Derivative Strategies for Portfolio Management

We often receive inquiries regarding equity volatility and effective hedging strategies. Here are key elements that form the foundation of our tail risk hedging approach: 1️⃣ **Direct Puts in the S&P Complex**: It's crucial to have a direct offset for your exposure. While the concept of tail risk is understood, the risk of execution is often overlooked. Certain ETPs (VXX/TVIX) may not perform as anticipated, with markets experiencing halts and exchanges temporary shutdowns during high volatility. Having an inverse correlation directly counters the risk being hedged. 2️⃣ **Calls in the VIX Complex**: The VIX serves as a proxy for variance and convexity, representing volatility squared to a significant degree. Despite the market's forward pricing skew, exposure in this complex performs exceptionally well during market stress, accelerating returns amidst turmoil. 3️⃣ **Puts on Low Vol ETFs**: Derivatives on assets with minimal volatility are essential. Hedging against correlations approaching 1 is critical in tail events. Assets with near-zero volatility prices are ideal targets. Historical data shows that repricing risk in low beta assets, even if the underlying assets don't suffer significantly, can yield substantial returns during market crashes. 4️⃣ **Dynamic Monitoring**: Continuous assessment and adjustment of exposure across these assets are vital to capture value in evolving market conditions. In a landscape where correlations can swiftly change, our proactive strategy aims to protect portfolios and boost returns in turbulent times. Let's remain vigilant together! 🌊 #RiskManagement #HedgingStrategies

Downside protected strategies allow investors to participate in part of the market’s upside, while limiting their downside (often to zero). These strategies are available in ETF form from providers like Calamos and First Trust, though sophisticated investors can construct these on their own by using options, T-bills, and/or the underlying stock (SPY in this case). One thing that’s often missing in the discussion about these strategies is whether now is a good time to enter the trade, and what past entry points have looked like. In this work, we propose a measure of trade attractiveness and show that it depends on the current level of short term rates, and, to a lesser extent, on the current level of the option implied volatility skew. The other question about these strategies is what their historical performance has looked like, and what it looks like as a function of the attractiveness of the entry point. Over the last 20 years—for which we have data—the entry-point contingent performance of these strategies has been interesting, characterized by lowish returns (in the 4% range) but also very low volatility (in the 3% range). Given these return characteristics, these strategies might be a fit for some investors’ portfolios. https://lnkd.in/e2Dz2kvB

Options are financial derivatives that give the buyer the right, but not the obligation, to buy (call option) or sell (put option) an underlying asset at a specified price (strike price) before or at a certain date (expiration date). There are several types of options traded in financial markets, each serving different strategic purposes for investors: 1. American Options: Can be exercised at any time before the expiration date. They are more flexible for the holder, making them potentially more valuable than European options. 2. European Options: Can only be exercised on the expiration date itself. These options are often traded on exchanges and are standardized. 3. Asian Options: Their payoff depends on the average price of the underlying asset over a certain period rather than at a single point in time. This can help reduce the volatility of the option's price. 4. Barrier Options: These options become activated or deactivated when the price of the underlying asset passes a certain level (barrier). Types include knock-in (option activates when barrier is breached) and knock-out (option deactivates when barrier is breached) options. 5. Binary Options: Have an all-or-nothing payoff based on whether the underlying asset reaches a certain price by the expiration date. They are simpler but riskier. 6. Lookback Options: The payoff depends on the maximum or minimum price of the underlying asset during the life of the option, allowing the holder to "look back" at the price action. 7. Exotic Options: A broad category that includes any options not fitting into the more standard categories mentioned above. They often have more complex features and are tailored to fit specific needs. Reasons for Using Options: 1. Hedging: Investors use options to protect against potential losses in their investment portfolio. For example, buying a put option allows you to sell the underlying asset at a predetermined price, providing a form of insurance against a significant drop in asset value. 2. Speculation: Options allow investors to speculate on the future direction of asset prices with a limited risk. The maximum loss for buying options is the premium paid, making it a popular choice for speculative strategies. 3. Income Generation: Selling (writing) options can generate income through the premiums received from the buyers. For example, writing covered calls on stocks you own can provide additional income. 4. Leverage: Options provide leverage since they allow control over a larger amount of the underlying asset with a relatively small investment (the premium). This can amplify both gains and losses. 5. Strategic Investments: Options can be combined in various ways (creating spreads, straddles, and strangles) to create specific investment strategies that profit from volatility, lack of movement, or directional bets on asset prices. Remember, options are risky too. Trading options without proper knowledge can hurt you badly. #quantitativefinance