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Finding Alpha with State-of-the-Art Risk Management
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7328 Dillman DriveHudson, OH 44236
p. LoneWolfAsymmetric@gmail.com
Table of Contents
I. Executive Summary2
Reactions are the Norm
Mission Statement
Keys to Success
II. Investment Management Process 4
Back Tested Trade Signals
Modified What If Analysis
Optimized Option Strategy
III. Option Investment Programs 6
Leveraged Macro
Current Market Forces
Option Writing
Volatility Trading - internal use only
Global Macro - internal use only
Global Currency - internal use only
IV. Marketing 7
Institutional Market
"Dead" Money
Women Investors
V. Conclusion - Final Thoughts 9
Philosophy
Disaster Insurance
Proactive versus Reactive
Executive Summary
Lone Wolf Asymmetric is an absolute return manager and is in business to
grow capital at an above rate of return through the use of options, leverage,
market timing and prudent risk controls.
It's through the use of options that we are able to have strong hands and
weather whatever storms that may occur in the bond, currency, commodity
and equity markets. While others may refrain from certain markets, it's our
ability to design strategies that tap into the unique characteristics of options
that allows us to feel safe and confident in extremely volatile markets.
Despite whatever chaos that’s thrown our way it's the use of options in our
investment management process that allows us to keep risk low, allows for
higher leverage and limits our losses while staying liquid.
Reactions are the Norm in all types of Markets
SPX & US Ten Year Bond courtesy of Bloomberg
- 2
Reactions are the Norm in all types of Markets
Ford & the Euro courtesy of Bloomberg
Mission Statement
We think the investment industry has been relying on outdated investing
ideas far too long and a change is needed. For those searching for a change
we want to be their first alternative. We are looking to engage investors who
understand the benefits of an "asymmetric" philosophy and who want to
invest alongside of us for the long haul.
Keys to Success
The key to success is the blending of our discretionary analysis of global
macro-economic and geo-political events with our back-tested technical
system's signals. The results of this combination are then expressed through
optimized option strategies that provide us with the best opportunities from
a risk/reward perspective. This strategy is applied to several global markets
and asset classes for diversification purposes. But the overriding factor is our
strong risk management approach to loss control that is our key to success.
Our ability to keep losses contained to predetermined amounts while letting
our winners “run” allows us to compound our returns faster over time than
other investment managers.
- 3
Investment Management Process
The heart of Lone Wolf Asymmetric is its ability to use options in its
investment management process. Through the use of options, leverage,
market timing and prudent risk controls we can create portfolios with
asymmetric returns. Asymmetric portfolios can produce unlimited gains
while limiting losses to a predetermined level.
It is our firm belief that a strong risk management approach to loss control
will win out over the long haul even if we don't produce the highest returns
in a particular year. The ability to not lose large sums but instead to keep
using our “edge” to build upon our winners helps us to compound growth
faster than other managers over time. Ultimately, the way the asymmetric
process works is that we'll eventually side-step some very large systemic
losses or we'll leverage some very large winners that will put us as the top
investment returns list.
- 4
Investment Management Process
Lone Wolf Asymmetric has developed a conservative system that trades both
the long and short sides of a market. The technical signals that form the
basis of our trading system have been back tested over a forty year span
and over a variety of markets and economic environments. While the system
generates a specific buy or sell signal it also includes a number of trade
signal parameters (i.e. number of winners / losers, average holding time,
average profit /loss, max profit /loss etc.). These parameters are later used in
the option optimization process.
The second part of the Lone Wolf Asymmetric process starts when we plug in
all the current option inputs into the appropriate pricing model. The model
then generates the current prices and Greeks for all of our option strategies
(outrights, spreads, in-the-money, at-the-money and out-of-the money
options and various ratio combinations). This sets the baseline for the option
costs from which comparisons and optimization will be based.
We then do a "modified what if" scenario. This is done by plugging in those
particular individual trade signal parameters such as "the average holding
time for a winner" and "the average profit" and re-calculating the option
strategies results. In this way we are able to ascertain the option strategy
which best optimizes the trade signal's parameters given the current market
conditions and pricing.
