Amid the uncertainty surrounding European markets and the turmoil of the U.S. debt crisis, one group of hedge fund traders seems to be leading the pack.
Hedge fund traders who ignore the direction of the overall markets and instead use options to take advantage of fluctuations in the price of securities have been making money in the first half of 2011, reports Bloomberg.
Known as volatility traders, they have racked up gains of 5.1 percent in 2011 as of June, based on data from Newedge Group SA’s Volatility Trading Index. This comes at a time when every other strategy tracked by the Newedge, such as macro funds that bet on broad economic trends, as well as firms that focus on oil and metals, have lost money in the first six months of the year. Even John Paulson’s giant $37 billion Paulson & Co is down 18 percent in his biggest fund this year, according to some reports.
Volatility traders use options on stocks, currencies, commodities and other assets to try to profit from pricing discrepancies and price swings. These traders can register a profit even when markets take a sharp drop, such as after the Japan earthquake or the near-default of Greek government debt. Volatility funds gained an average of 3.2 percent during the 2008 financial crisis, as well, while the broader hedge fund industry posted a 19 percent loss.
Mind you, volatility traders still represent a small fraction of the market. Newedge tracks 10 funds that manage roughly $4.6 billion in assets, a drop in the buck compared to the $1.8 trillion hedge fund marketplace.
Nevertheless, volatility traders profit from confusion in the marketplace and yes, volatility. Volatility is often measured by the Chicago Board Options Exchange Volatility Index or VIX, often called the “Fear Index.” The VIX has averaged 18.04 for the first six months of 2011, below its 21-year average of 20.34 and well below peak values. But things are heating up. The 30-day implied volatility for VIX options has surged 84 percent in the last week to a 14-month high. That points to more opportunities for quick, short-term moves that volatility traders thrive on.
“The increase in the “volatility of volatility” is giving us opportunities to create new positions and unwind old ones and that’s great for traders,” said Stephen Yashar, chief investment officer of New York-based Cosyne Capital Management LP.
What about you? Do you use volatility strategies or the increased use of options as a hedge to against downdrafts in the market? Add your comments below.