Volatility: Friend or Foe? - ETF.com · Christopher Cole, CFA Artemis Capital Management LLC...

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Paul Baiocchi, Moderator ETF Analyst, IndexUniverse Christopher Cole, CFA, Panelist Managing Partner & Founder Artemis Capital Management LLC Thomas M. Chapin, CFA, Panelist Chief Investment Officer Mill Creek Capital Advisors LLC Volatility: Friend or Foe?

Transcript of Volatility: Friend or Foe? - ETF.com · Christopher Cole, CFA Artemis Capital Management LLC...

Page 1: Volatility: Friend or Foe? - ETF.com · Christopher Cole, CFA Artemis Capital Management LLC Artemis Vega Fund LP 520 Broadway, Suite 350 Santa Monica, CA 90401 (310) 496-4526 phone

Paul Baiocchi, Moderator

ETF Analyst, IndexUniverse

Christopher Cole, CFA, Panelist

Managing Partner & Founder Artemis Capital Management LLC

Thomas M. Chapin, CFA, Panelist

Chief Investment Officer Mill Creek Capital Advisors LLC

Volatility: Friend or Foe?

Page 2: Volatility: Friend or Foe? - ETF.com · Christopher Cole, CFA Artemis Capital Management LLC Artemis Vega Fund LP 520 Broadway, Suite 350 Santa Monica, CA 90401 (310) 496-4526 phone

Paul Baiocchi Moderator ETF Analyst IndexUniverse

Volatility: Friend or Foe?

Page 3: Volatility: Friend or Foe? - ETF.com · Christopher Cole, CFA Artemis Capital Management LLC Artemis Vega Fund LP 520 Broadway, Suite 350 Santa Monica, CA 90401 (310) 496-4526 phone

Thomas M. Chapin, CFA Panelist Chief Investment Officer Mill Creek Capital Advisors LLC

Christopher Cole, CFA Panelist Managing Partner & Founder Artemis Capital Management LLC

Page 4: Volatility: Friend or Foe? - ETF.com · Christopher Cole, CFA Artemis Capital Management LLC Artemis Vega Fund LP 520 Broadway, Suite 350 Santa Monica, CA 90401 (310) 496-4526 phone

Christopher Cole, CFA Artemis Capital Management LLC Artemis Vega Fund LP 520 Broadway, Suite 350

Santa Monica, CA 90401

(310) 496-4526 phone

(310) 496-4527 fax

[email protected]

VOLATILITY: FRIEND OR FOE? I N S I D E E T F S T R A D I N G C O N F E R E N C E / N E W Y O R K S T O C K E X C H A N G E - D E C E M B E R 1 1 , 2 0 1 2

For Investment Professional Use. Not for Distribution

Page 5: Volatility: Friend or Foe? - ETF.com · Christopher Cole, CFA Artemis Capital Management LLC Artemis Vega Fund LP 520 Broadway, Suite 350 Santa Monica, CA 90401 (310) 496-4526 phone

Abnormally Steep VIX Futures Term Structure

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BULL MARKET IN FEAR

"There is no terror in the bang, only in the anticipation of it." Alfred Hitchcock

The most extreme term-structure for forward volatility in two decades reflects continued anticipation of a deflationary collapse and structural imbalance in risk

VIX

M3

M6

0.50x

0.70x

0.90x

1.10x

1.30x

1.50x

1.70x

1.90x

Ma

r-0

4Ju

n-0

4S

ep

-04

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4F

eb

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ug

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ep

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ar-

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r-0

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0

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12

Expiry

Vix

Fu

ture

s/S

po

t V

ix

Bull Market in Fear / VIX Futures Curve (normalized by spot VIX) 2004 to Present

VO

LATILITY: F

RIEN

D OR F

OE?

Page 6: Volatility: Friend or Foe? - ETF.com · Christopher Cole, CFA Artemis Capital Management LLC Artemis Vega Fund LP 520 Broadway, Suite 350 Santa Monica, CA 90401 (310) 496-4526 phone

10

15

20

25

30

35

Spot Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8

Forw

ard

VIX

ind

ex

(%)

Low Volatility? Really?VIX Futures Curve Comparison

August 2012 vs. September 2008

August 17, 2012 / Lowest VIX in 5 years

September 15, 2008 / Day after Lehman Bros. Bankruptcy

TEMPORAL PARADOX - Abnormally Steep VIX Futures Term Structure

2

Low VIX index does not mean cheap volatility

On August 17th 2012 spot VIX touched a 5 year low at 13.45 however…

It was more expensive to buy forward volatility at 6-12 months with the VIX at 13.45 in 2012 than it was one day after Lehman went bankrupt in 2008 when the VIX was at 31

Volatility hedge executed at the August 2012 low in spot-VIX would have already lost -12% of its value even while VIX increased by +15%

Successful hedging requires going beyond simplistic heuristics based on the absolute price of the VIX

!