Optimization maximizes expected results by matching that trade signal with
the appropriate option strategy. However, in the event that we are wrong –
wrong direction, taking too much time, volatility dropping more than forecast
- we are able to make adjustments to either eliminate or reduce our risks
with follow-up tactics or strategies. The risk management of our option
portfolios is crucial to the overall success of the program.
- 5
Option Investment Programs
Lone Wolf provides several investment programs that can fit a variety of
client objectives and risk appetites. It currently has three main investment
programs with several others awaiting approval.
The "Leveraged Macro" portfolio. This portfolio of options tries to achieve
large outsized returns by combining short and intermediate trading system
signals with an option to leverage a longer term macro view(s). As usual the
trading system generates the signals/ trades. The system's back-tested
signal's parameters are then fed into our option optimization program.
Holding period for these positions can range from one month to one year.
The "Current Market Forces" option program tries to achieve steady
above average returns through more option diversification while maintaining
less leverage. Similar to the above portfolio only less levered. Also, no macro
view is expressed through the options. Instead this program reflects current
market forces. Typical holding period for these trades is between one month
and three months.
An "Option Writing" program that tries to capture steady returns through
time decay. This includes naked and covered option writing strategies. This
program is run separately unto itself. However, a portion of the option
writing / covered option program is included in the above first two programs
to manage Greek risks.
A Volatility trading program for internal purposes only
A Global Macro-economic overlay program for internal purposes only
A Currency overlay program for internal purposes only
At a certain level, investors want to understand what we're doing - they want
some transparency to the process. We aim to provide as much transparency
as possible but not 100% of the whole process. For our investors we want
them to remain confident in us and what we do for them. But from a
competitive perspective we cannot reveal all. From what we see nowadays
too many people try and copy your original alpha ideas. Eventually if enough
folks copy them then it turns into some common beta product. We believe
- 6
we have merged some unique skills - option trading, global macro-
economics, portfolio allocation, computer programming, risk management
and technical analysis into a thoughtful system that few can replicate if at
all. Therefore, we believe that the investors are truly getting what they pay
for when they commit to us and we commit to them.
Marketing to Women, Institutions, & "Dead" Money
We believe we are appropriate for a variety of investors. The spectrum
includes private high-net worth individual investors, wealthy family offices,
pension funds, foundations and endowment funds. Basically we think we are
appropriate for anyone who has underperforming assets and wants to re-
energize some life into their portfolio while still keeping risk / losses under
control. By avoiding major draw-downs that occur to "buy & hold" managers
we can compound our gains at a higher rate of return than our competitors.
Lone Wolf Asymmetric believes that your money should be working hard for
you at all times and in the most efficient manner as possible. Money invested
in various non-performing "long-term" opportunities is "dead" money. Dead
or sleeping money is unproductive and a waste. It may have gotten that way
for a variety of reasons (i.e. investment attitude is too risk averse or the
investment is taking too long to manifest itself while other viable alternatives
are missed.) In any case, we can be the diversifying manager that re-
energizes an individual or institution’s portfolio.
No one needs "dead" money. There was a time when the Bass family fortune
was languishing under such circumstances. Investment manager Richard
Rainwater was brought in by the Bass family to re-energize the
fortune. He did it by leveraging the capital and taking risks. To
replicate a similar feat you'll need to leverage yourself and take on more
risk. But most investors don't have the stomach for such risk taking.
Nevertheless, we can prudently replicate it nowadays through options.
Additionally, the options will allow us to control more assets at a fraction of
the cost thereby spreading the risk around. Again, the risk/reward profile is
asymmetric (with unlimited gains / limited losses) and can be done when the
situation lines up in our favor.
Since, our investment time horizon is shorter, we can leverage the positions
under current known conditions. We can time our entrances and exits in a
- 7
more efficient manner. The investment horizon that we focus on is current
and better understood by us because the investment horizon has scheduled
releases that we can plan for with only a small amount of unaccounted
random variables.
But for those managers looking down the road three to five years their world
is a total mystery with an infinite number of unknown and unaccountable
variables. How can these investment managers with time horizons three to
five years down the road with some even saying they have twenty year
horizons predict what things will be like? In this age of technology change
happens a lot quicker. Therefore, in our minds taking a position today based
on a time horizon three to five years down the road is irresponsible and a
breach of fiduciary responsibility for those managing investor funds.
