Paul Baiocchi, Moderator
ETF Analyst, IndexUniverse
Christopher Cole, CFA, Panelist
Managing Partner & Founder Artemis Capital Management LLC
Thomas M. Chapin, CFA, Panelist
Chief Investment Officer Mill Creek Capital Advisors LLC
Volatility: Friend or Foe?
Paul Baiocchi Moderator ETF Analyst IndexUniverse
Volatility: Friend or Foe?
Thomas M. Chapin, CFA Panelist Chief Investment Officer Mill Creek Capital Advisors LLC
Christopher Cole, CFA Panelist Managing Partner & Founder Artemis Capital Management LLC
Christopher Cole, CFA Artemis Capital Management LLC Artemis Vega Fund LP 520 Broadway, Suite 350
Santa Monica, CA 90401
(310) 496-4526 phone
(310) 496-4527 fax
VOLATILITY: FRIEND OR FOE? I N S I D E E T F S T R A D I N G C O N F E R E N C E / N E W Y O R K S T O C K E X C H A N G E - D E C E M B E R 1 1 , 2 0 1 2
For Investment Professional Use. Not for Distribution
Abnormally Steep VIX Futures Term Structure
1
BULL MARKET IN FEAR
"There is no terror in the bang, only in the anticipation of it." Alfred Hitchcock
The most extreme term-structure for forward volatility in two decades reflects continued anticipation of a deflationary collapse and structural imbalance in risk
VIX
M3
M6
0.50x
0.70x
0.90x
1.10x
1.30x
1.50x
1.70x
1.90x
Ma
r-0
4Ju
n-0
4S
ep
-04
No
v-0
4F
eb
-05
Ma
y-0
5A
ug
-05
Oct
-05
Jan
-06
Ap
r-0
6Ju
n-0
6S
ep
-06
De
c-0
6M
ar-
07
Ma
y-0
7A
ug
-07
No
v-0
7
Fe
b-0
8
Ap
r-0
8
Jul-
08
Oct
-08
De
c-0
8
Ma
r-0
9
Jun
-09
Se
p-0
9
No
v-0
9
Fe
b-1
0
Ma
y-1
0
Jul-
10
Oct
-10
Jan
-11
Ap
r-1
1
Jun
-11
Se
p-1
1
De
c-1
1
Fe
b-1
2
Jul-
12
Expiry
Vix
Fu
ture
s/S
po
t V
ix
Bull Market in Fear / VIX Futures Curve (normalized by spot VIX) 2004 to Present
VO
LATILITY: F
RIEN
D OR F
OE?
10
15
20
25
30
35
Spot Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8
Forw
ard
VIX
ind
ex
(%)
Low Volatility? Really?VIX Futures Curve Comparison
August 2012 vs. September 2008
August 17, 2012 / Lowest VIX in 5 years
September 15, 2008 / Day after Lehman Bros. Bankruptcy
TEMPORAL PARADOX - Abnormally Steep VIX Futures Term Structure
2
Low VIX index does not mean cheap volatility
On August 17th 2012 spot VIX touched a 5 year low at 13.45 however…
It was more expensive to buy forward volatility at 6-12 months with the VIX at 13.45 in 2012 than it was one day after Lehman went bankrupt in 2008 when the VIX was at 31
Volatility hedge executed at the August 2012 low in spot-VIX would have already lost -12% of its value even while VIX increased by +15%
Successful hedging requires going beyond simplistic heuristics based on the absolute price of the VIX
!
Volatility is more than the VIX index
Overt focus on VIX is analytical equivalent using the 1yr UST to explain the entire bond market!
Volatility is more than the VIX index
Overt focus on VIX is analytical equivalent using the 1yr UST to explain the entire bond market!
Low VIX index does not mean cheap volatility Forward volatility more expensive in August 2012 at the 5 year low in the VIX than it was the day after Lehman went bankrupt
VO
LATILITY: F
RIEN
D OR F
OE?
