Friday, May 25, 2018
Please find below the notes from GAM’s Weekly Investment Meeting on 23 May 2018 – this week’s speaker was Camilla Schelpe commentating on the development of an options-based risk management approach.
Camilla Schelpe, lead scientist at GAM Systematic
- Systematic investing applies scientific methodology to financial markets, which begins with building a hypothesis and using data to prove or disprove it. Whenever large volumes of data are involved, it is important to be wary of overfitting – rigorously test the data but do not ‘torture’ it until it supplies the results you are looking for. Consequently, we employ a very regimented introduction process, which is systemised from the outset, before any models go live.
- One of the components in our portfolio construction process makes use of options-based risk management. We utilise implied volatility from the options market to gain a better estimate of risk. There are high barriers to entry for this methodology since all options have individual strike prices and expiration dates and each of these imply a level of volatility. A great deal of data processing is required to smooth and process that data into a volatility surface in order for it to be utilised.
- The Ukraine crisis and collapse of the Russian rouble in 2014 provides a useful case study in relation to a typical FX ‘carry’ trade. Such a trade would be where a long position is taken in a high yielding currency and a short in a low yielding currency. This allows the investor to benefit from the interest rate differential. Back in 2014, interest rates were much higher in Russia than the US, so a carry trade involving a long position in the rouble would have proved lucrative in a calm market environment. However, as events unfolded in Crimea, the rouble depreciated rapidly. In this scenario, historical realised volatility measures were slow to react. Conversely, the implied volatility picked up quickly and the negative skew became more pronounced. This indicated a much more dynamic and aggressive downsizing of long rouble positions was required.