Volatility is more than the VIX index

Overt focus on VIX is analytical equivalent using the 1yr UST to explain the entire bond market!

Volatility is more than the VIX index

Overt focus on VIX is analytical equivalent using the 1yr UST to explain the entire bond market!

Low VIX index does not mean cheap volatility Forward volatility more expensive in August 2012 at the 5 year low in the VIX than it was the day after Lehman went bankrupt

VO

LATILITY: F

RIEN

D OR F

OE?

Page 7: Volatility: Friend or Foe? - ETF.com · Christopher Cole, CFA Artemis Capital Management LLC Artemis Vega Fund LP 520 Broadway, Suite 350 Santa Monica, CA 90401 (310) 496-4526 phone

VO

LATILITY: F

RIEN

D OR F

OE? Sorcerer's Apprentice and TVIX

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DON’T BE A FOOL TVIX became the market for short-term VIX futures in Q1 2012

Overflowing TVIX vega exposure is a wake up call to the entire leveraged ETN industry

TVIX vega flows directly impacted implied VOV in Q1 2012 (the elephant in the room)

Leveraged vega introduces self-reflexivity and amplification in the direction of spot vol movement (see graph)

Fortunately SPX options open interest indicated excess vega from VIX ETN flows were absorbed without disruption to broader options markets

-$70

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-$20

-$10

$0

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-50%

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0% 10%

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Ch

ange

in V

ega

Exp

osu

re (

$m

m)

% Move in Vol (rebalanced 1+2 month VIX Futures)

TVIX Vega Exposure spot Vol Move

5

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15

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21

2/1 2/15 2/29 3/14 3/28

VIX index & TVIX

Feb 2012 to Mar 2012

TVIX ETNVIX

CS reissues TVIX shares 3/22

Moral of Story: Vol ETPs do not simplify the process of volatility trading any more than CDOs enhance the credit quality of their components

On February 21 Credit Suisse suspended issuance of the Velocity Shares 2x Short-Term VIX ETN due to "internal limits on the size of the ETNs“

Unbeknownst many retail investors continued to buy TVIX bidding it up to an 89% premium to NAV

TVIX's price collapsed by 50% in just two days after reissuance

Leveraged ETPs introduce self-reflexivity whereby the issuer's vol exposure is amplified in the direction of spot vol movement

Page 8: Volatility: Friend or Foe? - ETF.com · Christopher Cole, CFA Artemis Capital Management LLC Artemis Vega Fund LP 520 Broadway, Suite 350 Santa Monica, CA 90401 (310) 496-4526 phone

20

12

(VIX

Fut)

20

12

(Vix)

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11

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AM

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M

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:19

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M

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M

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M

Vo

lati

lity

of

VIX

by

Min

ute

(%

an

nu

aliz

ed

)

Volatility of VIX Index vs 1m Vix Future (2012) by Trading Minute

Averages by Year (annualized)

2012 (VIX Fut) 2012 (Vix) 2011 (Vix) 2010 (Vix) 2009 (Vix) 2008 (Vix)

Volatility Microstructure Changes due to VIX ETNs

Volatility-of-VIX futures in the last 15 minutes is substantially higher than that of the VIX index itself demonstrating the power of VIX ETNs Volatility-of-volatility microstructure is calmer than at any point

over the past six years of data (below)

The VIX index registered the lowest intra-day movement in history on January 11th (1.14%)

S&P 500 index had biggest yearly reduction in daily moves in eight decades (since FDR 1934 USD devalue)

Source: Calculations executed by Artemis Capital Management LLC with data from CQG data factory. Average executed trades by minute.

VO

LATILITY: F

RIEN

D OR F

OE?