VO
LATILITY: F
RIEN
D OR F
OE? Sorcerer's Apprentice and TVIX
3
DON’T BE A FOOL TVIX became the market for short-term VIX futures in Q1 2012
Overflowing TVIX vega exposure is a wake up call to the entire leveraged ETN industry
TVIX vega flows directly impacted implied VOV in Q1 2012 (the elephant in the room)
Leveraged vega introduces self-reflexivity and amplification in the direction of spot vol movement (see graph)
Fortunately SPX options open interest indicated excess vega from VIX ETN flows were absorbed without disruption to broader options markets
-$70
-$60
-$50
-$40
-$30
-$20
-$10
$0
$10
$20
$30
-50%
-40%
-30%
-20%
-10%
0% 10%
20%
30%
40%
50%
60%
70%
Ch
ange
in V
ega
Exp
osu
re (
$m
m)
% Move in Vol (rebalanced 1+2 month VIX Futures)
TVIX Vega Exposure spot Vol Move
5
7
9
11
13
15
17
19
21
2/1 2/15 2/29 3/14 3/28
VIX index & TVIX
Feb 2012 to Mar 2012
TVIX ETNVIX
CS reissues TVIX shares 3/22
Moral of Story: Vol ETPs do not simplify the process of volatility trading any more than CDOs enhance the credit quality of their components
On February 21 Credit Suisse suspended issuance of the Velocity Shares 2x Short-Term VIX ETN due to "internal limits on the size of the ETNs“
Unbeknownst many retail investors continued to buy TVIX bidding it up to an 89% premium to NAV
TVIX's price collapsed by 50% in just two days after reissuance
Leveraged ETPs introduce self-reflexivity whereby the issuer's vol exposure is amplified in the direction of spot vol movement
20
12
(VIX
Fut)
20
12
(Vix)
20
11
(Vix)
20
10
(Vix)
20
09
(Vix)
20
08
(Vix)
20
30
40
50
60
70
80
90
100
9:31
AM
9:47
AM
10:0
3 A
M
10
:19
AM
10:3
5 A
M
10:5
1 A
M
11:0
7 A
M
11:2
3 A
M
11:3
9 A
M
11:5
5 A
M
12
:11
PM
12:2
7 PM
12:4
3 PM
12:5
9 PM
1:1
5 P
M
1:3
1 P
M
1:4
7 P
M
2:03
PM
2:1
9 P
M
2:3
5 P
M
2:51
PM
3:07
PM
3:2
3 P
M
3:3
9 P
M
3:55
PM
4:1
1 P
M
Vo
lati
lity
of
VIX
by
Min
ute
(%
an
nu
aliz
ed
)
Volatility of VIX Index vs 1m Vix Future (2012) by Trading Minute
Averages by Year (annualized)
2012 (VIX Fut) 2012 (Vix) 2011 (Vix) 2010 (Vix) 2009 (Vix) 2008 (Vix)
Volatility Microstructure Changes due to VIX ETNs
Volatility-of-VIX futures in the last 15 minutes is substantially higher than that of the VIX index itself demonstrating the power of VIX ETNs Volatility-of-volatility microstructure is calmer than at any point
over the past six years of data (below)
The VIX index registered the lowest intra-day movement in history on January 11th (1.14%)
S&P 500 index had biggest yearly reduction in daily moves in eight decades (since FDR 1934 USD devalue)
Source: Calculations executed by Artemis Capital Management LLC with data from CQG data factory. Average executed trades by minute.
VO
LATILITY: F
RIEN
D OR F
OE?
Volatility-of-VIX microstructure is calmer in 2012 however the last 30 minutes of the trading day have become increasingly more violent than previous periods
4
Shadow Delta of VIX Derivatives
5
Systematic VIX ETN strategies that rely on constant hedging relationships will not track back-tests during changing SPX forward skew regimes due to “shadow” delta drift
How do popular VIX ETPs perform in relation to traditional Volatility Trades? NOT VERY WELL!
VIX options are priced from VIX futures (not the VIX) hence their volatility increases exponentially as a function of time to expiration and SPX forward skew
Systematic VIX ETN strategies that rely on constant hedging relationships will not track back-tests during changing SPX forward skew regimes due to “shadow” delta drift
VO
LATILITY: F
RIEN
D OR F
OE?
0.3
0.5
0.7
0.9
1.1
1.3
1.5
1.7
1.9
2.1
De
c-10
Jan
-11
Feb
-11
Ma
r-11
Ap
r-11
Ma
y-11
Jun
-11
Jul-1
1
Au
g-1
1
Sep
-11
Oct-1
1
No
v-11
De
c-11
Jan
-12
Feb
-12
Ma
r-12
Ap
r-12
Ma
y-12
Jun
-12
Jul-1
2
Gro
wth
of
$1
VIX ETPs vs. Traditional SPX Volatility Trades
Dec 2010 to July 2012
Traditional Volatility Trading Volatility ETNs
ATM Long
Straddle
ATM Short
Straddle10% OTM Put VXX VXZ XIV XVIX
Vol Bias Long Vol Short Vol Long Vol Long Vol Long Vol Short Vol Short Vol
Annualized Return -28.62% 31.31% -15.36% -52.35% -26.98% 12.13% -3.61%
Sortino Ratio -1.77x 0.79x -0.61x -1.94x -1.53x 0.18x -0.45x
Sharpe Ratio -1.20x 0.85x -0.45x -1.05x -0.87x 0.16x -0.30x
Return to Drawdown -0.57x 1.10x -0.36x -0.65x -0.58x 0.15x -0.20x
Max Drawdown -50.16% -28.39% -42.87% -80.38% -46.50% -79.53% -18.06%
Christopher Cole, CFA – General Partner and Founder
Artemis Vega Fund L.P. Artemis Capital Management, L.L.C.
