LJM: Opening up world of options
The biggest change Anthony Caine has seen since he first launched LJM Partners in 1998 is that volatility is being recognized as an asset class.
Like several traders recently profiled, LJM has evolved from a pure premium collecting CTA writing options on the S&P 500 to robust volatility traders capable of earning returns in rising volatility markets as well as from premium collection.
“I did some things extremely well, I also had some weaknesses,” Caine says of his original approach to option trading. Today Caine no longer pulls the trigger on his stable of options strategies. “I somewhat backed off from trading,” Caine says. “My role is in [directing] our macro discretionary overlay — the strategy is systematic and I am addressing how much risk to take.”
He says that LJM is much more disciplined in its approach to risk. “We have done a lot of research on selecting strikes; we track volatility and spend on hedging.”
Currently they target spending 12 to 14 basis points of risk in premium and four to six basis points in hedging.
LJM already had added long option positions to its conservative program and funds, but its original Aggressive Premium Collection program, which earned 46.47% in 2012, had a loss of 34% in August 2011 when volatility spiked.
“We made a lot of changes in our portfolio management,” says Caine, who is confident they would handle a similar spike much better now. “August 2011 was actually a much more extreme event than what occurred in 2008,” he adds, noting that volatility spiked at a faster rate.
A good example of the positive changes is that LJM’s Aggressive program earned 6% in May 2012 when the S&P 500 tanked and volatility rose rapidly. “Gamma wasn’t as high but the general movement of the S&P was similar [to 2011],” Caine explains. “Our longs were able to absorb the loss and cash in on our hedge.”
Caine says the programs have a bias against the upside. His daughter Lauren, who helps market the program, points out that this is the way they were positioned at the end of 2012. “During the fiscal cliff [debate] we shifted risk to the upside,” she says. “We were more prepared [for a rapid down move] than at any other time. We would rather take our risk on the upside.”
Caine says they remain that way in 2013. “Starting out 2013 is similar; if the market reverses we will do extremely well.”
Caine acknowledges that there is a maturation process for premium writers. “Ten years ago I might have gotten closer to the fire,” he says, adding, “[for premium collectors] without hedging the probability of a blow-up is 100%.”
He is no longer a pure premium collector, instead defining his approach as spreading between implied and realized volatility.
You don’t see too many longtime option traders, yet LJM has been around for 15 years and has produced a compound annual return of more than 20% despite experiencing and surviving some extreme volatility. Each painful drawdown has produced refinements and LJM is now at the forefront of a new, more robust volatility asset class.
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