Volatility-of-VIX microstructure is calmer in 2012 however the last 30 minutes of the trading day have become increasingly more violent than previous periods

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Page 9: Volatility: Friend or Foe? - ETF.com · Christopher Cole, CFA Artemis Capital Management LLC Artemis Vega Fund LP 520 Broadway, Suite 350 Santa Monica, CA 90401 (310) 496-4526 phone

Shadow Delta of VIX Derivatives

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Systematic VIX ETN strategies that rely on constant hedging relationships will not track back-tests during changing SPX forward skew regimes due to “shadow” delta drift

How do popular VIX ETPs perform in relation to traditional Volatility Trades? NOT VERY WELL!

VIX options are priced from VIX futures (not the VIX) hence their volatility increases exponentially as a function of time to expiration and SPX forward skew

Systematic VIX ETN strategies that rely on constant hedging relationships will not track back-tests during changing SPX forward skew regimes due to “shadow” delta drift

VO

LATILITY: F

RIEN

D OR F

OE?

0.3

0.5

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c-10

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-11

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-11

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wth

of

$1

VIX ETPs vs. Traditional SPX Volatility Trades

Dec 2010 to July 2012

Traditional Volatility Trading Volatility ETNs

ATM Long

Straddle

ATM Short

Straddle10% OTM Put VXX VXZ XIV XVIX

Vol Bias Long Vol Short Vol Long Vol Long Vol Long Vol Short Vol Short Vol

Annualized Return -28.62% 31.31% -15.36% -52.35% -26.98% 12.13% -3.61%

Sortino Ratio -1.77x 0.79x -0.61x -1.94x -1.53x 0.18x -0.45x

Sharpe Ratio -1.20x 0.85x -0.45x -1.05x -0.87x 0.16x -0.30x

Return to Drawdown -0.57x 1.10x -0.36x -0.65x -0.58x 0.15x -0.20x

Max Drawdown -50.16% -28.39% -42.87% -80.38% -46.50% -79.53% -18.06%

Page 10: Volatility: Friend or Foe? - ETF.com · Christopher Cole, CFA Artemis Capital Management LLC Artemis Vega Fund LP 520 Broadway, Suite 350 Santa Monica, CA 90401 (310) 496-4526 phone

Christopher Cole, CFA – General Partner and Founder

Artemis Vega Fund L.P. Artemis Capital Management, L.L.C.

520 Broadway, Suite 350 Santa Monica, CA 90401

[email protected] www.artemiscm.com

Christopher Cole, CFA

Managing Partner & Portfolio Manager (310) 496-4526 phone

(310) 496-4527 fax [email protected]

Contact Information Artemis Capital Management – Contact Information

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Christopher Cole, CFA

Managing Partner & Portfolio Manager / Artemis Capital Management LLC

Christopher R. Cole, CFA is the founder of Artemis Capital Management LLC and the portfolio manager of the Artemis Vega Fund LP. Mr. Cole’s core focus is systematic, quantitative, and behavioral based trading of exchange-traded volatility futures and options. His decision to form a fund came after achieving significant proprietary returns during the 2008 financial crash trading volatility futures. His research letters and volatility commentaries have been widely quoted including by publications such as the Financial Times, Bloomberg, International Financing Review, CFA Magazine, and Forbes. He previously worked in capital markets and investment banking at Merrill Lynch. During his career in investment banking and pension consulting he structured over $10 billion in derivatives and debt transactions for many high profile issuers. Mr. Cole holds the Chartered Financial Analyst designation, is an associate member of the NFA, and graduated Magna Cum Laude from the University of Southern California.

Key Information/ Biography

VO

LATILITY: F

RIEN

D OR F

OE?

Page 11: Volatility: Friend or Foe? - ETF.com · Christopher Cole, CFA Artemis Capital Management LLC Artemis Vega Fund LP 520 Broadway, Suite 350 Santa Monica, CA 90401 (310) 496-4526 phone

LEG

AL D

ISCLA

IMER

Legal Disclaimer

THIS IS NOT AN OFFERING OR THE SOLICITATION OF AN OFFER TO PURCHASE AN INTEREST IN ARTEMIS VEGA FUND, L.P. (THE “FUND”). ANY SUCH OFFER OR SOLICITATION WILL ONLY BE MADE TO QUALIFIED INVESTORS BY MEANS OF A CONFIDENTIAL PRIVATE PLACEMENT MEMORANDUM (THE “MEMORANDUM”) AND ONLY IN THOSE JURISDICTIONS WHERE PERMITTED BY LAW. AN INVESTMENT SHOULD ONLY BE MADE AFTER CAREFUL REVIEW OF THE FUND’S MEMORANDUM. THE INFORMATION HEREIN IS QUALIFIED IN ITS ENTIRETY BY THE INFORMATION IN THE MEMORANDUM.

