quant congress - barcap
TRANSCRIPT
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Investing in Equity Volatility
EQUITY RESEARCH
Maneesh Deshpande+1 212 526 2953
Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have aconflictof interest that could affect the objectivity of this report.Customers of Barclays Capital in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost tothem, where such research is available. Customers can access this independent research at www.lehmanlive.com or can call 1-800-253-4626 to request a copy of this research.Investors should consider this report as only a single factor in making their investment decision.PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 38
US Equity Derivatives Strategy | July 2009
QUANT CONGRESS USA
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Volatility as an Asset Class Investable Alternatives
Determining Richness/Cheapness
Systematic Volatility Strategies
Products with Embedded Volatility Leveraged/Inverse ETFs
Contents
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Equ ity Volatility as an Asset Class
Negative correlation with equity returns
Convex behavior in periods of market stress
Tendency to mean revert
Distinctive P ropertiesDistinctive P roperties
-40%
-20%
0%
20%
40%
60%
80%
100%
-20% -15% -10% -5% 0% 5% 10% 15%Wee kly & 500 et
Wee kly % e iIX
o c e: Bloomb erg
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Evol u tion of Volatility Investing
Fo u r generations of volatility tracking alternatives
Vanilla o tions Variance swa s V IX VIX-based E s nhedged straddles pot variance Fu tu res VXXDelta -hedged o p tions Forward -starting p tions VXZ
S : B Capital
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Abo u t t e VI
VI measures volatility implied by S P 500 options over next 30 calendar days
Calculated from prices of strip of vanilla options, hence model independent
Spot VI does not trade but VI futures allow trading of expected implied volatility
VI futures settle to spot VI on day of expiration based on SOQ
VI options settle against the index, but are priced off the futures
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S&P 500 VI Sh ort- Term an Mi -Term VI Fu tu res In exes
Source : Bloomberg
Investable benc hmarks tracking c hanges in the VI
0
50,000
100,000
150,000
200,000
250,000
300,000
Dec- 05 M ar- 06 Ju n-06 S e -06 D ec- 06 M ar- 07 Ju n-07 S e -07 D ec- 07 M ar- 08 Ju n-08 S e -08 D ec- 080
10
20
30
40
50
60
70
80
90
S&P 500 VI Mi -Term Fu tu res T S&P 500 VI Sh ort- Term Fu tu res T VI (r h s)
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Met ho ology Illu stration
Relative weights of each futures index change in defined proportion each business day
Actual weights need to be adjusted to absorb roll related losses
Date ay
F t res F )
nF t res
F
)
lF t res
F
)
gF t res
F )
# BizDays
to ext ebal
elWeig h t
F )
elWeig h t
F
)
elWeig h t
F )
elWeig h t
F
)
elative
cco ntVal e
cco ntVal e
ct alWeig h t
F )
ct alWeig h t
F
)
ct alWeig h t
F )
ct alWeig h t
F
)
n d ex
1
-J an -06 15.11 15.46 15.80 16.15 20 100 100 100 0 4,63 .00 4,519.44 9 .46 9 .46 9 .46 0.00 96.3218-J an -06 15.18 15.55 15.92 16.29 20 95 100 100 5 4,6 0.55 4,546. 3 92.48 9 .35 9 .35 4.8 96.9019-J an -06 15.09 15.46 15.83 16.20 20 90 100 100 10 4,649.10 4,520.44 8 .51 9 .23 9 .23 9. 2 96.3420-J an -06 15.30 15.64 15.98 16.32 20 85 100 100 15 4, 0 .30 4,5 2.0 82.56 9 .13 9 .13 14.5 9 .4423-J an -06 15.14 15.52 15.90 16.28 20 80 100 100 20 4,6 8.80 4,538.86 .61 9 .01 9 .01 19.40 96. 424-J an -06 15.05 15.40 15. 6 16.11 20 5 100 100 25 4,64 .50 4,503.35 2.6 96.90 96.90 24.22 95.9825-J an -06 15.01 15.32 15.64 15.95 20 0 100 100 30 4,625.20 4,4 .19 6 . 6 96.80 96.80 29.04 95.4226-J an -06 14. 8 15.16 15.54 15.92 20 65 100 100 35 4,58 .90 4,435.56 62.84 96.68 96.68 33.84 94.532
-J an -06 14.62 14.95 15.28 15.61 20 60 100 100 40 4,524.60 4,369.58 5 .94 96.5 96.5 38.63 93.1330-J an -06 14.55 14.92 15.28 15.65 20 55 100 100 45 4,524.50 4,364.1 53.05 96.46 96.46 43.41 93.0131-J an -06 14.54 14.93 15.31 15 . 0 20 50 100 100 50 4,536.00 4,369.6 48.1 96.33 96.33 48.1 93.13
1-Feb-06 14.4
14.8
15.26 15.66 20 45 100 100 55 4,525.45 4,353.
