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September 2016

CBOE RISK MANAGEMENT CONFERENCE EUROPE

TRADING CROSS-ASSET VOLATILITY & CORRELATION

Trung-Tu NGUYEN Portfolio Manager

Directional strategies

Neale JACKSONPortfolio Manager,

36 South Capital Advisors LLP

Kokou AGBO-BLOUAManaging Director

Head of Flow Strategy & Solutions Financial Engineering

September 2015 P. 2

I ) Thoughts about cross asset correlations

A. Long term vs Short term correlation using variance swap replication [TU]

B. Cross-asset correlation with Hybrid options and covariance swaps [KAB]

C. Correlation and Volatility have the same impact on portfolio volatility: [NJ]

Equity/rates correlation is unstable and distorts traditional multi-asset portfolios.

II) Managing Volatility and correlation distortion in a negative interest rates environment

A. Nash Equilibrium, central bank and social changes impacting the Expected utility... [NJ]

B. Alternative Beta Strategies and Tail risk parity approach ... [TU]

C. How do you deal with tail risk ? unknown unknowns [NJ]

III) Sourcing volatility efficiently: Production Innovation and liquidity constraints

A. Thoughts about product innovation [KAB]

B. Simple volatility trading with Black-Scholes-free-variance-swap... [TU]

C. Challenges and opportunity in sourcing volatility across asset classes [NJ]

Conclusion: Structured products’ Tail wagging the Correlation Dog

Structured products distortion on cross asset correlation, volatility and convexity .. [KAB]

AGENDA

• Time varying property of Cross-asset correlation of volatility trading

• How to deal with high correlation?

• Term structure of correlation: the difference between long-term correlation and short-term correlation

A few words on correlation

P. 3

Multi asset short variance swaps

P. 4

Volatility assets become more correlated after 2008

P. 5

�Highly correlated assets:

• Long Stock indices future

• Short Equity variance swaps

• Short Volatility Indices future

• Long CDX (IG, HY)

• 2 zones: US/EU

A simple trick to deal with high correlation

P. 6

Equity related : equity neutral (per zone) correlation matrix

P. 7

Term structure of correlation

P. 8

Correlation arbitrage

P. 9http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2777657

Tail Protection for Long Investors: Trend Convexity at Work

• We should be aware of the evolution of cross asset correlation,

• Some main factors could be removed using simple concept of beta-hedging to gain back the diversification,

• The term structure of correlation is far from being flat, which could be used as an alpha strategy by using correlation arbitrage

A few words

P. 10

CROSS-ASSET CORRELATION WITH HYBRIDS

Source: SG CIB Financial Engineering

Correlation drives the discount

� “Worst-of” options provide the

most discount.

� % discount vs vanilla assuming

cross-asset correlation of 0%:

� Worst-of option: 70%,

� Contingent option: 50%

� Basket option: 30%

Investment case for hybrids :

� A melting pot of derivative parameters

(correlation, volatility, forwards)

� Isolate specific outcome in joint

probability distribution

� Leveraged, yet with limited risk

� Exotics book supply & demand distortion

P. 11

TRADING SYNTHETIC COVARIANCE SWAP

� A three leg trade where:

� Long 1 x VarSwap Compo into composite currency

� Short x VarSwap quanto on the index

� Short x Currency VarSwap

� Proportions are determined so that the structure is VAR neutral �� a pure COVAR trade

� And your final P&L can be written as:

−−

−−

−=

fx

fxfxfx

qto

qtoqtoqto

compo

compocompo

2K

²KVar*w

2K

²KVar*w

2K

²KVarL&P

qtow

fxw

=

=

compo

fxfx

compo

qtoqto K

Kw&

K

Kw

swapCovar K

arImpliedCovovar(RealisedCL&P

compo

fxindex,fxindex, ⇔

−=

THE VALUE OF YOUR INVESTMENT MAY FLUCTUATE. THE FIGURES RELATING TO SIMULATED PAST PERFORMANCES REFER TO PAST PERIODS AND ARE NOT A RELIABLE INDICATOR OF FUTURE RESULTS. THIS ALSO APPLIES TO HISTORICAL MARKET DATA.

