Highly Evolved Vol

(This is an excerpt from my upcoming book on positional option trading.) The traders’ concept of the Efficient Market Hypothesis (EMH) is, “making money is hard”. This isn’t wrong, but it is worth looking at the theory in more detail. Traders are trying to make money from the exceptions to the EMH, and the different types of inefficiencies should be understood, and hence traded, differently. The EMH was contemporaneously developed from two distinct directions. Paul Samuelson (Samuelson, 1965) introduced the idea to the economics community under the umbrella of “rational expectations theory”. At the same time, Eugene Fama’s studies (Fama, 1965 a and b) of the statistics of security returns lead him to the theory of “the random walk”. The idea can be stated in many ways, but a simple, general expression is: A market is efficient with respect to some information if it is impossible to profitably trade based on that information. And the “profitable trades” are risk adjuste

2018 hasn't been a good year for volatility funds. In February there was a feedback driven catastrophe in the implied volatility space. The details are less important than the result. A lot of volatility funds lost more than 30% in the month and one of the largest funds lost over 80% in a day. The last few months have also been tricky. Equity markets have been more volatile than expected, but the bigger problems have been in the commodity space. In particular, crude oil and natural gas have been, to quote a very experienced trader, "****** unbelievably ****** insane! Like ****! Seriously dude. ****!". And you may have seen a sad youtube video where a hedge fund manager tearfully apologizes to his clients for losing all of their money due to the "rogue wave" in the natural gas market. I'm not dancing on anyone's grave. I hate to see a business fail and I hate to see investors lose money. But there are also some important lessons here. February e

Mid-term elections are not usually very memorable affairs. The voter turnout is much lower than for presidential elections (since 1960, voter turnout has averaged around 40% versus 60%). It seems likely that voter interest is atypically high this year, but that isn't the point of this post. What I want to know is, "How do mid-terms affect volatility?" It is generally true that volatility declines after scheduled events like this. It has been shown to be true for presidential elections, but it also applies to crop reports, earnings announcements and big economic releases. My guess was that mid-terms also produce a similar effect. The average voter might not be interested, but volatility prices are set by the marginal volatility trader not the average voter. Vix data only goes back to 1990. This isn't a particularly large sample, but it does cover some significant political issues including two gulf wars, the Lewinsky affair, a disputed election and the tea party fo

“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. People 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