43.29 96.21 96.21 52.91 92.
92-Feb-06 14.63 15.02 15.40 15 . 9 20 40 100 100 60 4,5 4.60 4,395.48 38.43 96.08 96.08 5 .65 93.683-Feb-06 14.61 14.98 15.35 15 . 2 20 35 100 100 65 4,566.15 4,382.03 33.59 95.9 95.9 62.38 93.396-Feb-06 14.64 15.02 15.39 15 . 20 30 100 100 0 4,584.10 4,393.83 28. 5 95.85 95.85 6 .09 93.65
-Feb-06 14. 0 15.08 15.4 15.85 20 25 100 100 5 4,611.25 4,414.34 23.93 95. 3 95. 3 1.80 94.08
To tal l eve l of all futures ba sed on re lative
we i hts (A)Ba sed on act ualcont r act s he ld (B)
Clos in leve ls of VIXfutures cont r act s
Act ual w e i hts a djus ted ba sed onr ati o of (A) an d (B)
Sour ce : Ba r cla ys Ca p ital
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Effect of Rebalance Fre qu ency
Optimal Rebalancing S trategy
Index scales down its vega exposure if volatility termstructure is upward sloping
With fixed number of VI contracts, index would havegone below zero in such a situation
Ensures index is self-funding and eases the creation of replicating products
Volatility surface is often non-linear and concave rollingat more frequent intervals reduces cost
Index corresponds approximately to a fixed point on thecurve
Daily rebalancing causes less impact on the VI futuresmarket
Nee for Rebalancing
-150
-100
-50
0
50
100
150
S i u l a e
n e
L e
!
VIX Futures Index with Rebalanced VegaVIX Futures Index with Constant Vega
0
20
40
60
80
100
120
S i
"
u l a
#
e$
% n
$
e&
L e
'
e l
VIXFutures index with dail y rebalance
VIXFutures Index with monthl y rebalance
Source : Barcla ys Ca pital
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Ch aracteristics of VXX an VXZ
Underlying index calculation based off VI futures prices rather than OTC marks ensures transparency
Exchange traded note (ETN) format means investor does not need to assume tracking error
Can be cheaper than buying underlying futures and rolling periodically since daily roll gets executed mid-market. Onlycost for investor staying in the product is 89 bp expense ratio.
V and V Z typically trade with much tighter bid-offer spreads than VI futures or forward starting variance swaps
Access to multiple layers of liquidity ETN level, VI futures and listed S P 500 options
In contrast with ETFs, ETN structure retains counterparty risk of issuer
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Tra eoff bet een Sh ort Term an Mi Term In ex
Typically short-dated implied volatility is more negativelycorrelated with equity returns than medium-term
V also has more negative higher correlation and betawith respect to SP returns
However, roll cost can be greater if volatility termstructure is humped rather than linearly upward sloping
V Z provides a more optimal choice for investorslooking to own volatility with a long investment horizon,in our view
Sh ort Term In ex More Negatively Correlate w ith Equ ities
Ret u rn CorrelationI Sh ort Term
In exI Mi Term In ex
2006wit S & -7 % - 6 %wit R ll 2 -76% -66 %2007wit S & -84 % -7 6%wit R ll 2 -78% -7 %
2008wit S & -84 % -8 %wit R ll 2 -8 % -7 8%
S o2 rc 3 : Barc lay 4 Cap ita l, Bloomb 3 rg
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Performance S tatistics
He ging Equ ity P ortfolios
Negative correlation with equities means V and V Zcan act as portfolio hedges
More effective for offsetting systemic risk rather thandaily mark-to-market losses
Hedge performed particularly well in the fall of 2008when implied vols rose far more than would have beenexpected given the selloff in SP
Maximum drawdown significantly lowered, especially inthe worst performing years
In flat or rallying markets, allocation to V /V Z resultsin underperformance for long portfolios
SP X He ge w ith VXX/VXZ
S 5 P 6 7 7 S 5 P 6 7 7 + VIX 8 e
9
i @ A B
e C A D @ t @ C e E S 5 P 6 7 7 + VIX Sh F C t
B
e C A D @ t @ C e E
G 7 7
H
return 15.8% 7.1% 4.3%standard dev iat iI n 10.0% 6.2% 5.8%max imum drawdown 7.5% 4.1% 2.8%