520 Broadway, Suite 350 Santa Monica, CA 90401
[email protected] www.artemiscm.com
Christopher Cole, CFA
Managing Partner & Portfolio Manager (310) 496-4526 phone
(310) 496-4527 fax [email protected]
Contact Information Artemis Capital Management – Contact Information
6
Christopher Cole, CFA
Managing Partner & Portfolio Manager / Artemis Capital Management LLC
Christopher R. Cole, CFA is the founder of Artemis Capital Management LLC and the portfolio manager of the Artemis Vega Fund LP. Mr. Cole’s core focus is systematic, quantitative, and behavioral based trading of exchange-traded volatility futures and options. His decision to form a fund came after achieving significant proprietary returns during the 2008 financial crash trading volatility futures. His research letters and volatility commentaries have been widely quoted including by publications such as the Financial Times, Bloomberg, International Financing Review, CFA Magazine, and Forbes. He previously worked in capital markets and investment banking at Merrill Lynch. During his career in investment banking and pension consulting he structured over $10 billion in derivatives and debt transactions for many high profile issuers. Mr. Cole holds the Chartered Financial Analyst designation, is an associate member of the NFA, and graduated Magna Cum Laude from the University of Southern California.
Key Information/ Biography
VO
LATILITY: F
RIEN
D OR F
OE?
LEG
AL D
ISCLA
IMER
Legal Disclaimer
THIS IS NOT AN OFFERING OR THE SOLICITATION OF AN OFFER TO PURCHASE AN INTEREST IN ARTEMIS VEGA FUND, L.P. (THE “FUND”). ANY SUCH OFFER OR SOLICITATION WILL ONLY BE MADE TO QUALIFIED INVESTORS BY MEANS OF A CONFIDENTIAL PRIVATE PLACEMENT MEMORANDUM (THE “MEMORANDUM”) AND ONLY IN THOSE JURISDICTIONS WHERE PERMITTED BY LAW. AN INVESTMENT SHOULD ONLY BE MADE AFTER CAREFUL REVIEW OF THE FUND’S MEMORANDUM. THE INFORMATION HEREIN IS QUALIFIED IN ITS ENTIRETY BY THE INFORMATION IN THE MEMORANDUM.
AN INVESTMENT IN THE FUND IS SPECULATIVE AND INVOLVES A HIGH DEGREE OF RISK. OPPORTUNITIES FOR WITHDRAWAL, REDEMPTION AND TRANSFERABILITY OF INTERESTS ARE RESTRICTED, SO INVESTORS MAY NOT HAVE ACCESS TO CAPITAL WHEN IT IS NEEDED. THERE IS NO SECONDARY MARKET FOR THE INTERESTS AND NONE IS EXPECTED TO DEVELOP. NO ASSURANCE CAN BE GIVEN THAT THE INVESTMENT OBJECTIVE WILL BE ACHIEVED OR THAT AN INVESTOR WILL RECEIVE A RETURN OF ALL OR ANY PORTION OF HIS OR HER INVESTMENT IN THE FUND. INVESTMENT RESULTS MAY VARY SUBSTANTIALLY OVER ANY GIVEN TIME PERIOD.
CERTAIN DATA CONTAINED HEREIN IS BASED ON INFORMATION OBTAINED FROM SOURCES BELIEVED TO BE ACCURATE, BUT WE CANNOT GUARANTEE THE ACCURACY OF SUCH INFORMATION.
7
The User Perspective
Context: Mill Creek Capital Advisors
Philadelphia-area investment advisory firm (“outsourced CIO” business model)
Work with HNW families, endowments/foundations, and defined benefit plans
Allocate assets across spectrum of global capital markets
Manager of managers
Execution: Separate Accounts, Mutual Funds, ETFs
Hedging Against (Equity Portfolio) Volatility
Hired by clients to take “appropriate risks” with their portfolios
Long-Term Hedges Own assets with positive return characteristics which are not as volatile
as (or which are non-correlated or have low correlation to) global equities
Short-Term Hedges Go to Cash?
Options + Futures?
Structured Notes?
Buy Gold?