P. 12

COVARIANCE = VOLATiLITY X CORRELATION

FTSE/ GBPUSD Covariance swap Backtest

0

2

4

6

8

10

12

Nov 05 Nov 07 Nov 09 Nov 11 Nov 13 Nov 15

1x UKX Compo $ Var vs. (1x UKX qto $ +0.5 GPBUSD) Var

Professional investors only. Private and confidential. Not for public distribution. Please see the full disclaimer at the end of the document

13

Alexander Calder, entropy and correlation

Source: Calder Foundation, New York; Bequest of Mary Calder Rower, 2011

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Nov 68

May 70

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Nov 13

May 15

Cor

rela

tion

Alexander Calder Small Sphere and Heavy Sphere, 1932-1933

Pan asset class rolling three year weekly correlation

Proxies are: S&P500, USGG10, DXY, CCI

Sources: Bloomberg, Standard & Poors, US Federal Reserve, US Treasury, Thomson Reuters


0

50

100

150

200

250

300

0

500

1000

1500

2000

2500

Dec 93

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Dec 15

SPX vs 10 %Volatility Control Index

SPX 10% Volatility Control Index

Volatility moves to anticipate future low realisedvolatility

ZERO , anything that moves

causes volatility, and therefore

approaching zero this scenario is approximated

Base rate volatility is

known unknowns,

either we know little is

unknown or accept low premium

% Change in Volatility is

greater off a lower base (Vol of Vol)

Probability of rapid volatility

expansion tends to 1

The floor (flaw?) in volatility control by correlation

Low volatility leads to greater amount known about

unknowns

Source: 36 South Capital Advisors LLPSource: Bloomberg as at 9 Sep 2016

Low volatility – the great educator

P. 14


Volatility regimes: Correlation and volatility

0

5

10

15

20

25

30

Jan Feb Mar Apr May Jun Jul Aug Sep Oct NovAsset 1 Asset 2

0

2

4

6

8

10

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov

Asset 1 Asset 2

Any change in volatility to this state, will by definition cause a reduction in correlation

0

2000

4000

6000

8000

10000

12000

1.0%

1.6%

2.2%

2.8%

3.4%

4.0%

4.6%

5.2%

5.8%

6.4%

7.0%

7.6%

8.2%

8.8%

9.4%

10.0

%

10.6

%

11.2

%

11.8

%

SP

X V

alue

Effective Yield ( 1/ PE)

SPX Level

US 10 Year @ 1.55%

PE ratio today (approx. 20.5) 4.9% earnings yield

PE ratio in 2012 (approx13) 7.7% earnings yield

Drift and Brownian volatility = 0 Correlation = 1

Drift volatility = 0 correlation =1

Source: 36 South Capital Advisors LLP

Source: Goldman Sachs 360; 36 South Capital Advisors LLP

SPX as Perpetuity

P. 15


Geometric mean, and variance no proxy for risk

Definition of Investment “Geometric Zeros”

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2

Tot

al P

ortfo

lio V

alue

Smooth Investment ReturnGeometric "Zero" Breached

Time as multiple of investment horizon

Geometric Zero of Capital: achieved by sufficient non-performance (erosion) of capital such that expected rate of

return for duration of investment time horizon no longer reinstates capital

Source: Poundstone,W. 2005. “Fortune’s Formula: The Untold Story of the Scientific Betting System that Beat the Casinos and Wall Street”

Hill and Wang, New York

Source: 36 South Capital Advisors LLP

P. 16


Factors affecting the gradient of the zero line Where correlation is an unsustainable rescue

Geometric Zero of Capital: achieved by sufficient non-performance (erosion) of capital such that expected

rate of return for duration of investment time horizon no longer reinstates capital

Winter White Dwarf Hamster

Life expectancy: 2 years

-1

0

1

2

3

4

5

6

Jan 06

Jan 08

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Jan 12

Jan 14

Jan 16

Inte

rest

Rat

e

EURIBOR

0

2,000,000

4,000,000

6,000,000

8,000,000

10,000,000

12,000,000M

ar 02

Mar 03

Mar 04

Mar 05

Mar 06

Mar 07

Mar 08

Mar 09

Mar 10

Mar 11

Mar 12

Mar 13

Mar 14

Mar 15

Mar 16

Deb

t (E

UR

,Bn)

EUR Debt- Social overhang

Source of charts: Bloomberg as at 9 Sep 2016

P. 17

September 2015 P. 18
















AGENDA

EQUITY / RATES CORRELATION IS CONVEX !

Source: SG CIB Flow Strategy & Solutions

P. 19

1yr Equity vs US 10yr rates Correlation on Weekly r eturns since 1962

High inflation 70s/80s

QE distortionsTapper Tantrum

� Challenges for multi-asset portfolios as Efficient Frontier

shifts due to correlation shifts (Harry Markovitz)

� Multi-asset portfolio are now more volatile

and subject to correlation shocks

� Need for new assets with more stable correlation

against risky assets = volatility or variance swaps (equity , fx,

rates, credit, commodities).