G 7 7
P
return 5.5% 15.8% 10.6%standard dev iat ion 16.0% 7.6% 7.0%max imum drawdown 9.9% 4.1% 2.8%
G 7 7
Q
return -37.0% -4.5% -9.1%standard dev iat ion 41.0% 14.0% 16.5%max imum drawdown 47.0% 18.3% 19.4%
G 7 7 9return 2.3% -3.5% -5.1%standard dev iat ion 36.0% 11.3% 12.0%max imum drawdown 29.0% 12.1% 10.2%
0
20
40
60
80
100
120
140
Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08
S&P 500 S&P 500 + VR S
Med ium Term S&P 500 + VR S
Short Term
Source : Barc lays Capita l, Bloom ber g
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Volatility as an Asset Class Investable Alternatives
Determining Ric hness/ Ch eapness
Systematic Volatility Strategies
Products with Embedded Volatility Leveraged/Inverse ETFs
Contents
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Sh ort Volatility S trategies
Index Implied vol usually trades at a premium to realized
volatilityPopular strategy is to sell index volatility in some form
Systematic call overwriting (B M : CBOEs BuyWriteindex)Variance swapsDispersion trades (short index volatility, long single stockvolatility)
Question : Can we do better using single stock options?
Diversification
Choose the stocks for which to sell volatility
Explore long-short volatility strategies to control risk
Source : Barclays Capital, OptionMetrics
SP X -mont h Implie vs Realize Vol
0%
10%
20%
30%
40%
50%
60%
70%
0% 10% 20% 30% 40% 50% 60% 70% 80%
RealizeT
Volatilit U ove V the P V io V W
X ont hs
I m p l i e
Y
V o l a t i l i t
`
Denotes Implied = Realized Vo l
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Determining Fair Implie Volatility for In ivi ual S tocks
Implied vs realized volatility does not work well for single stocks
because of large moves.Realized volatility has jumpy behavior when a large move isincluded or drops out from the sample period
Frequently, implied volatility does not even react after a largemove
Why?
Known event volatility (earnings announcements, drug trialresults). Implied volatility might actually decrease followingthe large move
The stock move could be because of a one time non-recurring adverse event
a
5%
30%
35%
40%
45%
50%
55%
60%
65%
b
0%
2 - J a n 9 - J a n 1 6 - J a
n 3 - J a
n
3 0 - J a
n 6 - F e
b
1 3 - F e
b 0 - F e
b - F e
b 6 - a
r
1 3 - a
r 0 - a
r - a
r
Ic d
1 month Realized V ol
The stock moved up 11 .5% on J ana
1 leadin to a spike in realized vol Realized vol fell back after a month had
passed
40%
45%
50%
55%
60%
65%
b
0%
b
5%
e
0%
e
5%
90%
J an- 09 Feb- 09d
ar- 09f
pr- 09d
ay- 09 J un-09
VLO 1 d
onth Implied V olVLO 1
d
onth Realized V ol
Impliedg
arningsd
ove = 4%f
ctualg
arningsd
ove = 1b
.b
e
%
Source : h
arclays Capital, O ptioni
etrics
Realize vol is jumpy
Implie vol does not al ways react after a large move
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Earnings Moves vers u s Normal Moves
For S P500 stocks since 2004 :
Non-earnings move 1.6% Average earnings move 4.1%
Higher volatility on the earnings day but dissipates fast
p
.p
%
p
.q
%
1.p
%
1.q
%
2 .p
%
2 .q
%
r
.p
%
r
.q
%
4.p
%
4.q
%
2 Day prior s
ot arnings
1 day u rior s
ot arnings
t arnings Day 1 Day u ostt arnings
2 Days u ostt arnings
Average 1 Day Return
Average v ove on non-earnings day
Earnings moves do not lea d to volatility post earnings
Source : Barclays Capital, OptionMetrics
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A P ossible Sol u tion : Adju ste d R ealize d Volatility
Basic idea : Dampen the effect of large moves
Calculate the two year trailing realized volatility to get a base volatility : Over past three months flag all moves more than 2.5*sigma and replace with 2.5*
Replace post earnings returns with median earnings day returns over the past two years
Calculate the realized volatility using these adjusted returns
Adjusted Realized Volatility is downward biased. Systematically lower than realized volatility
