Mr. Angel Serrat, Partner and Chief Investment Strategist of Capula Investment Management, delivered a presentation on Tail Hedging at the CBOE Risk Management Conference Europe on Sept. 5th in Ireland.
CHANGES FOR INDEXES DURING 2008 FINANCIAL CRISIS
One of the reasons for increased interest in tail hedging in recent years is the fact that, during the drawdown period from Oct. 31, 2007 through Feb. 28, 2009 several major “traditional” traditional indexes experienced big drops of worse than 50% (in total returns with reinvested dividends), while the CLL Index dropped 35.4% and the S&P 500 VIX Mid-term Futures Index rose 131.7% —
-61.6% MSCI Emerging Markets Index
-56.7% MSCI EAFE Index
-53.4% S&P GSCI Index
-52.0% Russell 2000 Index
-50.9% S&P 500 Index
-35.4% CBOE S&P 500 95-110 Collar Index (CLL)
131.7% S&P 500 VIX Mid-term Futures Index
After the 2008 drawdown, many investors became more concerned about higher correlations among certain asset classes during periods of market stress.
MR. SERRAT’S PRESENTATION
Mr. Serrat noted that there are a many possible strategies that one could consider for tail risk hedging. An investor could deleverage the portfolio to lessen tail risk. Mr. Serrat is exploring the use of VIX options to use in tail hedging. He presented a table in which he compared the Sharpe Ratio, standard deviation and correlations for the S&P 500 versus four tail hedge strategies: (1) dynamic tail risk strategy, (2) VIX (short maturity), (3) VIX (long maturity), and rolling of 3-month SPX puts. He noted that it can be difficult for a systematic hedging strategy (that consistently uses one hedging instrument in the same way) to add value over the long term, but he suggested that a dynamic strategy that uses a variety of hedging instruments and adjusts to market conditions does have the potential to add value with a higher Sharpe Ratio and lower standard deviation than the S&P 500 Index.
To learn more about hedging strategies, please visit www.cboe.com/Strategies