Pistols at dawnNash equilibrium proves necessity for a convex response

Source: Duel Between Burr And Hamilton, 1870s Engraving. (Photo by: Universal History Archive/UIG via Getty Images)

d, % move towards target

σ,P

roba

bilit

y of

suc

cess

Nashequilibriumfortakingashotwhen:��′(�) + �� 1 − � > 1

P. 20


Long volatility strategy in a portfolioVolatility paid vs expected outcomes

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0.5

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0.8

0.9

1

100 90 80 70 60 50 40 30 20 10 0

Pro

babi

lity

% of time from peak to trough

Convex Response Linear Response

Efficient hedge dynamic correlation gap

Self liquidatinghedges

Nash equilibrium probability of hit vs % move

Source of charts: Bloomberg and 36 South Capital Advisors as at 9 Sep 2016

15/04/2005 48 08/08/2011 3113/06/2006 29 01/06/2012 3005/03/2007 29 28/12/2012 2715/08/2007 31 25/02/2013 3112/11/2007 30 20/06/2013 3106/02/2008 51 03/02/2014 3117/03/2008 29 31/07/2014 3314/07/2008 30 15/10/2014 2910/10/2008 50 15/01/2015 3017/02/2009 43 29/06/2015 3401/09/2009 32 24/08/2015 3030/10/2009 31 28/09/2015 608/02/2010 29 08/01/2016 5120/05/2010 42 11/02/2016 2816/03/2011 30 24/06/2016 3016/06/2011 26

SPX volatilityDays from peak to trough

P. 21

�Normal correlation vs Tail correlation

Correlation and regimes

P. 22

� The risk of the long and short VIX position are equal

� Volatility (standard deviation) does not pick this up!

� Idea : risk premia = compensation for taking on a negatively skewed position

Asymmetry in the tails matters

P. 23

Risk Premia: Asymmetric Tail Risks and Excess Retur ns

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2502743

Classical diversification

P. 24

High moment diversification

P. 25

�Allocation solution “Tail risk Parity”

• Define independent sources of tail

• Equally allocation on tail scenario

• Combining tail-anti-correlated strategies as natural hedge:

• Trend following (positive skew)

• Risk premia (negative skew)

Skew diversification problem

P. 26http://www.thierry-roncalli.comA Primer on Alternative Risk Premia

Start date End date RP (%) TF (%)

20080801 20081101 -31.0 17.4

19871001 19871101 -13.1 2.6

19900701 19900901 -12.1 5.7

20140701 20150101 -9.6 17.9

19971001 19971101 -9.6 -0.7

20130301 20130601 -7.2 1.3

20100401 20100601 -5.9 3.0

20070501 20070901 -4.9 -0.2

Natural hedge with convexity of trend following

P. 27

September 2015 P. 28
















AGENDA

Source: Bloomberg, SG CIB Flow Strategy & Solutions

V2X – VIX term Structure

Past performance is not a reliable indicator of future returns.

VOL OF VOL: STRANGLE ON VSTOXX / VIX SPREAD

Var upward vs Vol downward slopping TS

Volatility of volatility term structure Spread of term structures consistently downward slo pping

2

4

6

8

10

12

Jul16 Aug16 Sep16 Oct16 Nov16 Dec16 Jan17 Feb17

V2X - VIX Spread today

V2X - VIX Spread 1w ago

-20

-15

-10

-5

0

5

Jun 09 Jun 10 Jun 11 Jun 12 Jun 13 Jun 14 Jun 15 Jun 16

V2X Term structure - VIX Term Structure(5m future - 1m future)

Average

Maturity FutSpread Option Strike Bid Offer

18/01/2017 5.38 Put 3 0.43 1.5

18/01/2017 5.38 Put 4 0.66 1.84

18/01/2017 5.38 Call 6 0.86 2.22

18/01/2017 5.38 Call 8 0.38 1.55

15/02/2017 5.13 Put 3 0.55 1.69

15/02/2017 5.13 Put 4 0.82 2.06

15/02/2017 5.13 Call 6 0.85 2.23

15/02/2017 5.13 Call 8 0.4 1.59

15/03/2017 4.58 Put 3 0.71 1.90

15/03/2017 4.58 Put 4 1.03 2.33

15/03/2017 4.58 Call 6 0.67 2.02

15/03/2017 4.58 Call 8 0.32 1.46

P. 29

P.