But spread against implied volatility is much stable
w x
2w x
y w x
w x
w x
w w x
2w x
y w x
a n a
r a y u
l
S e p
o v
a n a
r a y u
l
S e p
o v
a n a
r a y
V
O
onth Realized
V
O
onth AdjustedRealized Vol
5
2
2
2
o v
j
e c
2k
j
e c
l
m
a n
2
m
a n
k
n
e b
o
n
e b
k
a r
o
a r
A p r
5 A p r
2
A p r
a y
2l
a y
m
u n
V
O
mplied Realized Spread
V
O
mplied Adjusted Realized Spread
Source : Barclays Capital, Option
etrics Source : Barclays Capital, Option
etrics
Adju ste d realize d vol lo wer than realize d u t sprea d vs implie d vol more stable24M24M
24M
24M
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Adju ste d R ealize d Volatility ase d Metrics
Key metric : 3M Implied volatility - trailing 3M adjusted realized volatility ( IVAdjR V)
IVAdjR V. CS :C ross-sectional Ranking
Calculate IVAdjRV all stocks on a given date
Calculate the percentile rank of this spread across the stocks
The lower (higher) percentile stocks are cheap (rich)
0
50
100
150
200
250
300
350
400
-60 - -40 -30 -20 -10 0 10 20 30 40 50 60 7
Cheap VolStocks
Rich VolStocks
Median spread -3.1
Source : Barclays Capital, OptionMetrics
Distrib u tion of IVAdjR V for d ifferent stocks on 0 /15 /0
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Adju ste d R ealize d Volatility ase d Metrics
Some names have systematically h ig h or lo w
IVAdjR V sprea dsSector bias : Health care and Consumer Discretionarystocks have higher premia
Smaller capitalization stocks have higher premia
Key qu estions :
Is this spread justified? Perhaps these names havemore large moves?
How do we correct for this bias?
z
{
z
|
z
}
z
~
z
z
z
n e r g
a t e r i a l s
I n d u s t r i a
l s
o n s m
r s c r t n r
o n s m
r t a p l e
s
H e a l t h
a r e
i n a n c i a
l s
I n f e c h
e l e c o
m r v c
s t i l i t i e
s
Market Cap Percentile
Average IVAdjRV
Sou r ce : Bar clays Capita l, OptionM e tr ics
Healt hcare & Co n s Dis c s to ck s ha ve
h igher IVAdjR V pre m ium
Sm allcap s to ck s al so ha veh igher IVAdjR V pre m ium
Sou r ce: Bar clays Capita l, OptionM e tr ics
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Adju ste d R ealize d Volatility ase d Metrics
IVAdjR V. TS: C ross-sectional Time Series Ranking
Calculate the percentile rank of the current spread for each stock relative to its own history
Then rank the stocks according to this time series rank
-30%
-20%-10%
0%
10%
20%
30%40%
50%
60%70%
1/ 2/ 2008 4/ 2/ 2008 7/ 2/ 2008 10/ 2/ 2008 1/ 2/ 2009 4/ 2/ 2009
AAPL 1 Mon t
I
AdjRV
0
100
200
300
400
500
600
700
-20% -15% -10% -5% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45%
Current value of IVAdjRV spread =5.3%
Sour ce : Bar clays Cap ital , Opt ion Metr ics Sour ce: Bar clays Cap ital , Option Metr ics
AAPL 1 -m on t IVAdjRV Sprea d IVAdjRV Sprea d Dis trib ut ion f o r AAPL
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Volatility as an Asset Class Investable Alternatives
Determining Richness/Cheapness
Systematic Volatility S trategies
Products with Embedded Volatility Leveraged/Inverse ETFs
Contents
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Backtesting S et up
Time perio d : 1996-2008. Capture two high volatility periods and the volatility void years
Universe : Choose names based on liquidity (option open interest) ~ 800 stocksMat u rity : On every options expiration date options are traded for the next expiration (one month) and are held tomaturity
Instr uments use d:Static straddles (no hedging)Hedged straddles (delta rebalanced at the close)Sell -delta call options (call overwriting)
Portfolio composition :Equal vega for each chosen option
S tock selection criteria :Blind selling : Simply sell options on all stocks to capture volatility risk premiumLong short strategy : Sell the top 25% and buy the bottom 25% names according to various volatility metrics.
