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A ‘Nightmare Scenario’
If you're into nightmare scenarios, I've got one for you. I'll keep it short, commensurate with what (I hope) are the long odds of it playing out.
Back in March, I spent a few minutes editorializing around what Bloomberg billed as "the return of the short vol trade." The story was familiar to regular readers. I'm going to recycle some of my own copy in the course of briefly recapitulating.
"Short vol"'s a catch all for any number of trades and strategies ranging from the esoteric to the wholly
I wonder what could possibly reduce inflows into retail buy/write funds? I’d imagine that would require a fairly long period of subpar performance.
Also, is there any reason for the fund managers to actively manage their short calls? Wouldn’t they be more likely to roll up into higher strikes?
I suppose I should read a prospectus or two. Summer beach reading!
Upon further reflection, running a covered call fund may be easier or more complicated. Do you sell only longer-dated calls to earn some nice time decay while avoiding being called out of your underlying stocks? If so, how often do you roll out further? Etc.
These kinds of funds and strategies have been around “forever” (to most readers) so I’m sure that historical data has been thoroughly analyzed by man and machine to produce optimal fund structures. Over many years starting back when such database analysis was not called AI.
H, nightmare scenarios and mushroom skull and cross bones AI had me thinking Geopolitical issues and not the vol space. The graphic buried the lede!
The phrase “dispersion trade,” coupled with the opening image, immediately brought to mind those nasty cluster bombs we used to sell to our most bellicose partners in war. They would explode in the air disbursing dozens of powerful anti-personnel bombs over wide area. These little booby traps would be set to go off randomly over a period of time, surprising those they killed. To my old-timer’s baked out brain, this trading strategy looks much the same. As an old friend of mine used to say, “I’m not mature enough for this s***. One of my strongest life principles was never to be worried about the other guy’s deal. They get what they get and I get what I get. People who can make money off crazy derivative trades deserve my admiration but no green eyes.