PnL Long USD 10CMS vs SPX VAR Swap

P. 30

US10Y CMS VS SPX VARIANCE SWAPS

Source: Bloomberg, SG CIB Financial Engineering

P.


SPX VARIANCE SWAPS CONTINGENT ON USD 10Y < ATM + 50 BPS

PnL Long USD 10CMS vs SPX VAR Swap

P. 31

Source: Bloomberg, SG CIB Financial Engineering


SX5E vs SPX LT Skew

Past performance is not a reliable indicator of future returns.

SPX VS SX5E CORRIDOR VARIANCE SWAPS

Backtest Dec18 SX5E vs SPX Varspread Corridor vs vanil la

P.

P. 32

Variance swap replication

P. 33

Simple variance swap

P. 34


P. 35


P. 36


The future of volatility


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0

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Jan 04 May 05 Oct 06 Feb 08 Jul 09 Nov 10 Apr 12 Aug 13 Dec 14 May 16 Sep 17

Gra

dien

t

5 years 5 years 1.5 years

Gradients in volatility- the fast collapses after an “event ”

THE FAST 30 – Days from peak to trough15/04/2005 48 08/02/2010 29 15/01/2015 3013/06/2006 29 20/05/2010 42 29/06/2015 3405/03/2007 29 16/03/2011 30 24/08/2015 3015/08/2007 31 16/06/2011 26 28/09/2015 612/11/2007 30 08/08/2011 31 08/01/2016 5106/02/2008 51 01/06/2012 30 11/02/2016 2817/03/2008 29 28/12/2012 27 24/06/2016 3014/07/2008 30 25/02/2013 3110/10/2008 50 20/06/2013 3117/02/2009 43 03/02/2014 3101/09/2009 32 31/07/2014 3330/10/2009 31 15/10/2014 29

P. 37


38

Bull case for volatility


0.1

1

10

100

12/3

1/19

7612

/31/

1978

12/3

1/19

8012

/31/

1982

12/3

1/19

8412

/31/

1986

12/3

1/19

8812

/31/

1990

12/3

1/19

9212

/31/

1994

12/3

1/19

9612

/31/

1998

12/3

1/20

0012

/31/

2002

12/3

1/20

0412

/31/

2006

12/3

1/20

0812

/31/

2010

12/3

1/20

1212

/31/

2014

08/1

5/20

16

Yield on SPX vs 2 year Gov

Yield on SPX vs 2 year Gov

2

2.5

3

3.5

4

4.5

5

1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016

-0.8

-0.6

-0.4

-0.2

0

0.2

2004 2006 2009 2012 2014 2017

VIX 3 month futures - bull markets no longer calm

Velocity of Money (M2)

P. 39
















AGENDA

DVEGA/DSPOT (VANNA) AND DVEGA/DVOL (VOMA) DYNAMICS OF AUTOCALLS

P. 40


DISTORTIONS FROM ASIAN STRUCTURED PRODUCTS

P. 41

� In Europe, issuances have also slowed significantly since Sep15.

� Monthly vega from SX5E autocallable is now around $10mln (vs ~$20mln in 2014-2015)


