Vol of Vol

Practical thoughts on trading volatility as a distinct asset

class
Michael Fagan
Chairman
Levitas Capital

Vol of Vol: 2015 some extraordinary happenings

In 2015 the events of August represent

an extraordinary example of the ferocity
of vol of vol

This plot shows the percentage change

in implied vol of VIX options against a
change in the term structure of the
futures

The rise in the implied vol is

accompanied by some of the steepest
observations of the futures curves weve
seen since the inception of the product
group

No other financial product can capture

the velocity of the moves that we have
so far observed

2015

The Volatility Dichotomy

Volatility as a Hedge
Protect against macro or unforeseen
events
Allows managers to stick to core
holdings

Volatility as an
Asset Class
Agnostic to the noise of the market
Use statistical analysis of behavioral
patterns in volatility product groups

Positive convexity is comforting

Positioning independent of bottom-up

analysis

Extreme situations force abnormal

performance results

Acknowledge the power of volatility over

direction in certain circumstance

Cost of protection acts as a drag on

performance in good times

Scale volatility exposure by recognizing

the various tools available to the investor

Picking individual volatility winners is

cheaper, but difficult for most fund
managers to achieve

VIX: The Opportunity of negative correlation

VIX Relationships 2008 to 2015
50.00%
40.00%

SPX

30.00%

ASX200

20.00%

FTSE
Eurostoxx

10.00%
-15.00%

-10.00%

-5.00%

0.00%
0.00%
-10.00%

N225
5.00%

10.00%

15.00%

Linear (SPX)
Linear (ASX200)

-20.00%

Linear (FTSE)

-30.00%

Linear (Eurostoxx)

-40.00%

R = 0.5644

Linear (N225)

-50.00%

The VIX and its associated derivatives provide the opportunity to

capture negative correlated returns

Largest monthly SPX fall since 2007

Vol of Vol: What does it look like to a trader?

2008 and we enter into the
Lehmans phase of the financial
crisis
What works better? VIX options or
SPX puts?
The initial move shows the extreme
reaction of vol of vol to the events,
outperforming an equivalent SPX
put by a factor of 4
Here you can see the way the Vol of
Vol (represented here via the VVIX)
rising, reflecting the price action we
see in the VIX calls
(Chart utilzes the nearest OTM options; buying second expiry
month holding over 1 calendar month of interest.)

Second largest monthly SPX fall since 2007

Vol of Vol: What does it look like to a trader?

2009 and Central Banks are
injecting capital in response to the
credit crisis
Equity markets decline, but VVIX
declines with them
Note that the VIX and the VIX
Futures remain elevated
Here you can see the way the SPX
puts now out perform in response to
the one way nature of the S&P
500s movement
(Chart utilzes the nearest OTM options; buying second expiry
month holding over 1 calendar month of interest.)

SPX Puts vs VIX Calls Is there a difference?

In normal markets VIX calls act very
much like S&P puts, i.e. excluding major
market disrupTons = 1.00

At the start of the 09 recovery Vol of
Vol had to normalize, you couldnt hold
and ride the delta, you had to trade to
capture the outperformance

(Analysis 2007-2015, utilzing the nearest OTM options; buying second expiry
month holding over 1 calendar month of interest.)

Equity hedgers will want to concentrate

on the extreme events

In event of extreme outliers, VIX calls
grossly outperform S&P puts

SPX Puts & VIX Calls P&L Distribution

(Analysis 2007-2015, utilzing the nearest OTM options; buying second expiry month holding over 1 calendar month of interest.)

Timing remains key

Systematic buying of options (SPX puts or VIX calls) is unprofitable
Losses for > 90% of the time
Ave Put Losses = -25% of premium
Ave Call Losses = -12% of premium

Vol of Vol
VIX options are ultra sensitive to market inflexion points, more so than standard Vol
instruments (e.g. SPX puts)
The market overpays for insurance for the outlier events because of this sensitivity
(more on that later)
Systemic buying of options in itself produces significant drag on the portfolio of a
hedger because youre mostly losing
A trading mentality that separates the normal and the abnormal coupled with timing is
a better path
Vol of Vol is more tactical than strategic

VIX Strategy: Selling Volatility via Short Calls

PnL ($ per contract)
Statistics
Average
Median
STD
SKEW
% Positve
AVE/STD

VIX Index
<19
>19
42.6
75.2
90.0
175.0
247.2
496.0
-3.9
-5.0
89.1
87.8
0.17
0.15

Implied Volatility (%) Term Structure (%)

<75
>75
<9
>9
23.7
94.0
36.4
81.4
90.0
155.0
125.0
115.0
407.2
372.5
487.4
261.3
-5.9
-4.9
-5.1
-3.4
88.3
88.7
87.5
89.5
0.06
0.25
0.07
0.31

PnL ($ per contract)

Statistics
Average
Median
STD
SKEW
% Positve
AVE/STD

Index/Term Structure
Low/Low
High/High
-20.6
138.7
90.0
190.0
475.0
261.5
-5.2
-3.6
85.3
91.6
-0.04
0.53

Term Structure/Implied Volatility

low/Low
High/High
-0.8
118.2
90.0
160.0
477.8
268.4
-5.2
-3.4
87.8
89.2
0.00
0.44

This analysis shows the P&L per contract by selling OTM calls in the front month up to 2 weeks till expiry, after which point selling the second month with positions held to expiry.

