The rout that sent equity volatility spiking to its highest in more than a year on Monday had many investors scrambling for hedges if they hadn’t prepared themselves already. But in Greece, Yannis Couletsis had a different idea.
Athens-based Couletsis started shorting volatility on U.S. stocks — even as traders were fleeing in the opposite direction on rising fears that a global pandemic is at hand.
The director at Credence Capital, the volatility-trading arm of KM Cube Asset Management with 150 million euros ($164.2 million) under management, is betting that the fear gripping global markets will prove short-lived. He’s selling options to anxious investors who have sent the price of the derivatives soaring in an attempt to shield themselves from further pain.
The logic behind the strategy is received wisdom among derivatives traders but a puzzle to the uninitiated. It’s known as the volatility-risk premium, or the tendency of investors to demand higher compensation for future uncertainty compared with what actually comes to pass.
There’s risk in selling insurance in the midst of a sell-off, namely that stocks won’t stabilize but will keep falling, breaching the strikes on those options contracts.
But it’s a risk Couletsis says he’s willing to take. More than 65% of his portfolio is in short-vol positions on major equity indexes and single stocks — and he’s sticking to his guns.
“We are confident in our system’s signals,” he said. “Volatility is mean-reverting in nature. All our indicators signaling short-vol positions are still on.”
It’s a bold position, to say the least. With U.S. stocks extending losses into a fifth day, traders are wondering if this is the great unraveling of the decade-long bull market. The S&P 500 has turned negative for the year, and even the likes of Citigroup Inc. and Goldman Sachs Group Inc. are warning clients away from buying the dip. A complex signal lurking in the Cboe Volatility Index’s futures curve is potentially auguring lasting pain.
It’s just another day for volatility traders like Couletsis, who make money from the dislocation between market expectations and what really happens.
Options sellers expose themselves to the prospect of unlimited losses in tail scenarios, while the pain for buyers is limited to the premium paid. That keeps the difference between future expectations of volatility and what transpires at a persistent spread, providing a steady tailwind to shorts.
In fact, some of the biggest gains for the strategies are made in dark times. Societe Generale SA, for one, has extolled the virtues of being short-volatility even when growth is slowing. While the risk of disaster increases, so does the price that fearful investors are willing to shell out to protect themselves.
Couletsis had been on the sidelines for most of February, waiting for his model to deliver its signal. A proprietary metric based on indicators such as the term structure of S&P 500 volatility and skew, it started flashing on Monday, alongside an inversion of the VIX curve that is typically viewed as an ominous sign.
“February will be a negative month for us as we are underwater as it is and we keep rolling strikes lower,” Couletsis said. “But our strategy is basically agnostic to global macro and geopolitics, so we follow our rules and receive the bill in the end.”
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