Selective Dispersion Creating an affordable Long Volatility Exposure in an Equity Portfolio Assenagon Asset Management S.A.
Contents 1. Single Stocks Volatilities versus Index Volatilities 2. Volatility Flows and their Impact on Correlation 3. How to invest in Dispersion? 4. From a Pair Trade to a Selective Dispersion Portfolio Pair Properties What about the Skew? 5. Dispersion Portfolio An Example Cost of Carry 6. A "small" Digression 7. Summary Contacts Disclaimer Assenagon Asset Management S.A. 2
1. Single Stocks Volatilities versus Index Volatilities Standard dispersion investment: Trading an index volatility versus the volatility of its components But where do we stand on a broader scale? Volatility Pair Index (VPI) (Average implied volatility over 150 stocks worldwide) (Average implied volatility over 5 main indices worldwide) measured ATM forward with a maturity of 270 calendar days Value of X% average single stocks volatility trades X vol.-%-points above our basket of indices Current VPI value @ 5.5% VPI behaves positively wrt to volatility and offers a decent carry. How to gain such exposure? Can we further enhance carry and convexity of such a position? Volatility Pair Index 25% vol.-%-points 15% 25% 15% 5% 5% 2004 2006 2007 2008 2010 2011 2012 Volatility Pair Index (implied, ATMf, 270d) Volatility Pair Index (realized, 90d) 2014 y = 0.2352x + 0.0418 R² = 0.6486 4 6 8 implied volatility SPX Index (ATMf, 270d) Source: Assenagon Equity Derivatives Database, Bloomberg Assenagon Asset Management S.A. 3
2. Volatility Flows and their Impact on Correlation Contrarian flows explain distortions in correlation On indices The protection and hedging flow is focused on liquid indices. Tendency to drive the volatility higher. On stocks Dealers get long single stocks volatility through the issuance of structured products. Dealers books are short vol. convexity need to sell more volatility in markets with decreasing volatilities Overwriting flow for yield enhancement strategies 4 35% Tail Hedging Implied Single Stock Volatilities 4 35% Barrier Options put dealers long volatility: - Selling Down & Out puts - Reverse Convertible Structures - Autocallable Structures (Down & In puts) 25% 15% Variable Annuities Upside Protection Implied correlation increases when index volatility gets closer to stocks Implied Index Volatilities 25% 15% Overwriting Flow 5% 900.00 1300.00 1700.00 2100.00 Call Bid Call Ask Putl Bid Put Ask 80.00 130.00 180.00 230.00 Call Bid Call Ask Put Bid Put Ask Source: Assenagon Equity Derivatives Database Assenagon Asset Management S.A. 4
3. How to invest in Dispersion? Main trades offering dispersion exposure for the buyside: A practical perspective. ++ Fixed Strike Options Liquid and transparent instruments ++ Allows for active position Mgmt -- -- -- Path dependency Heavy maintenance: daily delta hedging, changing Γ & Ѵ etc Difficult to track the floating strike used when analyzing the correlation level ++ Low maintenance ++ Self delta hedging ++ Constant gamma +/- -- -- Variance Swaps Vol. convexity Valuation concerns (OTC product) Difficult to actively manage the position due to liquidity constraints ++/-- Volatility Swaps Mostly the same arguments as for the variance swap trade Assenagon Asset Management S.A. 5
How to invest in Dispersion? From an actively managed perspective: Instrument that can be frequently traded in & out Instrument where valuation can be independently determined IX Short Vol. 1 V+ S1 V+ S2 IX Short Vol. 2 Dispersion Exposure is generated through a sum of Volatility Pair Trades Actively managing your pairs (profit or loss taking) Liquidity & Transparency Var./ Vol. Swap Options Monitoring carry (realized implied) on a micro level Keeping an optimized dispersion position at any time Trading fixed strikes options (liquid, listed, transparent for valuation) #1 OTC Counterpart + only selected banks quoting Listed Market Transparent Valuation OTC Market Trading with some improvements taking into account the skew dynamics Assenagon Asset Management S.A. 6
4. From a Pair Trade to a Selective Dispersion Portfolio In order to get exposure to an optimized version of the "Volatility Pair Index", one can apply a comprehensive screening on all volatility pairs to detect those with the following properties: Long convexity bias Minimizing implied draw downs given volatility regimes Vega neutral (long/short volatility in the same amount) Maximizing carry (realized implied volatility) Diluting the correlation risk Implied volatility pair GS US SPX Index (ATMf, 360d) 7 7 y = 0.83x - 0.0443 R² = 0.5759 6 Convexity 5 45% 4 6 35% 5 4 4 25% 15% 5% Historical implied floor 4 5 implied volatility SPX Index (ATMf, 360d) 6 2005-5% 2007 2009 2011 2013 Carry implied volatility pair GS US - SPX (rhs) Implied volatility pair GS US - SPX (lhs) Source: Assenagon Equity Derivatives Database Assenagon Asset Management S.A. 7