S trategy eval uation metrics :Information ratio, Sortino ratio
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Ho w G oo d are the Metrics?
A test for a good metric is if it has explanatory power across all percentiles
For our purposes this translates into the metric being able to identify both rich and cheap optionsVol Selling P L using delta hedged straddles increases with increasing percentile for both IVAdjRV IVSect
This indicates that they can identify both rich and cheap options
-
-
-
-
-
-
-
-
-
-
-
-
V Adj V VS ect
S ource : Barclays Capital, OptionMetrics
Metrics have explanatory po wer across percentiles
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Volatility S trategies P erformance He dge d & Un he dge d
Despite the sector and market cap biases the IVAdj1M is the
best strategy, indicating that the excess premium in thesenames is not justified (structural alpha)
In general while the delta hedged strategies outperform their static counterparts the difference is not large
For pure short strategies the extra effort in dailyrebalancing might not be worthwhile
The difference between delta hedged and static strategies isnow quite stark
For the unhedged implementation, long-short strategies areactually less profitable than the short only versions
With delta hedging, the long-short strategies are far superior to the pure selling versions
Source : Barclays Capital, OptionMetrics
Performance of s hort stra dd les
Long/s hort stra dd les performance
Metric
Monthly
Alpha (VolPoints)
Monthly Std
Dev (VolPointsl)
IR
IVAdj1M.CS 4.7 6.3 2.6IVAdj1M.TS 3.7 6.1 2.1IVSect1M.TS 3.2 6.5 1.7IVRV.CS 3.7 5.7 2.3IVRV.TS 3.0 5.5 1.9
All Stocks 1.1 5.5 0.7SPX 1.1 4.9 0.7
IVAdj1M.CS 4.1 13.0 1.1IVAdj1M.TS 3.1 12.1 0.9IVSect1M.TS 3.3 13.8 0.8IVRV.CS 2.6 13.1 0.7IVRV.TS 2.4 12.3 0.7
All Stocks 1.0 12.6 0.3
Delta H e d g e d
o n Delta H e d g e d
MetricMonthly
Alpha (VolPoints)
Monthly StdDev (VolPointsl)
IR
IVAdj1M.CS 6.3 4.6 4.7IVAdj1M.TS 4.8 3.8 4.4IVSect1M.TS 4.0 3.6 3.9IVRV.CS 4.2 4.4 3.3IVRV.TS 3.0 3.7 2.8
IVAdj1M.CS 4.5 9.5 1.7IVAdj1M.TS 3.6 8.2 1.5IVSect1M.TS 4.0 8.5 1.6IVRV.CS 1.5 8.8 0.6IVRV.TS 1.7 8.6 0.7
Delta He d ge d
on Delta He d ge d
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Consistency of the S trategies
2
2
7
a n
nth y V P&L
D taH
g
L ng Sh tSt at gy
S u c : Ba c
ays Capita
, Op ti n
t ics
2
2
2
a n
a n
a n
a n
a n
2
a n
a n
a n
a n
a n
7
a n
nth y V P&L D taH g Sh t S&P
Long/ Sh ort hedge d stra dd les using IVAdjR V.TS h ave done well
Performance of selling SP X volatility is more jumpy
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Call Over w riting
Volatility metrics previously outlined are successful in generating outperformance for call overwriting strategies
Methodology consists of buying stock and selling the nearest 1 month 40 delta call.