P. 41

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IMPORTANT DISCLAIMER

P. 44

NOTICE TO U.S. INVESTORS:Communications written by SG personnel in the U.S. are a product of SG Americas Securities LLC (“SGAS”), a U.S. registered broker-dealer and futures commission merchant (FCM). SGAS is a member of FINRA,NYSE, NFA and SIPC. Such communications are directed: (i) only to institutional investors (as defined under FINRA Rule 2210); (ii) when referencing options, only to such institutional investors who have received andreviewed the proper options risk disclosure document titled "Characteristics and Risks of Standardized Options" at http://www.optionsclearing.com/about/publications/character-risks.jsp.; and (iii), when referencingsecurity futures, only to such institutional investors who have received and reviewed the proper security futures risk disclosure document titled “Risk Disclosure Statement for Security Futures Contracts” athttp://www.nfa.futures.org/NFA-compliance/publication-library/security-futures-disclosure.pdf. Trading in options and security futures involves additional risks and is not suitable for all investors. Please visithttp://www.sgasdisclosure.com/ for important disclosures regarding SGAS and transactions you may enter into with SGAS.In addition, for the sole purpose of CFTC Rule 1.71(a)(9), to the extent the trade idea or commentary contained herein includes an analysis of a price of a derivative and contains information reasonably sufficient tobase a decision to enter into a derivatives transaction, it is conveyed as a solicitation for entering into a derivatives transaction.Communications that are written by SG personnel located outside the US are distributed in the U.S. pursuant to SEC Rule 15a-6. Distribution is restricted to “Major U.S. Institutional investors” only (as defined in SECRule 15a-6). Any Major U.S. Institutional Investor wishing to discuss this institutional sales document, or effect transactions in any security or financial instrument discussed herein should do so with or through theirsalesperson at SGAS. The SGAS registered address is at 245 Park Avenue, New York, NY, 10167. (212)-278-6000.Transactions in derivative instruments involve numerous risks including, among others, market, counterparty default and liquidity risk. If you are a “U.S. person” (as defined by the U.S. Commodity Futures TradingCommission), please visit http://swapdisclosure.sgcib.com/ for important information with respect to derivative products. By transacting with Societe Generale, you are deemed to acknowledge that you have read andaccepted the information provided on the website.SG and affiliates are not acting as your fiduciary under Section 15B of the Securities Exchange Act of 1934, as amended (the “Act”), and, unless we have agreed in writing to act as your municipal advisor, ourrelationship will not be subject to the provisions of such Section 15B, the rules there under, or the rules issued by the Municipal Securities Rulemaking Board that relate to the provision of advice to municipal entities ortheir obligated persons.Exchange Traded Funds (ETFs) are redeemable only in specified units and only through a broker that is an authorized participant in that ETF program. SGAS acts as an authorized participant for a number of ETFprograms and participates in the creation and redemption of ETFs, including ETFs that may be referenced in this document. SGAS, as an authorized participant or otherwise, may acquire securities of issuers of ETFsfor the purpose of resale. Redemptions are for the underlying securities. The public trading price of a redeemable unit of an ETF may be different from its net asset value. An ETF can trade at a discount or premium tothe net asset value. There is always a risk of declining stock prices, which can cause investment losses. Clients should consider their investment objectives and the risks, charges and expenses of an ETF beforeinvesting. Each ETF prospectus contains such information and it is recommended that clients review such prospectus before investing.

NOTICE TO CANADIAN INVESTORS:This document is intended for use by Permitted Clients, as defined under National Instrument 31-103, Accredited Investors, as defined under National Instrument 45-106, and to the extent related to derivatives,Accredited Counterparties as defined under the Derivatives Act (Québec) and, in certain provinces, "Qualified Parties" as defined under applicable provincial rules or orders.In Canada, certain services may be provided by Société Générale Capital Canada Inc. (“SGCC”), being a regulated entity, having a principal place of business at 1501 McGill College Ave., suite 1800, Montréal,Québec, Canada, H3A 3M8. SGCC is an affiliate of Société Générale S.A. (French banking institution) and SG Americas Securities LLC. SGCC is a member of the Canadian Investor Protection Funds (www.cipf.ca).Société Générale S.A. is not a Canadian regulated financial institution and does not carry on business in Canada.Canadian investors should consult their own tax advisors to determine the Canadian tax consequences of purchasing, holding and redeeming any product described herein. For the province of Quebec (Canada), it isthe express wish of the parties that this document be drawn up in the English language only. Il est de la volonté expresse des parties que ce document soit rédigé en anglais seulement.

NOTICE TO SWISS INVESTORS:This document is reserved and must be given in Switzerland exclusively to (ii) FINMA licensed entities or (ii) corporates having their own treasury department in Switzerland, in each case acting on their own account.This document does not contain personalized recommendations or advice and is not intended to substitute any professional advice on investments in financial products.This document is of summary nature. The products referred to herein involve numerous risks (including, without limitations, credit risk, market risk, liquidity risk and currency risk). In respect of securities trading, pleaserefer for more information on such risks to the risk disclosure brochure “Special Risks in Securities Trading (Edition 2008)”, which is available for free on the following website of the Swiss Bankers’ Association:http://www.swissbanking.org/en/home.This document is neither a prospectus as per article 652a or 1156 of the Swiss Code of Obligations, a listing prospectus according to the listing rules of the SIX Swiss Exchange or any other exchange or regulatedtrading facility in Switzerland, nor a simplified prospectus, key investor information document or prospectus as defined in the Swiss Federal Collective Investment Schemes Act. Any benchmarks/indices cited in thisdocument are provided for information purposes only.This document is not the result of a financial analysis and therefore is not subject to the “Directive on the Independence of Financial Research” of the Swiss Bankers Association.

IMPORTANT DISCLOSURES http://email.sgmarkets.com/Content/resource/SGM_MAD2MAR_DISCLAIMER

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