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VIX: Using Vol of Vol like an Actuary

By using statistical analysis of VIX Cash levels, Implied Vol and Term Structure to
determine option positioning. We believe a successful quantitative strategy is possible
with an agnostic view of price movement.
One would assume that due to VIX Cash mean reversion characteristics, selling VIX
when it is high would be a successful trade. However, on an Average/Standard
Deviation basis, there is no clear trade based purely on the VIX Cash level.
Positioning based on the Term Structure alone (which is often when the cash is at its
lowest levels) results in double the success based on the Average/Standard Deviation
of the VIX Cash level.
Combining high VIX Cash and high Term Structure achieves near double again the
Average/Standard Deviation of the Term Structure alone.

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VIX Futures Term Structure Realized Volatility -

Hold on at the short end

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VIX Cash & Futures Term Structure: August 2015

VXX
45.00

VX1

VX2 VX3

40.00
35.00
30.00
25.00

40.00-45.00

20.00

35.00-40.00

15.00

30.00-35.00

5.00

25.00-30.00

0.00

20.00-25.00
15.00-20.00
10.00-15.00
5.00-10.00
0.00-5.00

31-Aug-15

03-Aug-15
04-Aug-15
05-Aug-15
06-Aug-15
07-Aug-15
10-Aug-15
11-Aug-15
12-Aug-15
13-Aug-15
14-Aug-15
17-Aug-15
18-Aug-15
19-Aug-15
20-Aug-15
21-Aug-15
24-Aug-15
25-Aug-15
26-Aug-15
27-Aug-15
28-Aug-15

10.00

13

60

50

40

30

20

10

0
02-Jan-15
22-Jan-15
10-Feb-15
02-Mar-15
19-Mar-15
08-Apr-15
27-Apr-15
14-May-15
03-Jun-15
22-Jun-15
10-Jul-15
29-Jul-15
17-Aug-15
03-Sep-15
23-Sep-15
12-Oct-15

02-Jan-08
23-Jan-08
12-Feb-08
04-Mar-08
25-Mar-08
14-Apr-08
02-May-08
22-May-08
12-Jun-08
02-Jul-08
23-Jul-08
12-Aug-08
02-Sep-08
22-Sep-08
10-Oct-08
30-Oct-08
19-Nov-08
10-Dec-08
31-Dec-08

VIX Cash & Futures Term Structure: 08 v 15

2008
2015

70

30
25
20
15
10
5

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Vol of Vol vs Vol Risk Premium Distribution

Compare the realized 1M vol of VXX (rolling 30-day VIX futures) with its
corresponding implied vol derived from its option price confirms similar
distribution of risk premium and the same median of 11% with a negative
skew of -1.2.
Compare the realized 1M vol of SPX with the VIX Index shows a more
centred distribution and lower risk premium of 4% with larger negative skew
of -2.3

The greater risk premium in the VoV is justified by the great

dispersion of daily returns found in underling Vol instrument
compared equity cash.
The higher risk premium combined with a lower negative
skew suggests selling vol of vol is superior to selling vol

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Returning to our first slide - Vol of Vol: 2008 v.

2015

Which was a tougher environment for

investment decisions, Lehmans 08 or
2015?

In 2015 (orange dots) the VIX market

has arguably been more dangerous
than 2008

The three largest moves in vol of vol

measured by the shift in VIX futures
term structure and change in implied vol
of the options there on, have taken
place this year.

No other financial product can capture

the velocity of the moves that we have
so far observed

24/10/08 S&P gapped down -8.3% and closed the day down -5.1%.
VIX 67.8 VVIX 121 (starting from high vol levels)

24/08/15 S&P gapped down -5.4% and closed the day down -4.1%
VIX 28 VVIX 138 (starting from low vol levels)

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VIX: Options and context

VIX options represent the purest form of

leverage to the velocity of market moves

2015 was less expected by the markets

than what occurred during 2008 as
volatility was at a much lower absolute
level

The gradient of the line of best fit for 2015

is as a series far stepper than that in
2008, indicating a significantly higher level
of surprise

What we saw in August this year was a

release of stored energy as multiple
macro factors shook markets

24/10/08 S&P gapped down -8.3% and closed the day down -5.1%.
VIX 67.8 VVIX 121 (starting from high vol levels)

24/08/15 S&P gapped down -5.4% and closed the day down -4.1%
VIX 28 VVIX 138 (starting from low vol levels)

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Vol of Vol Summary

!The mean reverting nature of the product means that a long vol of
vol has to be traded
!Vol of Vol is hyper-sensitive to market inflexion points
!Systematic buying of volatility rarely beats selling in the simple
sense of win / loss

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Levitas Capital
About Us:
Levitas Capital was founded in 2013 as an Asset Manager and is based in Sydney, Australia. We currently service
clients in Australia, Singapore and Hong Kong. We are leading managers of volatility as an asset class with
a quantitative investment process and advanced risk management models. In addition we offer active portfolio
solutions. Interested investors can contact through our website: http://levitascapital.com.au/contact/

Disclaimer:
Levitas Capital is the trading name of Volatility Funds Management Pty Ltd (ACN: 165 110 476) that is a Corporate
Authorised Representative (CAR No. 448549) of HLK Group Pty Ltd (ACN: 161 284 500) which holds an Australian
Financial Services Licence (AFSL no. 435746).
Any information or advice contained in this presentation is general in nature and has been prepared without taking
into account your objectives, financial situation or needs. All securities and financial products or instruments
transactions involve risks. Please remember that the past performance results are not necessarily indicative of future
results. Trading derivatives carries a high level of risk to your capital and you should only trade with money you can
afford to lose. Trading derivatives may not be suitable for all investors, so please ensure that you fully understand the
risks involved, and seek independent advice if necessary.

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Levitas Capital
info@levitascapital.com.au
Level 5, 120 Sussex Street
Sydney NSW Australia

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