Buy Volatility?
Why Buying Volatility Look(ed) Interesting
$-
$5.0
$10.0
$15.0
$20.0
$25.0
$30.0
$35.0
$40.0
$45.0
$50.0
$55.0
$60.0
$65.0
$70.0
$75.0
$80.0
$85.0
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
S&P Price Volatility
VIX Price (RHS)
10-year average
What About Selectively Owning “Dynamic Volatility”?
Own Vol (1=Yes) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2006 1 1 1 1 1 1 1 1 1 1 1 1
2007 1 1 1 1 1 1 1 1 1 1 1 1
2008 1 1 1 1 1 1 1 1 1 - - -
2009 - - - - - - - - - - - -
2010 - - 1 1 1 1 - - - - - 1
2011 1 1 1 1 1 1 1 1 - - - -
S&P 500 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Year
2006 2.65% 0.27% 1.24% 1.34% -2.88% 0.14% 0.62% 2.38% 2.58% 3.26% 1.90% 1.40% 15.79%
2007 1.51% -1.96% 1.12% 4.43% 3.49% -1.66% -3.10% 1.50% 3.74% 1.59% -4.18% -0.69% 5.49%
2008 -6.00% -3.25% -0.43% 4.87% 1.30% -8.43% -0.84% 1.45% -8.91% -16.80% -7.18% 1.06% -37.00%
2009 -8.43% -10.65% 8.76% 9.57% 5.59% 0.20% 7.56% 3.61% 3.73% -1.86% 6.00% 1.93% 26.46%
2010 -3.60% 3.10% 6.03% 1.58% -7.99% -5.23% 7.01% -4.51% 8.92% 3.81% 0.01% 6.68% 15.06%
2011 2.37% 3.43% 0.04% 2.96% -1.13% -1.67% -2.03% -5.43% -7.03% 10.93% -0.22% 1.02% 2.11%
VXZ-linked Index Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Year
2006 -0.76% -1.62% -5.02% 0.40% 11.92% -2.71% -2.33% 3.61% 3.68% -2.53% -2.31% 2.36% 3.66%
2007 -2.42% -5.12% -3.57% 1.01% 3.46% 4.17% 19.19% 6.35% -7.19% 5.88% 11.62% 1.52% 37.18%
2008 -0.19% 2.10% -1.58% -4.79% 4.29% -0.40% -4.96% 2.50% 14.48% 77.60% 13.03% 4.61% 132.29%
2009 0.12% 3.23% 1.22% -2.55% -8.18% -0.25% 3.81% 2.61% -0.34% 0.87% 2.68% -1.88% 0.74%
2010 -1.73% -1.49% 3.03% 4.41% 10.81% 2.72% -3.02% 7.39% 1.66% -2.17% 0.06% -1.78% 20.66%
2011 -5.75% -3.90% -4.86% 2.16% -2.25% -1.22% -6.01% 38.77% 9.55% -11.97% 3.63% -1.79% 8.82%
Relative Perform. Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Year
2006 -0.17% -0.09% -0.31% -0.05% 0.74% -0.14% -0.15% 0.06% 0.06% -0.29% -0.21% 0.05% -0.51%
2007 -0.20% -0.16% -0.23% -0.17% 0.00% 0.29% 1.11% 0.24% -0.55% 0.21% 0.79% 0.11% 1.45%
2008 0.29% 0.27% -0.06% -0.48% 0.15% 0.40% -0.21% 0.05% 1.17% 0.00% 0.00% 0.00% 1.59%
2009 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
2010 0.00% 0.00% -0.15% 0.14% 0.94% 0.40% 0.00% 0.00% 0.00% 0.00% 0.00% -0.42% 0.90%
2011 -0.41% -0.37% -0.25% -0.04% -0.06% 0.02% -0.20% 2.21% 0.00% 0.00% 0.00% 0.00% 0.90%
Back-tested Example: Equity Portfolio Impact of 5% position bought when VIX < $22, sold when VIX >$35
But…it’s never that simple!
0.70
0.80
0.90
1.00
1.10
1.20
1.30
1.40
1.50
1.60
1.70
$10.
00
$12.
50
$15.
00
$17.
50
$20.
00
$22.
50
$25.
00
$27.
50
$30.
00
$32.
50
$35.
00
$37.
50
$40.
00
$42.
50
$45.
00
$47.
50
$50.
00
Ratio
, 4-7
Mo
VIX
Cont
ract
s to
VIX
Fro
nt M
onth
Con
trac
t
VIX Spot Price
Slope of the VIX Futures Curve: Steeper at Low Levels of VIX Index
Thank You.
Questions?