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Volatility as an asset class: Interview with Marshall Gause, Geneva Fund Partners

Release date: 07 Jun 2018 | Eurex Exchange, Eurex Clearing

Volatility as an asset class: Interview with Marshall Gause, Geneva Fund Partners

Question and Answer Session with Marshall Gause, Founder of Geneva Fund Partners on Volatility as an Asset Class and the ability to be opportunistic with equity index and volatility portfolio risk exposure.

For the volatility asset class products, the year 2018 has been interesting.

Earlier in the year in February, the CBOE Volatility Index (VIX) surged 115.6%, its largest one-day rise on record as panic selling hit the U.S. stock market.  Tuesday, February 6, 2018, the European markets sank and the region’s equivalent to the VIX - the VSTOXX - followed suit with its biggest one-day surge since the Sept. 11 attacks in 2001.  

Since their introduction fourteen years ago, the volatility asset products have significantly increased in trading and popularity this includes the Eurex VSTOXX products.  For this reason, we thought it useful to have a question and answer session with Marshall Gause and Roxanne Bennett of Geneva Fund Partners, LLC an investment advisor that specializes in trading the defined risk volatility asset class products and equity index arbitrage.  

Are there any brief ‘takeaways’ to consider in regard to the 100% overnight jump in volatility, earlier in the year?

Yes, three short important points: 

(1) Risk Management.

Products based on volatility indices, including the Eurex VSTOXX products are singularly unique compared to others as they are the only index type products that routinely gap open higher by +20% to +30% and in February we witnessed a +100% price jump.  That said, volatility, for lack of a better word, is ‘volatile’, and consequently, risk management in trading the volatility asset class is very important.  

What do we mean by defined risk strategy?

Traditionally, selling or shorting volatility has been the popular volatility asset class strategy.  Traditionally this has been done by either shorting calls and puts on the S&P 500 or by directly by selling volatility futures contracts.

The trouble with both of those two strategies is that they are fraught with risks, with the most significant of those risks being a sharp rise in volatility, (like the 100% rise in volatility we saw in February) and/or combined with a sharp drop in the S&P 500. 

That is why it is our opinion that systematic defined risk positions are the only safe way to trade the volatility asset class products, that is ensuring that loses to the upside of volatility are capped and known.  Then it is simply a manner of sizing volatility asset class positions to work in concert with the asset size of an underlying portfolio.

(2) We do not think it makes sense to be short volatility all the time.

One of our philosophies is that most every portfolio has volatility risk already embedded and priced into it. Consequently, it makes more sense in a portfolio to monetize the volatility in a defined risk structure, while reducing long equity holdings, opportunistically in periods like now when equities are still fundamentally overvalued.  At other times, when index equities are priced at a better value, it makes more sense to derive more of a portfolio’s returns from increased equity index exposures.

Additionally, at a minimum, we would offer to an investor to calculate how much they may be able to generate from the volatility in their portfolio to compare those defined risk returns to what is expected from their index equity holdings.  During different periods of time, one should be better than the other and vise-versa during other periods.

(3) As a follow-on to (2) above, properly structured, volatility asset class products can potentially solve a very important problem; that is how to get adequate returns during periods when equity indices are fundamentally overvalued, consequently, the forward equity index returns are expected to be lower and with likely much higher variance in returns. 

Or asking the question another way, if there is good evidence that the S&P 500 is fundamentally overvalued, what options are available to find returns other than just buying the S&P 500? 

We would encourage investors to look at the defined risk strategy solution because it allows an investor to reduce risky S&P 500 long positions while potentially earning better returns in a systematic, defined risk manner and additionally, being able to be opportunistic when the S&P 500 does experience a significant sell-off. 

Substituting long equity exposure for a defined risk strategy solution, particularly when stocks are expensive or overvalued, allows an investor to be opportunistic in re-deploying that long equity when equity markets experience periodic selloffs.

