Skip to main content


Due Diligence as an Alpha Generator

“People, process and product”
-Marcus Lemonis, host of CNBC’s “The Profit”
In my last post I discussed some of the hazards of assigning numerical measures to hedge fund performance and suggested that keeping things simple might be the most robust approach. Here I’m going to write about evaluating the business side of a fund.
In his business turnaround TV show, Marcus Lemonis is fond of saying that he evaluates a business based on people, process and product; his “three p’s”. I’m going to use the same framework but add one more as well. I must list these in some order, but that doesn’t reflect any degree of importance.
Everything a fund does is because of the people running it. You are not investing in a fund. You are investing with people. It is important to know who the managers are, their backgrounds, their experiences, their levels of involvement and the amount, both professionally and financially, they have invested.Do they treat your money even more respectfully than they…
Recent posts

The Siren of Statistics

A siren was a mythological being who lured sailors with their enchanting music to shipwreck on the rocky coasts of their island. Their songs were almost impossible to resist. But more generally a “siren” is a bad thing that we are attracted to, either physically or psychologically.
For investors, an example of a siren’s song is simplicity. Many investors are prone to looking for just a few metrics to evaluate a fund or a strategy. This is a problem. It is a problem for me because my answers to reasonable sounding questions will be incomplete. “What is your Sharpe ratio?” sounds reasonable enough. But the answer on its own is close to meaningless without a much more detailed elaboration. What is the sampling error around the point estimate? How constant has it been across sub-periods? How distorted is it due to the shape of the full return distribution? But, more importantly, it is a problem for the investor because the simple answer gives a false sense of certainty.
Is the Sharpe rat…

The VIX is Not Broken

On April the 24th, the Wall Street Journal ran a story detailing the huge move of the VIX index in the opening 30 minutes of trading on the previous Wednesday. The VIX spiked up 12% in 30 minutes despite the underlying S&P 500 index not moving much at all. To put this 12% move into perspective, the current expected move in a 30-minute period is less than 2%. In addition to being a large move, the timing was suspicious. It was during this period that the settlement price for the April VIX futures was calculated. Anyone holding a long futures position would have benefitted greatly, at the expense of the shorts.
There have been rumors about the manipulation of the VIX index for many years. Whether or not the anomalously large S&P 500 option trades during the settlement period are evidence of manipulation, part of an arbitrage or just coincidence, the fact is that the VIX settlement period is often atypically volatile. This is alarming for market-makers and professional arbitrage…

New Volatility Regime

The equity market hasn’t really decided what it wants to do. However, we are now very clearly in a new volatility regime. From the start of 2017 through to the end of this January, realized volatility was 6.9%. In February and March, it was 23.6%. 

Below I show the S&P 500 from the start of 2017 until the end of this March.

Things have changed.

But what is particularly interesting to me is how exactly things have changed, because that is a little unusual. 

Generally periods of high volatility have one major cause: the Asian crash, LTCM blowup, the dot-com bubble or the housing credit crisis. But this year we have had two distinctly different periods.

The start of the turmoil was on Friday, February 2nd, when the S&P 500 dropped 2.1% and the VIX rallied 28.5% from 13.47 to 17.31. This was a large move: the 34th largest in history. But Monday the 5th was truly exceptional. The S&P 500 dropped 4.2%, but the VIX rallied 115.6%. This was the largest VIX move ever, and nearly twice t…

Adversity and the Variance Premium Part 2

Following on from the last post we will now look at how the concept of adversity can lead to the variance premium.
Let’s think about a $100 stock and the $100 strike call and put. Assuming no interest rates or dividends, and a volatility of 30%, both the one-year call and put will each be worth $9.92. One trader sells the put, and another buys the call. Now let’s look at two price paths for the stock.
Case One:
On the first day, the stock jumps to $119.84. It stays there until expiration. Each trader makes $9.92 at expiry, but the PL evolves slightly differently over time.

Figure One: PL for short put.

Figure Two: PL for long call.
Now consider the case when the jump happens right at expiration.

Figure Three: PL for short put.

Figure Four: PL for long call
My contention is that the shape of Figure Four is the one most preferred by investors. That the long option maintains the ability to “snatch victory from the jaws of defeat” is important. People prefer this, which points to options…