Selecting stocks where vol is rich according to our metrics, outperforms blindly selling calls on all stocks and the B M(CBOE S P 500 Buy Write index)
50
100
150
00
50
00
an
an
an 00 eb 01 eb 0
Mar 0
Mar 04Mar 05 Mar 0
Mar 0
Mar 0
Stock Blind VSect V
d
V V V B
M
MetricMonthly
lpha(%)
MonthlyStd Dev
(% )nnual
Stock 0.1 4. 5 0.1Blind 0. .5 0.VSect 0. . 0. 0V d V 0. 4.1 0.5V V 0. 0 4.4 0.1
B M 0. 4 .5 0.
Source : Barclays Capital, OptionMetrics Source : Barclays Capital, OptionMetrics
Call over w riting performance Comparison of screening metrics
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Volatility as an Asset Class Investable Alternatives
Determining Richness/Cheapness
Systematic Volatility Strategies
P ro du cts with E mbe dd e d Volatility Leverage d /Inverse ETFs
Contents
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Tracking Error an d Implicit Costs
To hedge an ultralong (2x leveraged) ETF with a current NAV of $100 the exposure to the underlying 2*100
So,
Borrow $100 worth of cash. Cost r, where r financing rate
Lend the securities out. Benefit b*2 where b borrow rate
Receive dividends on $2*100 worth of the underlying, Benefit q Index where q Index underlying dividend
Pay the management fee
Putting all this together, for ETF with leverage m :
where is the effective cost of Leveraged ETF*
f
*)(.
1
f qq Rm
f qr mbq Rm R LETF Index Index
LETF Index Index LETF
!
!
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Terminal Distrib u tion of a Leverage d ET F
N-day return for a lognormal underlying :
Hence distribution of Leveraged ETF :
Leveraged ETF is still lognormal but with twice the volatility
Static leveraged position return can be < -100%
Max loss for leveraged ETF 100%
i N N
I eI W
W Q
! 22
1
im N m N m
E eI W
W Q
! 22
2
1
-0 .
0 0 .
.
.
L v g
E TF ( =
)
t tic l v g
siti
U
l i g I
Leverage d ET F d istrib u tion
!
" u # c $ : B% # c l% & s C % ' it% l
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Con d itional Distrib u tion of a Leverage d ET F
Multi-day return of a Leveraged ETF is path dependent
Depends on the return of the underlying index and the realized volatility
Even if underlying in unchanged, the return of the Leveraged ETF will be negative
The pure dependence on the underlying return is non-linear
Thus a leveraged ETF has option-like characteristics
The extra term is simply the convexity correction and reflects the option premium
N mmm I E e R R 21
2
11W
!
-0.5
0
0.5
1
1.5
2
2.5
3
0 0.5 1 1.5 2 2.5 3 3.5
Source : Barclays Capital
Form u la for terminal ret u rn Convexity in leverage d ET F payoff
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Dynamic He dging of Leverage d ET Fs
Hedge ratio or delta of a Leveraged ETF :
Thus for an ultra-long ETF (m 2) :
As the underlying rallies (sells-off) the value of the ETF increase (decreases)
Hence need to buy (sell) more shares of the underlying to maintain the same leveraged exposure
Leveraged ETF hedging is a buy high /sell low strategy
This short gamma is what the convexity term captures
Index
t
ETF t
ETF P P
m!(
Day Unde rlying # Und
l Sha r es Da
ily P/L Shar es t
Buy/Se ll Pri e # Und
l Sha r es Da
ily P/L Shar es t
Buy/Se ll Pri e
0 100 - .00 0 .00 0 .00 100 .00 2 .00 0 .00 0 .00 100 .001 110 -1 .4 -20 .00 0 . 80 .00 2 .1 8 20 .00 0 .1 8 120 .002 90 -2 .42 29 .09 -0 .9 7 109 .09 1 .70 -43 .64 -0 .48 76.3 63 105 -1 .3 9 -3 6.3 6 1 .0 4 72 .73 1 .9 4 25 .45 0 .2 4 101 .824 95 -1 .82 1 3 .85 -0 .44 86 .5 8 1 .74 -19 .3 9 -0 .20 82 .425 100 -1 .55 -9 .11 0 .2 7 77 .47 1 .82 8.68 0 .09 91 .10
6 9 6 -1 .74 6 .20 -0 .19 83 .66 1 .75 -7.29 -0 .0 8 8 3 .817 92 -1 .9 7 6.9 7 -0 .2 3 90 .64 1 .67 -6.9 8 -0 .0 8 76.838 88 -2 .2 4 7.88 -0 .2 7 9 8.52 1 .59 -6.68 -0 .0 8 70 .159 84 -2 .5 6 8 .9 6 -0 .3 2 10 7.47 1 .52 -6.3 8 -0 .0 8 6 3 .77
10 80 -2 .9 4 10 .2 4 -0 .3 8 11 7.71 1 .44 -6.0 7 -0 .0 8 5 7.70
Ultr asho rt ETF U ltr a long ETF
Source : Barclays Capital
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Dynamic He dging of Leverage d ET Fs
