Investment XYZ

Monday, June 02, 2014

2013: A Year of Simplicity (Again!)

Last year at this time, I summarized that 2012 was a year of simplicity. Sophisticated strategies fared much worse than simple buy-and-hold. 2013 turns out that the same statement can be repeated, except in bold: simple buy-and-hold in S&P gives you 30% return. Try coming up with a strategy to beat that.

Last year, we saw positive correlation for stocks, bonds and gold, but this year it is all about equities, while bonds ended down, gold crashed into bear territory. Looking back, there is a simple reason for such simplicity of good returns for equities: the Fed's powerful printing machine is the engine that pulls up the equity market. If we learned anything, we should have realized early in 2013 that such force is usually slow moving, thus it is a definite driver to define a trend, which is up. Translated into volatility, the trend is down. We witnessed in December another 1 for 4 reverse split of VXX.

BellCurve's meager 10% returns (before fees) for the year is a disappointment, comparing with general market. However, typical criticism of hedge funds of "not long enough" last year didn't apply to us. We have been always maintaining market neutral in our book, including during all previous near 3 years which we clocked around 20% returns each year (before fees).

A few lessons learned from our under-performance. First, with the prolific weekly option products available out there, we ended up trading a lot of such products, without keenly aware one major pitfall: in these near term options, Theta overtakes Vega, and to trade these options successfully without taking on a lot of risk (theta selling is not our strategy); forecasting movements (or the lack of) is the key. Even though we trade volatility, we should realize that stock movements are hard to predict, and probably futile trying to predict that. Forecast movement is probably even harder than predicting the direction of stocks, the latter can translate into much easier trading ideas if successful.
If we are not predicting the movement, what does our vol model do? We should first realize any model is limited, and our model is best used as a fair value baseline. If it can predict anything, it is the future implied vol level, not the future movements (or realized volatility). In this area, stock movement is the job of risk management, where we would be projecting the possibilities of stock movement, but not making any prediction.

Second lesson: beware of macro thematic investment idea. Yes, taking a view of the market, especially with a story to tell, is quite fashionable. But putting the money to work based on a theme is not a good idea for our size -- unless we have too much money seeking too few ideas. 2013 had a few macro themes that occupied the financial media airway throughout the year: QE3, Debt ceiling, government shutdown, QE tapering talk, etc. Overall we are not doing too bad in handling these macro events, and we didn't put in too much capital in this area (except for a few macro ETF like SPY). But it is a pitfall we need to be careful about. Our strength lies in discovering relative values on the volatility surface, or, mispricing opportunities that can be realized through time. For example, in December 2012, Goldman made a correct prediction that gold would be down substantially in 2013. While we do not pay particular attention to such a theme throughout the year, GLD turned out to be one of the best return names for us, by trading the vol surface reaction and skew throughout the year. A theme is an absolute idea, which is speculative at best in the direction. How well a theme can be translated into volatility is even more remote.

Just like stock movement forecasting, macro theme is an important risk management measure, but a bad trading idea generator.

We had a great year in applying our execution platform. We have set up several FIX engines and have become the first user for some option algo service providers. Now we are at a point of ramping up more volume in both the electronic channel and institutional flow, development of more proprietary automatic or human facilitated order generated algo, and trade more nimbly, with more liquidity providing trades.

BellCurve is becoming a powerful trading engine, with multiple trading venues connected smoothly and effectively into the platform. We are at a good timing, while on one hand, electronic trading in option market is stepping up, on the other, Volcker rule would eventually encourage and push buy-side firms like us to be more active in participating in the liquidity functions of the derivative market.

I see a great year ahead for us.

 Derek Wang, CEO, Bell Curve Capital LP - dwang at

Web This Site