AN INVESTMENT IN THE FUND IS SPECULATIVE AND INVOLVES A HIGH DEGREE OF RISK. OPPORTUNITIES FOR WITHDRAWAL, REDEMPTION AND TRANSFERABILITY OF INTERESTS ARE RESTRICTED, SO INVESTORS MAY NOT HAVE ACCESS TO CAPITAL WHEN IT IS NEEDED. THERE IS NO SECONDARY MARKET FOR THE INTERESTS AND NONE IS EXPECTED TO DEVELOP. NO ASSURANCE CAN BE GIVEN THAT THE INVESTMENT OBJECTIVE WILL BE ACHIEVED OR THAT AN INVESTOR WILL RECEIVE A RETURN OF ALL OR ANY PORTION OF HIS OR HER INVESTMENT IN THE FUND. INVESTMENT RESULTS MAY VARY SUBSTANTIALLY OVER ANY GIVEN TIME PERIOD.

CERTAIN DATA CONTAINED HEREIN IS BASED ON INFORMATION OBTAINED FROM SOURCES BELIEVED TO BE ACCURATE, BUT WE CANNOT GUARANTEE THE ACCURACY OF SUCH INFORMATION.

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Page 12: Volatility: Friend or Foe? - ETF.com · Christopher Cole, CFA Artemis Capital Management LLC Artemis Vega Fund LP 520 Broadway, Suite 350 Santa Monica, CA 90401 (310) 496-4526 phone

The User Perspective

Page 13: Volatility: Friend or Foe? - ETF.com · Christopher Cole, CFA Artemis Capital Management LLC Artemis Vega Fund LP 520 Broadway, Suite 350 Santa Monica, CA 90401 (310) 496-4526 phone

Context: Mill Creek Capital Advisors

Philadelphia-area investment advisory firm (“outsourced CIO” business model)

Work with HNW families, endowments/foundations, and defined benefit plans

Allocate assets across spectrum of global capital markets

Manager of managers

Execution: Separate Accounts, Mutual Funds, ETFs

Page 14: Volatility: Friend or Foe? - ETF.com · Christopher Cole, CFA Artemis Capital Management LLC Artemis Vega Fund LP 520 Broadway, Suite 350 Santa Monica, CA 90401 (310) 496-4526 phone

Hedging Against (Equity Portfolio) Volatility

Hired by clients to take “appropriate risks” with their portfolios

Long-Term Hedges Own assets with positive return characteristics which are not as volatile

as (or which are non-correlated or have low correlation to) global equities

Short-Term Hedges Go to Cash?

Options + Futures?

Structured Notes?

Buy Gold?

Buy Volatility?

Page 15: Volatility: Friend or Foe? - ETF.com · Christopher Cole, CFA Artemis Capital Management LLC Artemis Vega Fund LP 520 Broadway, Suite 350 Santa Monica, CA 90401 (310) 496-4526 phone

Why Buying Volatility Look(ed) Interesting

$-

$5.0

$10.0

$15.0

$20.0

$25.0

$30.0

$35.0

$40.0

$45.0

$50.0

$55.0

$60.0

$65.0

$70.0

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$80.0

$85.0

0%

10%

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40%

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80%

90%

S&P Price Volatility

VIX Price (RHS)

10-year average

Page 16: Volatility: Friend or Foe? - ETF.com · Christopher Cole, CFA Artemis Capital Management LLC Artemis Vega Fund LP 520 Broadway, Suite 350 Santa Monica, CA 90401 (310) 496-4526 phone

What About Selectively Owning “Dynamic Volatility”?

