Investment Strategies

Our team doesn’t use Black–Scholes Option Pricing Model in our trading of options. We created our own  model of  valuation options for equities indexes. It helps to make more precise valuations of option prices and shows better performance than funds with option strategies which are using Black–Scholes Option Pricing Model

The most commonly used option pricing model is the Black–Scholes Option Pricing Model. This model is available in any options software. The Black–Scholes Option Pricing Model makes an assumption that future price returns distributed normally (Gaussian distribution). With a current volatility assessment using normal distribution formula, it obtains fair current prices for options. More advanced option strategies use “Volatility Smile”, but usually in more of a qualitative than quantitative way.

In reality, the normal distribution assumption of future price returns doesn’t hold for most of the asset classes. In the case of equity indexes price returns distributions show long tails (excess kurtosis), significant asymmetry (the left tail is heavier than the right tail, price moves faster on downsides than on upsides). Moreover, strong volatility clustering is observed.  That is why our team uses the alternative option pricing method which allows to get quantitative estimations, taking into account above mentioned price features of the equities indexes: distribution abnormality and volatility clustering. Our team supposes that our option pricing method gives us a competitive advantage before other hedge funds implementing options strategies.

In our option strategies, we use historical data for reconstruction of observed price returns distribution, which we use further to get option price valuations.  The historical distribution holds all abnormalities, with all its features. Also, our method uses the volatility normalization to take into account volatility clustering effect. It allows making more precise valuation of option prices and showing better performance than funds with option strategies not taking into account the price features of equities indexes.

The combination of strategies

The main fund strategy is option buying strategy as described above. But since October 2016 we combine a set of strategies which to make an optimal use of various market features and contacts with various factor premiums, leaving an overall contact with the market volatility at a moderate level. One of our additional strategies is a long-term stock portfolio to contact with market factors of Value and Quality. To reduce the contact of fund overall position with a market beta, we use a strategy which creates a hedging position from a combination of instruments negatively correlated with a market index: treasury ETFs, VIX-related derivatives, and others.

The goal of hedging position is to reduce the overall fund’s beta position by 50-65%. We suppose reasonable not to remove fund’s beta position completely and leave some contact with market premium. 

Thus, a complete set of strategies is as follows: strategies of buying call options on S&P 500 Index and long-term value and quality portfolio create positively correlates with market part of a fund position. On the other side, in a part which correlates negatively with the market, we have the strategy which creates a position from hedging instruments. In all strategies, we use position size normalization to the medium-term volatility to control the overall portfolio volatility.

Also, we use a strategy of selling modest volumes of market neutral option constructions.

 

 

 

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