How asset price affects your alpha

[ironchef]

There is no specific low beta etf. You can substitute SPLV, which is minimum vol. etf which has half the beta of SPHB. It is screened from the same pool (SP500) stocks, but screened for slightly different factor. But for this exercise that is good enough

Thanks.

 

[ironchef]

Since Beta is risk/volatility of a stock compared to the rest of the market, wouldn’t you sell (short straddle/fly) low beta, high IV stocks; and buy (long straddle) high beta, low IV stocks?

Also I guess low beta would be large caps and high beta would be growth stocks ...

Actually I was thinking the same thing but you were one step ahead of me.

I was reading Colin Bennett's book the other day (from sle's post) and tried to generate some positions using correlation pair. Your comments mean maybe I can find high beta and low beta stock pair and use this BAB strategy to get better risk adjusted returns?

I don't know what I am talking about, so please comment.

 

[Adam777]

Actually I was thinking the same thing but you were one step ahead of me.

I was reading Colin Bennett's book the other day (from sle's post) and tried to generate some positions using correlation pair. Your comments mean maybe I can find high beta and low beta stock pair and use this BAB strategy to get better risk adjusted returns?

I don't know what I am talking about, so please comment.

I was asking about how how to use Beta in basic options trading, not pairs trading. I found Sinclairs books had more complete ideas and less scattered than Bennet’s book

 

[ironchef]

I was asking about how how to use Beta in basic options trading, not pairs trading. I found Sinclairs books had more complete ideas and less scattered than Bennet’s book

I don't know, from my experience Beta is a two edge sword. In a bull market it is wonderful but in a down market unless you are careful it can hurt bad. I am looking at pair so I can trade delta neutral and less affected by direction.

 

[ironchef]

It was explained in the article. Here is the direct link to their paper.

https://ac.els-cdn.com/S0304405X130...t=1549504127_439c3f17dfa45093ce529ffd0f191296

"A basic premise of the capital asset pricing model (CAPM) is that all agents invest in the portfolio with the highest expected excess return per unit of risk (Sharpe ratio) and leverage or de-leverage this portfolio to suit their risk preferences. However, many investors, such as individuals, pension funds, and mutual funds, are constrained in the leverage that they can take, and they therefore overweight risky securities instead of using leverage. For instance, many mutual fund families offer balanced funds in which the “normal” fund may invest around 40% in long-term bonds and 60% in stocks, whereas the “aggressive” fund invests 10% in bonds and 90% in stocks. If the “normal” fund is efficient, then an investor could leverage it and achieve a better trade-off between risk and expected return than the aggressive portfolio with a large tilt toward stocks. The demand for exchange-traded funds (ETFs) with embedded leverage provides further evidence that many investors cannot use leverage directly. This behavior of tilting toward high-beta assets suggests that risky high-beta assets require lower riskadjusted returns than low-beta assets, which require leverage."

srinir,

After reading the paper a few more times, ignoring the math, I think I have a better understanding of what you, Kevin and Magic are saying.

As a retail trading my own money, I have few constraints so I can invest/trade leverage low-beta assets. Will I be better off trading a beta neutral high-low mix?

 

[srinir]

.

As a retail trading my own money, I have few constraints so I can invest/trade leverage low-beta assets. Will I be better off trading a beta neutral high-low mix?

I would caution making wholesale changes in portfolio based on some recent results or backtest. These factors can under-perform after they were discovered and can go years before they mean revert. Just look at Value and Size factors. Value has been a dog for almost a decade and Size is not that much better. If I employ these long short strategies, i would do so at the margins.

 

[ironchef]

I would caution making wholesale changes in portfolio based on some recent results or backtest. These factors can under-perform after they were discovered and can go years before they mean revert. Just look at Value and Size factors. Value has been a dog for almost a decade and Size is not that much better. If I employ these long short strategies, i would do so at the margins.

Thanks.

 

[Adam777]

In dynamic hedging by NT, he states that alpha = theta/gamma = 1/2*variance*S.
He also follows up by writing a table describing fair value of alpha per volatility.

Would this not imply that selling options on higher priced assets and buying options on lower priced assets increase your alpha? I do not follow this as it would imply higher alpha for example selling SPX options vs SPY options.

Lastly, he comments "an alpha that is lower than the fair value alpha for a short gamma position will result in long term losses". Is he implying that I could just scan for these low/high "rent ratio" options and have long term success?


Reference is on pages 178:183 in Dynamic hedging

Thank you for the book. Reading it now, as well as two of Sinclair's books for the third time.

I'm very new to all this, but in "Volatility Trading" by E. Sinclair he mentioned on page 61 regarding "the market overestimating volatility for firms with: large size, high return on assets, and high leverage". Hence theres profitable opportunities selling volatility on large caps with low PE, which agrees with you mentioning selling options on the higher priced underlying.

Also wouldn't jumps with high priced large caps be smaller percentage wise, than jumps on lower priced stocks/growth stocks? Hence with the large cap, it's underlying price would be less likely to jump out of, and hence stay within the breakeven prices of the straddle/fly when shorting implied volatility during earnings etc?

 

[TheBigShort]

Hence theres profitable opportunities selling volatility on large caps with low PE, which agrees with you mentioning selling options on the higher priced underlying.

Hi adam, low P/E large MKT cap is very different than high priced high vol stocks.

Also wouldn't jumps with high priced large caps be smaller percentage wise, than jumps on lower priced stocks/growth stocks?

If you could provide research showing this is true I would love to see it. Although Euan mentions this in his book, and tries to prove it with a small table of data, it does not excite me. On top of that Low P/E Low Growth companies have a smaller implied move associated with them. If you could prove that the variance premium is overstated in mature companies vs growth companies with at least 100 companies and 20 quarters under the microscope, that could be the start of a trading strategy.

 

[Global OptionsTrades]

Fascinating thread that resonates with something I am thinking about.

I don't want to derail this, but are there any thoughts on the merit of buying volatility of an index such as NQ and selling volatility of (some or all of) the constituent shares?

There is obviously a correllation (beta) to calculate respective position size so that the lower-priced long index option hedges higher-priced short stock option for an individual stock, but I'm struggling with how to correctly hedge for more than one stock.

Thanks in advance for any thoughts.