Shares required to rebalance the hedge :
Index notional to be traded for a 1% move (Dollar Gamma) :
Number of shares to bought/sold is proportional to the daily return of the index
Rebalancing for ultrashorts is three times that of ultralongs
E.g. a 5% move in the index > Ultrashort ETF needs to trade 30% of its AUM from the previous day
100
1%1 ETF
t ETF
P mm Dolla r !+
Indext ETF
t Indext
ETF
t Indext
ETF
t P P
r r
mm P P
m P P
m ! 1111
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Impact on Market Volatility
Does leveraged ETF hedging add to market volatility?
Issue attracted much attentionPossible measure correlation between return till 30 minutes before close and return in last half hour of trading
At broad market level, little impact on correlation with advent of leveraged ETFs
However, in some sectors (real estate) rebalancing flows have had measurable effect
Rebalance flo ws effect on SPY ret u rns
-40 %
-20 %
0 %
20 %
40 %
60 %
80 %
2001 200 2 2 00 3 200 4 2 005 200 6 2 00 7 200 8 2 009S P
(
) 0 rr 1 l2 ti 0 3 (P r 1 v ) l0 s 1 -15 3 0 R 1 tur 3 vs 15 3 0 -1 600 R 1 tur 3 )
Rebalance flo ws effect on IYR ret u rns
-20 %
-10 %
0 %
10 %
20 %
3 0 %
40 %
50 %
60 %
70 %
80 %
2005 200 6 2 00 7 200 8 2 009I
(
R ) 0 rr 1 l2 ti 0 3 (P r 1 v ) l0 s 1 -15 3 0 R 1 tur 3 vs 15 3 0 -1 600 R 1 tur 3 )
So ur c 4 : B5 r cl5 ys 6
5 pit5 l, F 5 s tTick
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Analyst Certifications an d Important Disclos u res Analyst Certification
I, Maneesh Deshpande, hereby certify (1) that the views expressed in this research report accurately reflect my personal views about any or all of the subject securities or issuers
referred to in this research report and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.Important Disclosures
Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interestthat could affect the objectivity of this report.
Customers of Barclays Capital in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost to them, wheresuch research is available. Customers can access this independent research at www.lehmanlive.com or can call 1-800-253-4626 to request a copy of this research.
Investors should consider this communication as only a single factor in making their investment decision.
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Options are not suitable for all investors. Please note that the trade ideas within this report do not necessarily relate to, and may directly conflict with, the fundamental ratings appliedto Barclays Capital Equity Research. The risks of options trading should be weighed against the potential rewards.
Risks
Call or put purchasing : The risk of purchasing a call/put is that investors will lose the entire premium paid.
Uncovered call writing : The risk of selling an uncovered call is unlimited and may result in losses significantly greater than the premium received.
Uncovered put writing : The risk of selling an uncovered put is significant and may result in losses significantly greater than the premium received.
Call or put vertical spread purchasing (same expiration month for both options) : The basic risk of effecting a long spread transaction is limited to the premium paid when the positionis established.
Call or put vertical spread writing/writing calls or puts (usually referred to as uncovered writing, combinations or straddles (same expiration month
for both options) : The basic risk of effecting a short spread transaction is limited to the difference between the str ike prices less the amount received
in premiums.
Call or put calendar spread purchasing (different expiration months7
short must expire prior to the long) : The basic risk of effecting a long calendar spread transaction is limited tothe premium paid when the position is established.
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Important Disclos u res contin ue d
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Important Disclos u res contin ue d
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