Investing Women - Longer Lives & Less Money than Males
One market that we believe has great potential for us is the market tailored
towards women investors. It is a market that hasn’t been adequately served
but it’s especially suited to us. We see a couple of factors converging that
will influence their investment choices. Therefore, we want to market
ourselves as a financially appropriate investment that caters to their long-
term financial needs and conservative investment concerns
Traditionally women are more conservative in their investments than their
male counterparts. Generally, they want to understand what they are getting
into before they invest. Statistically, more women are graduating from
universities than men and not only with degrees but advanced degrees. Yet
they will be earning 20% to 30% less.
Nevertheless, women have to reflect these current biases into their
investment choices. Women need to add to their calculations that they have
been living longer and have been earning 20%-30% less than their male
counterparts. Thus they will need to step up their investing habits if they
want to live comfortably in their retirement years. While our program of
using options keeps risk low and limits losses it also allows for greater
returns by using leverage. Knowing that their long-term investment goals
are being met should allow them to sleep soundly.
- 8
Conclusion - Final Thoughts
Philosophy
Let's talk a little about distributions and probabilities. In a normal
distribution, 95% of events occur within 2 standard deviations, while 99.7%
of events will be contained within 3 standard deviations. Most people build
their portfolios around this concept. However, when you delve into high
frequency financial data you'll see that markets have a tendency go way
beyond those 3 standard deviations and more frequently than ever
estimated by statistics.
On page 5 we show the S&P 500 Index from back in 1987. It's a graph of
daily returns showing 5,10 & 20+ standard deviations within a period of
three days. I can't tell you how terrifying this was. I worked with a few guys
back then who were really big time traders and who would regularly take
down large portions of bond auctions and were very familiar with managing
substantial risks. But during those days they were calling their wives and
telling them to go the banks "right now" and take everything out. They were
that terrified that the financial system was on the verge of a total collapse. A
5 standard deviation move would theoretically occur every 9,500 years or so,
while a 20+ standard deviation move would be expected to occur every
355,120 billion years. So just try and imagine what those three days in row of
improbable events felt like. I can say you won't be able to come even close
to those feelings unless you were there and were interacting with the folks
during those days. The tension and the fraying of nerves was reaching
everyone as long delays on trade reports had people guessing where they
stood position wise.
It was in this type of environment that I became a total convert to options.
Even if your positions were wrong the massive spike in volatility drove prices
on both puts and calls higher enabling you to get out with some profit even
on totally wrong directional positions.
Disaster Insurance
Getting back to asymmetrical portfolios you may find other hedge funds that
try and duplicate an asymmetrical payoff - it sometimes is called hedging
tail-risk. But they haven't thought the whole process through. We have seen
a number of equity managers just buy deep out-of-the-money put options
- 9
and then pray that a major market correction doesn't occur. But they forget
that buying out-of-the-money options is a low probability bet and can be
costly if done over a long period of time or the adverse move doesn't quite
reach their strike protection.
There is another group that doesn't own the underlying but they do buy a
variety of out-of-the-money options hoping to profit from disaster in a variety
of markets. Again if you use the delta as an approximation of the trade
coming to fruition most of the time it will incur losses before a winner occurs.
In this type of investment process you take numerous losses before getting
your winner. And even then you hope your gain will offset your previous
losses.
Proactive versus Reactive
But to do asymmetric investing properly you really need to think about doing
it from a proactive rather than a reactive perspective. You want to design
your strategy and investment around the current environment that you
know, the environment that you anticipate and understand what you can and
can't control to your benefit. You need to think about the properties of
options, option theory, probabilities, leverage, money management,
directional trading and trade timing. In addition, you need to have back-
tested trading strategies that can be applied via the options. Once you have
that you can start to proactively design asymmetric portfolios. In the end
you still need to play great defense /loss control so that you deliver above
average returns. You don't need to swing for the fences and have 300% to
500% returns to show that asymmetric trading is the way to go you just need
to outperform others by controlling your downside risk.
- 10
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