By mixing long options with premium collection, “we felt confident to be in the market, comfortable being engaged,” Tang says.
While Tang’s strategy always is short gamma, by buying options on the wings through his “black box,” the strategy gains protection and sometimes profits.
“Our black box [long option overlay] gives us the confidence to engage in the market despite uncertainty,” Tang says.
He is just one of a growing group of options traders who view volatility as an asset class instead of just looking to collect premium, a trend also highlighted by Waksman. For example, of the 102 option managers in the Barclay database, only 66 have at least three years of experience.
Despite the last two years, it is an exciting time to be involved in managed futures. Regulatory changes are opening up the space to retail investors and many programs are being recalibrated to fit into a mutual fund structure. Also, more allocators are seeing the need to gain exposure to this space.
“We have seen a sea change and you can see it in [assets under management (AUM)] figures,” Waksman says. “We have had two down years in managed futures and throughout that period AUM has grown. Having 40 Act [managed futures funds] is allowing for the retailization of managed futures.”
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