Own Vol (1=Yes) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2006 1 1 1 1 1 1 1 1 1 1 1 1

2007 1 1 1 1 1 1 1 1 1 1 1 1

2008 1 1 1 1 1 1 1 1 1 - - -

2009 - - - - - - - - - - - -

2010 - - 1 1 1 1 - - - - - 1

2011 1 1 1 1 1 1 1 1 - - - -

S&P 500 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Year

2006 2.65% 0.27% 1.24% 1.34% -2.88% 0.14% 0.62% 2.38% 2.58% 3.26% 1.90% 1.40% 15.79%

2007 1.51% -1.96% 1.12% 4.43% 3.49% -1.66% -3.10% 1.50% 3.74% 1.59% -4.18% -0.69% 5.49%

2008 -6.00% -3.25% -0.43% 4.87% 1.30% -8.43% -0.84% 1.45% -8.91% -16.80% -7.18% 1.06% -37.00%

2009 -8.43% -10.65% 8.76% 9.57% 5.59% 0.20% 7.56% 3.61% 3.73% -1.86% 6.00% 1.93% 26.46%

2010 -3.60% 3.10% 6.03% 1.58% -7.99% -5.23% 7.01% -4.51% 8.92% 3.81% 0.01% 6.68% 15.06%

2011 2.37% 3.43% 0.04% 2.96% -1.13% -1.67% -2.03% -5.43% -7.03% 10.93% -0.22% 1.02% 2.11%

VXZ-linked Index Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Year

2006 -0.76% -1.62% -5.02% 0.40% 11.92% -2.71% -2.33% 3.61% 3.68% -2.53% -2.31% 2.36% 3.66%

2007 -2.42% -5.12% -3.57% 1.01% 3.46% 4.17% 19.19% 6.35% -7.19% 5.88% 11.62% 1.52% 37.18%

2008 -0.19% 2.10% -1.58% -4.79% 4.29% -0.40% -4.96% 2.50% 14.48% 77.60% 13.03% 4.61% 132.29%

2009 0.12% 3.23% 1.22% -2.55% -8.18% -0.25% 3.81% 2.61% -0.34% 0.87% 2.68% -1.88% 0.74%

2010 -1.73% -1.49% 3.03% 4.41% 10.81% 2.72% -3.02% 7.39% 1.66% -2.17% 0.06% -1.78% 20.66%

2011 -5.75% -3.90% -4.86% 2.16% -2.25% -1.22% -6.01% 38.77% 9.55% -11.97% 3.63% -1.79% 8.82%

Relative Perform. Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Year

2006 -0.17% -0.09% -0.31% -0.05% 0.74% -0.14% -0.15% 0.06% 0.06% -0.29% -0.21% 0.05% -0.51%

2007 -0.20% -0.16% -0.23% -0.17% 0.00% 0.29% 1.11% 0.24% -0.55% 0.21% 0.79% 0.11% 1.45%

2008 0.29% 0.27% -0.06% -0.48% 0.15% 0.40% -0.21% 0.05% 1.17% 0.00% 0.00% 0.00% 1.59%

2009 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

2010 0.00% 0.00% -0.15% 0.14% 0.94% 0.40% 0.00% 0.00% 0.00% 0.00% 0.00% -0.42% 0.90%

2011 -0.41% -0.37% -0.25% -0.04% -0.06% 0.02% -0.20% 2.21% 0.00% 0.00% 0.00% 0.00% 0.90%

Back-tested Example: Equity Portfolio Impact of 5% position bought when VIX < $22, sold when VIX >$35

Page 17: Volatility: Friend or Foe? - ETF.com · Christopher Cole, CFA Artemis Capital Management LLC Artemis Vega Fund LP 520 Broadway, Suite 350 Santa Monica, CA 90401 (310) 496-4526 phone

But…it’s never that simple!

0.70

0.80

0.90

1.00

1.10

1.20

1.30

1.40

1.50

1.60

1.70

$10.

00

$12.

50

$15.

00

$17.

50

$20.

00

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50

$25.

00

$27.

50

$30.

00

$32.

50

$35.

00

$37.

50

$40.

00

$42.

50

$45.

00

$47.

50

$50.

00

Ratio

, 4-7

Mo

VIX

Cont

ract

s to

VIX

Fro

nt M

onth

Con

trac

t

VIX Spot Price

Slope of the VIX Futures Curve: Steeper at Low Levels of VIX Index

Page 18: Volatility: Friend or Foe? - ETF.com · Christopher Cole, CFA Artemis Capital Management LLC Artemis Vega Fund LP 520 Broadway, Suite 350 Santa Monica, CA 90401 (310) 496-4526 phone

Thank You.

Questions?