Volatility and the Allegory of the Prisoner’s...
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ARTEMIS CAPITAL MANAGEMENT LP CONFIDENTIAL For Investment Professional Use. Not for Distribution Unauthorized Reproduction Prohibited Volatility and the Allegory of the Prisoner’s Dilemma Volatility & Tail Risk Summit – London, April 16 th 2015 Christopher Cole, CFA Littlefield Building 106 East 6 th Street, Suite 650 Austin, TX 78701 Phone (512) 467-4735 [email protected] “Allegory of the Prisoner’s Dilemma” by Andy Diaz Hope & Laurel Roth. Reproduced with permission of artists. Unauthorized reproduction prohibited.
Transcript of Volatility and the Allegory of the Prisoner’s...
ARTEMIS CAPITAL MANAGEMENT LP CONFIDENTIAL For Investment Professional Use. Not for Distribution Unauthorized Reproduction Prohibited
Volatility and the Allegory of the Prisoner’s Dilemma Volatility & Tail Risk Summit – London, April 16th 2015 Christopher Cole, CFA
Littlefield Building
106 East 6th Street, Suite 650
Austin, TX 78701
Phone (512) 467-4735
“Allegory of the Prisoner’s Dilemma” by Andy Diaz Hope & Laurel Roth. Reproduced with permission of artists. Unauthorized reproduction prohibited.
“The only thing that will redeem
mankind is cooperation”
Bertrand Russell
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“Peace is not the absence of
conflict”
Dorothy Thompson
“Allegory of the Prisoner’s Dilemma” by Andy Diaz Hope & Laurel Roth. Reproduced with permission of artists. Unauthorized reproduction prohibited.
Volatility is the only real asset class Most active management strategies are short volatility in sheep's clothing
Volatility and the Allegory of the Prisoner’s Dilemma
Investors are trapped in a Prisoner’s Dilemma Global central banking “arms race” to fight deflation has trapped
investors in an equilibrium of excessive risk, debt, and false prosperity
Volatility is your only escape from the Prisoner’s Dilemma Hedge unknown unknowns and sell known unknowns
Global Macro Straddle + Asset Beta
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Volatility in the Prisoner’s Dilemma two purely rational entities may not cooperate, even if it is in their best
interests to do so
Global central banks are in an arms race of devaluation resulting in suboptimal outcomes for all parties and greater systemic risk
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Cooperation
COOPERATION COMPETITION
Istockphoto.com
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Prisoner’s Dilemma and Risk Suppression Volatility in the Prisoner’s Dilemma
Source: Artemis Capital Mgmt LP, FRED, MarketDataExpress
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Volatility and Asset Prices in the Prisoner’s Dilemma
Regime of Prisoner’s Dilemma (2009 to 2015)
Source: Artemis Capital Mgmt LP, Global Financial Data
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Volatility in the Prisoner’s Dilemma Exchanges short term equilibrium for longer term tail risk
Suppress Tail Risk Suppress Tail Risk
Increase Peak of the Distribution
Deflation War Political Revolution
Inflation Currency Devaluation
Hyper-Asset Bubble
Source: Artemis Capital Mgmt LP, Bloomberg
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Volatility in the Prisoner’s Dilemma
Forward Volatility
Convexity
Tail Risk Hedging
Vol Curve Trades
Great Depression
WWI WWII
Great Recession?
282% 252% 517% 401%
Total Debt-to-GDP by Country & World
Source: Global Financial Data, Recent Debt-to-GDP data from McKinsey Global Institute
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286% (+40% since 2007)
Volatility in the Prisoner’s Dilemma Is global deflation an economic or a demographic phenomenon?
Forward Volatility
Convexity
Tail Risk Hedging
Vol Curve Trades
Source: Global Financial Data
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Relationship between Hedge Funds and Short Volatility3 year Rolling Correlation HRFX Hedge Composite to S&P 500 Short Put
(HFRX Absolute Return, Equity Neutral, Hedge Index, Merger Arb, RV Arb, Convertible Arb / Monthly)1m ATM Put Sale on S&P 500 Index
0.93
1.43
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Hedge Funds vs. 10% OTM SPX Put (Growth of $1) Short S&P 500 Index Put Option
Cross-Section of Hedge Funds
Source: Hedge fund monthly returns from HFRX, volatility returns from Artemis Capital.
