G. DeSimone and O. Shih: Reducing Risk through Multifactors: Implied Variance Asymmetry and Implied Beta
OptionMetrics’ latest study challenges conventional risk assessment using metrics like implied variance asymmetry (IVA), calculated as the measure of downside variance relative to upside variance, and option-implied beta strategies. By combining low beta with high IVA, we yield a superior portfolio with 12% annualized return, 0.85 Sharpe Ratio, and 1.23 Sortino Ratio. Contrary to expectations, the relationship between IVA and returns suggests complexities beyond simple risk factors, with high IVA portfolios showing lower downside variance and better risk-adjusted returns relative to the benchmark.
G. DeSimone and A. Rotach: The Implied Advantage: Empowering Beta-Neutrality with Options-Based Metrics
In this research, we present evidence showcasing the superior effectiveness of implied betas in achieving beta neutrality for leveraged long/short factor portfolios compared to historical beta estimates. We find that nearly all portfolios using implied beta for leverage calculation are more successful in approximating the target beta of zero.
G. DeSimone, A. Gupta, A. Rotach & O. Shih: The Implied Bet Against Beta (IBAB) Factor: A New Frontier for Low-Volatility Investing
In this research, we introduce a new factor, IBAB, which utilizes implied betas to construct a long-short portfolio of leveraged low-beta and short high-beta securities. Our results show that in the universe of S&P 500 constituents, IBAB outperforms the traditional BAB factor, with an annualized return of 5.3% compared to BAB’s -3.0%. Moreover, IBAB delivers a positive FF5 alpha of 2.5% while BAB exhibits a negative alpha of -6.0%. We further investigate the economic drivers behind the performance difference between IBAB and BAB and find that the implied correlation component of IBAB is the main driver of its superior performance.
G. DeSimone: Demand for Option Order Delta
OptionMetrics’ latest research paper, Demand for Option Order Delta (DOOD), proposes a new options-based metric to estimate demand imbalance for delta by end-users of options. Read the full white paper below to learn more.
G. DeSimone: Emergency Rate Cuts and Beware of the Bull Steepener
On March 3, 2020, the Federal Reserve announced its first emergency rate cut since the Financial Crisis in order to combat mounting Coronavirus fears. This rate trimming of 50 basis points from 1.75% was intended to calm markets and reduce business uncertainty. The rare nature of such actions provides valuable information regarding the current economic backdrop.
G. DeSimone: Assessing Option Demand from Signed Volume Order Flow
Supply and demand in option markets matter. A critical assumption of popular pricing models, such as Black-Scholes is that investors are subject to a no-arbitrage constraint, which implies a perfect elasticity of supply. In reality, a market maker will not provide endless options contracts without charging higher prices. This demand theory of option pricing is a crucial piece in understanding the behavior of implied volatility surfaces.
G. DeSimone: Min Vol: More than a Safety Trade
Minimum volatility strategies are having a scorching run in 2019. This year min volatility funds are boasting outperformance above the benchmark in a largely bull market, with IShares Min Vol ETF (USMV) gaining 22% against S&P 500’s 19%. These figures may come across as surprising; min vol is typically pitched as safety trade with better downside protection than the market, but less upside potential. Is minimum volatility purely a defensive portfolio solution?
G. DeSimone: Amplified Momentum
This article takes a deeper look at the drivers of the momentum factor. A traditional momentum strategy involves buying winners and selling losers based on the past 12 months returns. This strategy can be amplified by selecting stocks within the Winner-minus-Loser portfolio that have high implied idiosyncratic volatility (IVOL), extracted from option prices. The short portfolio of high IVOL loser stocks generates significant underperformance, due these stocks being overpriced by investors for their lottery-like payoffs.
G. DeSimone, P. A. Laux: The Timing of Variance Risk Premia Around Macroeconomic News Events
The majority of the variance risk premia is concentrated around the time of macroeconomic news announcements. Risk premia embodied in variance futures are negative around such events, consistent with theory. Risk premia in index option straddle positions are also negative around announcements, except that they are positive around Fed Open Market Committee (FOMC) meetings. Upon decomposing the straddle returns, we find that they primarily represent compensation for jump risk. On the other hand, the positive returns on FOMC meetings are due to extraordinary actions by the board to calm volatility.
D. Hait: VIX — Fear of What?
The VIX, while promoted as an indicator of future market volatility, has more to do with present and past market returns than future volatility. Most (98.8%) of the daily variation in the VIX can be explained by current SPX returns and lagged VIX values. Unexplained changes in the VIX are more likely due to contemporaneous market reactions rather than fear of future events. Despite its lack of predictive ability, the VIX could be useful as a hedge against bidirectional jump risk.