Follow up to yesterday – when positioning drives markets

Posted by Michael Mescher on 16 Feb, 2017

We just came across the following on Bloomberg’s market overview:

The S&P 500 Index erased 0.4 percent in a matter of minutes after a $3.4 billion fund that specializes in options trading told CNBC that it had exited a short position in calls on futures. Speculation swirled overnight that buying by Catalyst Capital Advisers had contributed to gains during a seven-day winning streak.

Let that sink in for a second. An announcement about the positioning of a 3.4B fund just erased 80B of market cap in a few minutes, never mind the market action of the previous week. When we wrote about the breakdown of the relationship between volatility and SP performance yesterday, the move was “currently 1.62 standard deviations from the mean and still expanding”. When the dust settled at the close, we were at a 2.6 st dev move. That’s a 1 in 200 shot – equivalent to flipping heads 8 times in a row. A further blow out in basis has occurred today, suggesting that while they may have exited the delta risk, volatility risk may still be present.

We could easily write a piece on risk management and options – we’re pretty familiar with it. More importantly though, is to take notice of the fact that wild, unpredictable swings can happen on a macro level – even if the reason behind it is of relatively small consequence. It is situations like this that lead us to fully embrace using derivatives. Properly executed, they provide phenomenal risk management and risk/reward opportunities. For those who didn’t ask, Gammon only lost 67 bps yesterday. All things considered, we’re really proud of that. Convexity is a powerful concept in the financial markets and we consider it of paramount importance in a well balanced portfolio.

As always, if you have any questions about basis, positioning, volatility, and convexity (or how to leverage Machine Learning in derivatives to achieve outsized alpha), we are happy to help.