Correlation Correlation Correlation 4. From a Pair Trade to a Selective Dispersion Portfolio One can understand and quantify how each pair reacts to correlation movements 10 75% 5 25% 7 6 5 4 2006 2008 2010 2012 2014 SPX 1y realized correlation SPX 1y implied correlation Implied volatility pair GS US SPX Index (ATMf, 1y) vol.-%-points 9 4 8 7 6 5 4-2006 2008 2010 2012 2014 SPX 1y realized correlation SPX 1y implied correlation Implied volatility pair SIE GY DAX Index (ATMf, 1y) vol.-%-points 9 8 7 6 5 4 2006 2008 2010 2012 2014 9% 8% 7% 6% 5% 4% 3% 2% 1% vol.-%-points SPX 1y realized correlation SPX 1y implied correlation Implied volatility pair RTY Index SPX Index (ATMf, 1y) Source: Assenagon Equity Derivatives Database Assenagon Asset Management S.A. 8
4. From a Pair Trade to a Selective Dispersion Portfolio What about the skew? Buy Optionality: Sell an amount of Δ to compensate the skew effect In its magnitude, this Δ is similar to a Variance Swap Δ 4 35% 25% 15% 5% 900.00 1300.00 1700.00 2100.00 Call Bid Call Ask Putl Bid Put Ask Volatility Pair Volatility Pair Long Vega Short Vega Long Vega Short Vega Short Delta Long Delta Source: Assenagon Equity Derivatives Database Assenagon Asset Management S.A. 9
5. Dispersion Portfolio An example With Fixed Strike Options Managing the skew effect is essential to mitigate tracking errors Residual long Δ (skew difference index vs. stocks) Note: variance swap dispersion is showing similar long Δ net exposure Plain Vanilla Selective Dispersion Position SPX -400k USD Vega AFL US BHP US CAT US CMCSA US CMI US Total net Δ Additional Δ +7.2M USD -141k USD -122k USD -115k USD -89k USD -100k USD +3.9M USD Variance Swap Selective Dispersion Position SPX -400k USD Vega AFL US BHP US CAT US CMCSA US CMI US Total net Δ Additional Δ +5.7M USD -100k USD -110k USD -100k USD -90k USD -80k USD +2.7M USD 18% 16% 14% 12% 8% 6% 4% 2% 2014 collapse in dispersion levels 2009 2010 2011 2012 2013 Selective dispersion (fixed strikes + additional deltas) Volatility Pair Index Source: Assenagon Equity Derivatives Database Assenagon Asset Management S.A. 10
5. Dispersion Portfolio Cost of Carry Managing the cost of carry in the portfolio is essential for the long-term sustainability of the position. Carry is produced through realized volatilities and captured by means of daily delta hedging. Despite a challenging year 2014 with shrinking implied levels of dispersion, the carry was a constant source of return. Selective dispersion in 2014 (net carry) 1.4 1. 1.0 0.8 Dispersion Performance YTD 8% 7% 6% 0.6 5% 0.4 4% 0. 0.0 Jan 14 Mar 14 May 14 3% Jan 14 Mar 14 May 14 Jul 14 Dispersion performance Dispersion performance + carry Source: Assenagon Equity Derivatives Database Assenagon Asset Management S.A. 11
6. A "small" Digression What is that? Without a 30 months shift forward in FDFD Index 45 8 45 8 40 7 40 7 35 6 35 6 30 5 30 5 25 4 25 4 20 3 20 3 15 2 15 2 10 1 10 1 5 0 5 0 0-1 Apr 95 Jun 98 Sep 01 Nov 04 Feb 08 Apr 11 Jun 14 0-1 Oct 92 May 96 Nov 99 May 03 Dec 06 Jun 10 Jan 14 SPX realized 360 volatility Days Realized SPX Index Volatility (360d)? SPX realized 360 volatility Days Realized SPX Index Volatility (360d) FDFD index Index Source: Bloomberg Assenagon Asset Management S.A. 12
7. Summary Trading dispersion can offer both long volatility and positive carry Current dispersion levels are very attractive compared to recent years Practical implementation can be tricky and cumbersome (but not impossible) Ensuring liquidity in the dispersion portfolio is crucial Assenagon Asset Management S.A. 13
Contacts Customer Coverage Hans Günther Bonk Phone +49 89 519966-410 hans-guenther.bonk@assenagon.com Michael Huber Phone +49 89 519966-452 michael.huber@assenagon.com Matthias Kunze Phone +49 89 519966-421 matthias.kunze@assenagon.com Michael van Riesen Phone +49 89 519966-419 michael.vanriesen@assenagon.com Ronald Siebel Phone +49 89 519966-420 ronald.siebel@assenagon.com Marcus Steudner Phone +49 89 519966-451 marcus.steudner@assenagon.com Sales Operations Simone Alanne Phone +49 89 519966-460 simone.alanne@assenagon.com Carina Herz Phone +49 89 519966-462 carina.herz@assenagon.com Senior Advisor Christian Maria Kreuser Phone +49 89 519966-378 christian-maria.kreuser@assenagon.com Chief Economist Dr. Martin W. Hüfner Phone +49 89 519966-150 martin.huefner@assenagon.com Imprint Assenagon Asset Management S.A. Aerogolf Center 1B, Heienhaff 1736 Senningerberg, Luxemburg Assenagon Asset Management S.A. Zweigniederlassung München Prannerstraße 8 80333 München, Deutschland Assenagon Schweiz GmbH Paradeplatz 4 8001 Zürich, Schweiz Assenagon Client Service GmbH Prannerstraße 8 80333 München, Deutschland www.assenagon.com Scan for App Assenagon Asset Management S.A. 14
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