Key Takeaways from Benn Eifert Podcast
This month a member of KM Cube had the chance to follow Mutiny Fund’s podcast with Benn Eifert, CIO of QVR Advisors. Eifert is considered amongst the smartest investors and an expert in the volatility complex today.
The full replay of the podcast (for those who have the time) may be found here. We present you our take on the key topics discussed:
- Derivatives markets are no longer a space where the big banks dominate. Dodd-Frank regulation put an end to this.
- Options’ Market-Makers are today the prime source of liquidity and warehousing risk. They do not hold the same kind of capital as the major banks do, hence today hedge funds find it strenuous to get the compelling pricing and liquidity they need to hold onto huge positions.
- Markets are switching to electronic trading. Bid/Ask spreads are tighter on the screen (as opposed to OTC) but liquidity behind that is much worse (as opposed to calling a bank to trade a massive trade OTC).
- The VIX universe is heavily trafficked by non-sophisticated investors who are mostly using VIX products as a hedge. This creates opportunities for the specialists, particularly in the front end of the curve (1M-2M).
- The biggest such example for the above observation is the investor that got known as “Fifty-cent” (because he trades options that are nominally cheap – usually priced around 0.50-). It is today a common secret that this is a large UK asset manager who runs long-only equity mutual funds, which systematically buy short-dated VIX calls that trade for around 0.50. That’s it for them. They do not care if it is the 23 strike, or 26, or whatever, they just go out and buy 1-month and 2-month VIX calls that trade at 50c. They are not picky, hence they affect the front-end of the VIX curve (keeping VVIX artificially high). These are price-insensitive, non-economic-efficient hedgers.
- The underlying market (say, an index like the S&P500) is driven by pricing of derivatives (i.e. its options) rather that the other way around. So, nowadays, the sequence of influence is: options -> market-makers -> index. And not index -> big banks -> options, as in the past.
- The obvious negative correlation between volatility and equity prices is structural, hence a most frequent trade is always some kind of Long vol/Long index or Short vol/Short the index trade.
- Another core VIX strategy for Eifert is what he referred to as a ‘VIX basis trade’, i.e. a 1-month variance versus the 1-month SPX options. The chart below is from his notes. This is essentially very similar to our own approach to the convexity premium we are following in-house – we have put a lot of effort towards this and I can share it with whoever is interested. It basically follows with where forward VIX prices trade, and compares those with the forward starting volatility implied by SPX options in an attempt to identify attractive dislocations to invest in.
- A major target for any market-neutral portfolio is to make sure you survive any major downturn. You have to make sure you have some trade with the necessary convexity that will offset those things that you did not see coming.
- European dividend futures are becoming a favorite trade, because of the major dislocations created by structured products issuance from French banks. The French sell structured products based on an index’s future nominal price; not the index’s cumulative return. Hence when they sell a structured note they do not include future dividend payments in the calculations. When they buy the underlying index to hedge their exposure they are left with forward dividend payments risk, thus they go out and sell dividend futures AT ANY PRICE to balance their portfolio. This puts an artificial pressure on European dividend futures. Although due to relatively lower volume this is a capacity-constraint trade, EuroStoxx dividend futures is a way for smart beta.