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Volatility Trading and Risk Management

Last week was interesting.
There is actually NOT a Chinese curse that says, “may you live in interesting times”. Apparently, the whole thing was made up by a British diplomat. Nonetheless, a lot of volatility funds were cursed by last week being interesting.
There are many things volatility funds can do, so their returns have a wide range. I’ve seen numbers ranging from up 25% to down 95% (we made a few percent and thank you for your concern). The median was a loss of about 30%. This is because most volatility funds are option sellers trying to collect the volatility premium. I’ve written aboutthisalot. It is a perfectly viable strategy. So how did a professional fund lose 95%?
I don’t know. Thankfully I wasn’t in that trading room. But some of it may be down to misunderstanding trade sizing when returns are highly negatively skewed, as they are when short volatility. I’ve written about trade sizing in these situations before, but the general problem can be seen in a simple example.

We Don't Know as Much as We Think We Do

Traders don’t know much either. I’m not talking about the general ignorance of most traders, but specifically the history of markets is nowhere near as big as we often assume. For example, equity options have only been traded in liquid, transparent markets sine the CBOE opened in 1973. S&P 500 futures and options have only been traded since 1982. The VIX didn’t exist until 1990 and wasn’t tradable until 2004. And the average lifetime of a S&P 500 company is only about 20 years.
This might seem like a decent length of history that we can study and look for patterns. But I doubt that it is. I think that while there appear to be many thousands of data points, there might only be dozens. Options and volatility wiggle around a lot but their long-term values are related to macro variables such as inflation, monetary policy, commodity prices, interest rates and earnings. And these change on the order of months and years. Even worse, they are all co-dependent.
I think this makes quan…

The Government Shutdown

Over the last ten years, a number of congress members have been elected on a fairly nihilistic platform, voting against practically any spending bill (unless it buys tanks). This is a good way to get elected but it makes it hard to govern. The government has to spend money. While the Republicans have majorities in both houses, there is a huge difference in political philosophies between members of that party. So the current shutdown was probably inevitable.
What does a shutdown entail?
Apart from “essential services” (active military, FBI, air traffic controllers etc, and the congressional gym) federal government functions are frozen, and about 800,000 federal employees will be furloughed.
National parks, monuments and the Smithsonian museums in Washington will be closed. Other things that stop are processing of applications for passports and visas, and the maintenance of U.S. government websites. The Internal Revenue Service and the Federal Housing Administration close. In the 2013 shut…

Holiday Party Wisdom

Now that trading floors are basically a thing of the past, traders don't socialize together as much as they once did. This time of year is an exception as we go to (and stagger back from) the holiday parties of trading firms, brokerages and exchanges. I thought it would be a good time to get some thoughts from revelers on traders, trading, bitcoin, and the future. It was a fairly random process. I just chatted until they said something memorable.

I've edited the comments for readability and, in a few cases, sobriety.

"Young traders think it is all about some super smart move they make. This is bullshit. Tricky situations come up maybe once or twice in a career. Who cares what you do then? It is about grinding it out."
- An old trader.

" The biggest lie is, "It is all about psychology. It is all about edge."
-Owner of a prop trading firm.

"A lot of successful traders don't really know what they are doing."
- A risk manager.

"I can…