Be long change

“To sum up, it is not volatility that scares good investors, its the opposite – calmness. Calmness indicates you are with the herd, and while that can be comforting at times, it ultimately leads to some very scary moments and dealings with wolves.”

This is something I wrote previously on the topic of volatility (Volatility- The punishment for Group-Think) and how I believe it is the ultimate force to correct group-think in financial markets especially.

I cant help but the note how currently the inverse of that statement is true, if volatility is the punishment for group-think , then lack of volatility is the punishment for anti-group think or contrarianism.

I will often be found grumbling like a cantankerous old man about the dangers of selling vol. I dont like it as a “strategy” full stop and I will probably never be convinced otherwise.

However, I am of course completely wrong . As a strategy over the long term selling vol has proven to be very profitable. See below return profile of a hypothetical put option writing strategy ( CBOE S&P500 PutWrite Index). Any strategist, PM, Quant etc would dream to have a pnl curve that goes from bottom left to top right with relatively very little interference in between. Sure there have been periods of drawdown but over the long term its hard to argue its merits. If I was correct, there would be no insurance companies in the world.


However, I am still not a convert. it matters very much at what point on this hypothetical pnl curve you enter the mix. Lets say you started to employ this strategy but a few years ago , like say 2011/2012 – why 2011 you ask ? well that is roughly when XIV US entered the mix. An ETF that replicates a short VIX strategy. It too has been very successful as per below. Price appreciation has gone again from bottom left to top right with a little more vol in between but never the less it got there.


You can tell from the above chart how it now matters more where upon you join the pnl curve when implementing a strategy. Just put your hand up against the screen and cover years 2015 and 2016. The pnl curve still looked very handsome until all of a sudden a big draw down occurred …twice in succession I may add.

I could use the old cliche of picking up pennies in front of a steam roller but I prefer to think of it now as being “short change”. Shorting vol is an admission that nothing is going to change and therefore I do not want positive exposure to change but rather seek to profit from stagnant behavior. If you are to think of it like this then the last few years makes a lot of sense.

How has vol continued to trade lower over the last few years when all around us we are often witnessing terrible economic problems, political uncertainty and massive change?

The only possible explanation I can give is despite all these issues that are going on in the real world, the financial world, or those in charge of fiduciary responsibilities have taken the view that come what come may the central banks have broad enough shoulders (or indeed will have to have) to absorb “any” economic shocks. As recently as a few months ago when the largest German bank was in a perilous situation in the market the over riding message was that the Bundesbank/ ECB  or German government would step in and save the day should anything go seriously awry. This is probably the case, but the ease at which people let that thought escape from their mouth without the slightest thought for the implications of this I find fascinating.

This dogma that central banks have it covered is a frighteningly lazy state of conscious for any money manager to employ, it would also go a long way to describing how this pro-longed but unloved equity rally has endured for so long. You will find few people who agree in entirety that all will end well when discussing the behavior of global central banks, most are begrudgingly going with the flow out of fear of taking on the central banks. The phrase “don’t fight the FED” has been in imprinted on most investors mind for many years now. Most agree that it will all end in tears – they just dont know when.

The power of the market has been all but deputized to the central banks. I cant think of a more dangerous scenario than when hundreds and thousands of people, investors, professionals, etc etc all defer responsibility to a small group of individuals often totally unsuited to managing anything in the real world. The role of financial markets is really often quite simple- ebb and flow back and forth to find a valuation for a given asset class at a given time. Handing this power over to central banks implicitly or tacitly is like building a dam, it will stem the tide for as long as possible, but one day the crack will appear.

I cant think of a better scenario where I would like to be positioned with positive exposure to when this situation changes. Like everyone else, I dont know when the shoe is going to fall, if I did I would be an exceedingly rich man already, but by putting myself on the side of change I stand a greater chance of not being squashed by the steamroller and picking up vastly more than pennies.











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