Why overlays – why now?
2008 market downturn exposed fundamental weaknesses
-Hedge funds did not provide a hedge.
-Fund of Funds did not provide diversification.
-Decoupling held true for only a short period.
-When global markets sank, correlation across all asset classes went to one.
-Not enough managers used dynamic hedging and volatility indices to control risk across asset classes.
-Minimal expertise and trading acumen available for using these instruments effectively
Monetizing Volatility – Management Strategies
-Volatility is typically negatively correlated with market movement and can be an important asset to manage. When done so effectively, volatility management may enhance overall portfolio returns
-Equity portfolio managers could use volatility strategies to implement long and short directional views in volatility.
-Credit managers can use volatility strategies as a diversifying hedge against broad market exposure.
-Based on these characteristics, VIX option strategies can be structured to provide a “catastrophe hedge” within stock portfolios
Strategy for Large Cap Long Term Holds as Yield Enhancer
-MSFT is one of the largest firms in the world and by most pension plan, index funds, ETF’s they must own a certain percentage of the stock. These people cannot sell out of the stock entirely due to investment guidelines.
-If as an investor you think MSFT is dead money or will not have huge up side or down-side moves
-With MSFT at $25.70, the September 27 calls are trading at $0.40. Sell that call; receive the premium for ~1.5% return on your money every 2 months. Area you would average in and buy more of stock, you Sell Sep 23 put at $0.30 for total of ~1.2% yield every 6 months.
-Net, if MSFT is range bound, then yield enhancement 2.7% x 6 = 16.2%