We are all volatility traders Most active management strategies produce alpha by being short volatility
or correlation
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Volatility is the Only Real Asset Class In the real world… there are two asset classes… long and short volatility
Sources: Special thanks to Drobny Global Macro for original visual conceptualization of this idea
WHEN DOES PORTFOLIO #1 turn into PORTFOLIO #2?
1. Deflationary collapse followed by financial repression and negative real rates and/or;
2. Historical correlation (negative correlation) between equities and bonds breaks down rendering traditional diversification useless
20.0%
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0.4% 0.4% 0.4%0.4%
What you think you are investing in
Long/Short Equity Value Investing Special SituationsConvertible Arbitrage Currency Arbitrage 130/30 FundPrivate Equity Real Estate Risk ParityDistressed Directional Long Merger ArbitrageCredit Index Fundamental Value Fundamental GrowthSystematic CTA Global Macro Tail Risk
97%
3%
What you actually are investing in
Short Volatility, Correlation & Dispersion
Long Volatility, Correlation & Dispersion
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Source: Global Financial Data, Artemis Capital Management LLC
Volatility is the Only Real Asset Class Changing Correlations Between Fixed Income and Equity Prices
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Volatility is the Only Real Asset Class
Source: Global Financial Data, Artemis Capital Management LP
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What Will be the Outcome of the Economic Prisoner’s Dilemma?
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Source: The Tower of Babel / Pieter Bruegel the Elder
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What Will be the Outcome of the Economic Prisoner’s Dilemma? V
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Cooperation + Growth + Austerity
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Global War
Source: istockphoto.com, worldly
Hyper-Asset
Bubble
Volatility is your Only Escape from the Prisoner’s Dilemma GLOBAL MACRO STRADDLE + BETA
Note: Artemis created a model to simulate the behavior of the equity returns, volatility movement, and “greek” sensitivities of options. Volatility simulations are expected to represent real potential scenarios but there is no guarantee as to accuracy of the model.
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Illustration by Brendan Wiuff based on concept by Christopher Cole
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Volatility is an Instrument of Truth Regardless of how it is measured volatility reflects the difference between the
world as we imagine it to be and the world that actually exist
Source: Financial Times / September 2014
One Last Thing… V
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Christopher Cole, CFA – General Partner and Founder
Artemis Capital Management, L.P. 106 East 6th Street, Suite 650
Austin, TX 78701 [email protected] www.artemiscm.com
Christopher Cole, CFA
CIO and Founder (512) 467-4735 phone
Contact Information Artemis Capital Management – Contact Information
Christopher Cole, CFA
Managing Partner & Portfolio Manager / Artemis Capital Management LP
Christopher R. Cole, CFA is the founder of Artemis Capital Management LLC. Mr. Cole’s core focus is systematic, quantitative, and behavioral based trading of volatility derivatives. His decision to form a fund came after achieving proprietary returns during the 2008 financial crash trading volatility futures. Mr. Cole's research letters and volatility commentaries were influential in derivatives circles and thereafter widely referenced and quoted by the mainstream financial media, academic, and institutional asset management communities. He previously worked in capital markets and investment banking at Merrill Lynch. During his career in capital markets and pension consulting he structured over $10 billion in derivatives and debt transactions for many high profile issuers. Mr. Cole holds the Chartered Financial Analyst designation, is an associate member of the NFA, and graduated Magna Cum Laude from the University of Southern California.
Key Information/ Biography
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LEG
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ISCLA
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Legal Disclaimer
THIS IS NOT AN OFFERING OR THE SOLICITATION OF AN OFFER TO PURCHASE AN INTEREST IN ARTEMIS VEGA FUND, L.P. (THE “FUND”). ANY SUCH OFFER OR SOLICITATION WILL ONLY BE MADE TO QUALIFIED INVESTORS BY MEANS OF A CONFIDENTIAL PRIVATE PLACEMENT MEMORANDUM (THE “MEMORANDUM”) AND ONLY IN THOSE JURISDICTIONS WHERE PERMITTED BY LAW. AN INVESTMENT SHOULD ONLY BE MADE AFTER CAREFUL REVIEW OF THE FUND’S MEMORANDUM. THE INFORMATION HEREIN IS QUALIFIED IN ITS ENTIRETY BY THE INFORMATION IN THE MEMORANDUM.
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