 | Volatility Arbitrage Strategies | |
The Proteom Volatility Arbitrage strategies
are based on proprietary econometric models (licensed from Investment
Analytics) that produce forecasts of future volatility of exceptional
accuracy. One measure of the ability of the models, direction
prediction accuracy, shows that, on average, the models enable the
correct timing of the volatility market approximately 75% of the time. |
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Description |
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Proteom uses proprietary quantitative models to
generate trades with theoretical edge in indices for global equity
markets. The Class E, F, G & H Series Funds also use a new class of high
frequency econometric models that produce highly accurate short term
volatility forecasts and use fractional co-integration analysis to
model the multivariate behavior of index volatility process. The
differentiation within the sub-classes of the E F, G & H Funds is
primarily based on the amount of leverage with which the strategy is
employed. | |
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The investment universe for the E Series Funds
comprises all of the available option series on the S&P500, QQQ and
other publicly traded market indices, including indices of non-US
equity markets. In addition, Exchange Traded Funds (“ETFs”), variance
swaps, volatility swaps and over-the-counter (“OTC”) derivatives may
also be employed. Also included are derivative products based upon
the VIX and other volatility indices which provide a tradable measure
of current and future market volatility in US and non-US equity
markets. The investment universe for the F Series Funds and G
Series Funds comprises options in the nearest two months in
approximately 200 stocks of the S&P500 index, together with the S&P500
and QQQ indices. The investment universe for the H Series Funds
comprises exchanges traded and OTC options, volatility and variance
swaps and volatility futures contracts on equity and volatility
indices. | |
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Data comprising closing market prices and risk
parameters are downloaded overnight and analyzed by the modeling
systems. A number of forecasting models are applied to each index in
the investment universe, which vary both in terms of forecast
frequency and in the emphasis given to individual aspects of
volatility behavior such as long-term memory or short-term memory,
volatility correlation, volatility asymmetry and the volatility of
volatility (kurtosis). A model management system continuously
evaluates each model on approximately 20-30 performance criteria and
weights the forecasts according to current performance. |
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Using these volatility forecasts, the modeling
systems then seek to identify risk arbitrage opportunities comprising
options and other OTC derivative products which the Investment Manager
believes are substantially under-priced or over-priced, on the basis
of proprietary derivatives pricing models. These arbitrage
opportunities are identified in an electronic trading sheet which is
routed to the trading system for review by the Investment Manager’s
trading team prior to execution. These arbitrage opportunities are
used to construct the volatility portfolios incrementally each day.
Volatility portfolios are consequently widely diversified, not only
with regard to the diversified indices in which positions are held,
but also with regard to option expiration, strike and entry point.
This serves to mitigate the stock-specific volatility risk in the
portfolio of each of the Series Funds. As a consequence, the number
of positions in a given portfolio, as well as its average tenor, will
vary over the course of time as existing positions expire and new
positions are added. The average tenor of the portfolio will
typically be of the order of 1-3 months, with annual turnover of
approximately six times or more. |
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Since the profitability of the
strategies is dependent upon the differential between the strategies’
view of volatility and that held by the market (as expressed by option
implied volatility), it is important that the majority of the
positions in the portfolio of each of the Series Funds are held until
option expiration. Consequently, the Investment Manager is attentive
to the issue of hedging the portfolio risk over the expiration cycle,
and in particular to maintaining market neutrality. At the end of
each day, the inventory of current positions is loaded automatically
into the risk management system for analysis. A daily risk analysis
is produced several hours before the start of each trading day which
seeks to identify the Value-at-Risk (VaR) in the existing volatility
portfolio of each Series Fund and each of its constituent elements.
Positions which may be contributing significantly to the total VaR, or
which have low or negative expected return, are marked for individual
hedging using underlying stocks, or may be liquidated prior to
expiration. The risk management system also seeks to identify an
excess or deficit in the overall portfolio deltas, which are then
hedged at the start of the trading session using an underlying index
stocks. The risk system also evaluates the Gamma, Theta and Vega risk
of the portfolio, and performs stress tests to assess the exposure to
crashes either in the overall market or in market volatility, or both.
The H Series Long-Only Volatility Funds are designed primarily as
hedging strategies which which provide insurance against major market
moves or volatility spikes. The strategies consist of long Gamma and
Vega positions in options and other derivatives which are designed to
increase substantially in value during major market moves. The hedge
portfolio is carefully constructed so that the cost of the insurance
is minimized during normal market conditions and will even provide a
modest return. The Funds will be used by equity portfolio managers
and investors in equity strategies wishing to cover their downside
market exposure in a highly cost-efficient way. |
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