Zem Sternberg from Lake Hill Capital Management and Sorina Zahan of Core Capital Management shared the state at RMC for a discussion titled Portfolio Construction: Finding Options Where You Least Expect Them.
Zahan began the presentation saying that her section saying that the title – To the Right of the Right Tail – may be a more appropriate title for her section. She notes that most investors and funds focus on the left tail and do not pay enough attention to right tail risk. She showed that when the overall stock market is strong and moving higher that hedge funds start to underperform. That is a version of right tail risk. Thinking of this another way, if hedge funds begin to underperform as the stock market is strong, they are structurally short calls.
Zem Sternberg began his presentation with an interesting anecdote. He mentioned that his career began in the SPX pit and he was hired because he is tall, not due to his math ability. He said today a version of being tall is having the fastest computers.
Sternberg went through a dynamic method of replicating an option position through the underlying stock. Using the delta of an option and certain number of shares are bought or sold to mirror an option position. He states just about every position initiated has an embedded option in it. You may need to search for the option, but you can find it and if needed you can hedge that exposure.