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Inside top volatility trading duo's performance drivers

Inside top volatility trading duo's performance drivers

What is difficult in volatility trading is to find the right collateral, according to Feri’s Daniel Lucke and Steffen Christmann.

The Feri duo behind the OptoFlex fund currently sit joint third in the volatility trading category, having returned 12.7% over the past three years.

This is only a slight lag behind the sector's top manager, HSBC’s Florian Reibis, who returned 13.8% for the HSBC Aktienstrukturen Europa fund.

‘We invest in volatility risk premium using US stock and volatility index options. The target of OptoFlex is to harvest the volatility risk premium in a risk-reduced way. This strategy is required to hold a lot of cash as collateral.

‘It’s currently challenging to buy high-quality collateral bonds at good prices as there is high demand for those bonds in the market.

'On the other hand, our collateral is very easy to sell and, in case of fund flows, very quickly liquidated. We have strict guidelines which mean we just invest in quasi-sovereign euro-denominated floaters which have an AAA- or AA rating’, Christmann said.

Christmann said the team buys high-quality, floating rate quasi-sovereign bonds. This is a hot part of the market with heavy investor interest, including action from the European Central Bank.

While Lucke said the team is currently focused on European bonds with a tilt towards Germany and Austria.

‘Bonds have to be high quality and low-interest rate duration. It’s just the collateral to prove the ability to pay on the potential liabilities from taking insurance risk against stock market crashes through the options portfolio.

‘On the options side of things we don’t see any difficulties at the moment, liquidity is extremely good and our positions are systematic and static, so not dependent on market timing.’

Driving returns

Over the past year the fund has returned 4.4%, Lucke said the main driver of returns has been the put options the fund currently has.

‘The volatility risk that is dominating the price of the S&P 500 put options that we sell to collect premium is driving the performance,' he said.

Volatility risk premia is currently in the mid-range in terms of attractiveness. Additionally, there is no significant decline in the spread between implied and realised volatilities.

‘The difference in risk which is priced into the options, so implied volatility, and the subsequently realised market moves have been quite stable despite generally declining volatility over the last few years. Due to this our collected premium – which drives our returns - has been very stable over the year.’

Lucke said everything has gone to plan so far for the team this year as there have been no significant drops in the S&P 500, allowing them to collect the right amount of option premiums.

‘We are short volatility as our main income generating position and we use about half of the collected options premium to pay for tail-risk hedges to protect our portfolio and keep drawdowns relatively low.

‘This makes the strategy interesting for investors as they can hold on to the positions and profit from the good performance after temporary drawdowns.

'If we go into market drawdown it helps our strategy that volatility increases because our hedges then reduce the losses on our core positions.'

Lucke said 2015 was a great environment for the strategy because the implied volatility they sold was much higher than subsequently realised volatility.

'We could earn the difference,' he said, 'Despite the market drop in August 2015 and January 2016 the higher implied volatility in the months thereafter generated very attractive returns.

'Since then markets have been calm and volatility premiums still on a mid-range level which led to mostly positive monthly results.'

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