Pete Clarke was the keynote speaker for the final day at the CBOE Risk Management Conference in Europe today. Clarke is the Global Head of Equity Derivatives Strategy at UBS and his talk was appropriately titled Global Equity Derivatives Trading Themes.
As part of his opening comments he said that risk may be greatest when everyone is completely happy about their performance and the market environment. He noted that when VIX is low it also turns out that volatility is most rich (to use his word) versus realized volatility. He notes that traders may sit around waiting for the next volatility event while being prepared to take advantage of it. He cites how Warren Buffett approaches purchasing stocks where he may be patient for a long period of time, but ready to buy when the price is right.
Just three years ago VIX futures hit the 30’s and now we have VIX futures traders willing to sell in the low teens. In addition to VIX being low, a large number of US stocks have individual volatility at historically low levels. Clarke mentioned that skew can be impacted by low current volatility. He emphasized this point by saying that when considering the angle of skew you should take into account the premium of an option.
Buying at the money calls has better risk adjusted returns versus buy and hold. It allows you the ability to benefit from the upside, but you miss the drawdowns. Clarke invokes Buffett again by saying effectively you are being patient since your downside is limited when buying call options and if you are not applying all your capital to the call purchases you have the ability to be patient.
He noted that there is a high level of interest in Europe to spread trade US versus European volatility or VIX versus VSTOXX. This sort of trading has been made much easier since CBOE extended VIX futures trading hours to coincide with European market hours.
Something I found particularly interesting was a demonstration of the cost of owning puts on the S&P 500. He showed consistently buying puts and that when volatility is very low or volatility is very high the costs are greater than when volatility is in the middle third of historical levels.
Clarke finished up his presentation by noting that clients are still looking to make money through carry trades. In this environment look to some convexity through long VIX calls. His analogy for the current environment is that we all know selling premium is like picking up nickels in front of a steamroller. The nickels are getting smaller and the steam roller is getting bigger.