Additionally, by structuring a defined risk strategy solution, utilizing the Eurex VSTOXX products, an investor can know with certainty the worst case drawdown scenario which is very important in terms of risk management and portfolio peace-of-mind.

It is hard to understate the benefits of a Defined Risk strategy when equity markets are at highs and can be more prone to significant market sell-offs.

By being opportunistic using VSTOXX products, and with the proper strategy, an investor may be relatively indifferent to equity market price moves.  That is, the investor knows that when the equity markets sell-off there may be substantial opportunities available because they are positioned correctly, or conversely if the equity markets stay flat or go higher the investor can potentially make systematicreturns that may surpass equity index returns.

In addition to allowing you to be opportunistic with long equity exposure are there any macro themes volatility asset class  products like the VSTOXX  allow you to take advantage of ?

Yes, we think using the products in a defined risk, repeatable and predominantly systematic strategy is the single best way to profit from the macro view that the continued increase in computerized/algorithmic based trading can create equity markets that, for most trading days, are more efficient and less volatile than they have been historically.  This computerized trading effect has evidenced itself in the very low daily trading volatility ranges experienced in 2017. 

The continued increases in computerized trading in our opinion has the effect of pushing down near-by price volatility, and subsequent near-dated VSTOXX products, while increasing the back part of the VSTOXX volatility curve, and later dated VSTOXX products.

This increased ‘skew’ in our opinion can create sustainable opportunities for investors, in as much as it is managed in a largely systematic and repeatable manner.  Additionally, the strategy should be appropriately sized and structured to work in concert with an underlying portfolio. 

Are there any specific advantages to using the VSTOXX futures and options on futures?

Yes, we would say most importantly, the VSTOXX options on futures have markets that go far out in time, often by at least two to three months relative to other volatility markets.  This additional length of time feature is very important to the volatility asset class products because it increases the probability that equity markets will normalize, and volatility will mean revert back to a historical range after a market dislocation.

Additionally, the VSTOXX futures and options on futures are both approved and regulated by the Commodity Futures Trading Commission (CFTC).  The ability to trade volatility index options under CFTC mandate is unique to the VSTOXX.  Additionally,  the VSTOXX market offers the benefit of lower contract sizing for the futures that exactly matches the contract size for the options (100x). 

Are there any final comments in regard to volatility as an asset class? 

Yes, the recent price dislocations in the index equity markets and volatility have created significant opportunities for investors to invest in structured defined risk positions, taking advantage of the continued high volatility.  

Also, if we have not mentioned it earlier, the VSTOXX products allow for new ways to profit from the volatility asset class that do not incur unlimited/open-ended price risks and offer investors new innovations from how short volatility strategies have been managed in the past.  

Mr. Marshall Gause

Mr. Gause has over 25 years of institutional portfolio management experience in equities, derivatives, and commodities.  Mr. Gause began his derivatives career with Nations Bank/Chicago Research & Trading in the 30yr fixed income option trading pit at the CBOT in 1993.  Additionally, Mr. Gause started the derivatives trading desk for a Fortune 500 operating company and served as Managing Director for a $400 million-dollar hedge fund in Denver, CO.

Geneva Fund Partners, LLC:

Geneva Fund Partners has been trading a proprietary Defined Risk Mean Reversion Strategy in the volatility asset classes with proprietary capital since 2015.  Geneva Fund Partners is now offering the strategy to outside investors with limited capacity.  Our initial capital raise will be capped at under $25 million due to the relative newness Eurex Volatility Asset Class products.  It is our intention to add capacity to this boutique strategy on a $10 million incremental basis as the Volatility Asset Class trading volume continues to grow. 

To contact Geneva Fund Partners, LLC:

Marshall Gause: (303) 997-7997 / mgause@genevafundpartners.com

Roxanne Bennett: (312) 636-4004 /rbennett@genevafundpartners.com


 
 

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