Schadenfreude Warning: "Karen the Supertrader"

[Maverick74]

in your opinion and drawing from your experience, do you think these funds are truly hedging their risks?

"Rolling for duration" as Tastytrade loves to preach is simply a martingale strategy doomed to fail as capital and margin disappears.

From what I can tell there doesn't appear to be any hedging at all (using underlying securities or related products to hedge delta, vega, etc.).

I think the word hedging is very much misunderstood. You cannot hedge these positions by definition of the word. What hedging really means is reducing exposure to something. I buy health insurance so that if something happens to me, the insurance absorbs some of the shock that would come from an unexpected medical expense. Insurance does NOT keep me from getting sick. Same with car insurance, homeowners insurance, etc. It's purpose is to minimize loss. The problem with how the word gets used on ET, it gets used as this magical potion where losses disappear or turn into profits. The other missing part is somehow in the magical world of ET, hedging can be done "after" the fact. With health insurance for example, we have the so called "waiting period". If I get sick, I can't simply go out and buy insurance and then take advantage of the benefits. The insurance has to be bought "before" the fact. Same is true with ALL insurance. But many on ET don't like that, because of the cost. They think they can wait until something bad happens, and THEN go out and get insurance and magically make the fire disappear.

The fact of the matter is, these positions cannot be hedged without either "increasing risk" or simply shifting it. For example, if I sell a naked put 10% down and the market tanks 10% and I sell shares to hedge, all I did was shift the risk from the put side to the call side (short put and short shares = short call). That is NOT hedging. Rolling to the next month by rolling up and out or down and out is not hedging, it's simply doubling down and building a close relationship to God via praying.

The fact is, you have sleep in the bed you make. If you sell this 5 delta crap, that's your bed for better or worse. The absolute best thing to do is if the market moves against you, just buy them back and eat the loss. Because you can't hedge them. This is why insurance companies who specialize in this business and they happen to be pretty good at them which is why Buffet likes to own them, this is why they spend so much time on "pricing" insurance. If you price the risk correctly, then you let the central limit theorem do it's thing. When a hurricane hits south fl and it will, you simply eat the loss because the pricing you built into your policies will cover the loss over the long run.

 

[tradelosses]

selling calls can be worse than puts. It would not suprise me if she blew up that way.

Well, there are things we have to separate here and they are very important. The "short vol" trade is very crowded. Any kind of small correction can see a very over exaggerated move in vol because the short 5 delta crowd will panic and lift offers like no tomorrow which is one of the reason this trade is so utterly god forbidden stupid by any reasonable measure. But the index itself has been relatively calm. Even on the August correction we had like one bad day and a few little bad days. If you took a 3 day vacation with the family and never turned on CNBC then you completely missed it. The short vol trade in options is very different though because the sheer size of that trade in the aggregate will get margin called very fast. So hypothetically we could get a 5% correction that could see the VIX spike 50% where in 2008 a 5% drop might spike the VIX 10%.

a lot of people also get blowup selling calls (rising IV + rising prices = account death) or from correlation breakdown (2007 quant meltdown). There are so many ways to lose money in the stock market, no disagreement on that. Correlation breakdown is in many ways worse because it's harder to quantify and or understand correlations than IV.

 

[Niten Doraku]

I think the word hedging is very much misunderstood. You cannot hedge these positions by definition of the word. What hedging really means is reducing exposure to something. I buy health insurance so that if something happens to me, the insurance absorbs some of the shock that would come from an unexpected medical expense. Insurance does NOT keep me from getting sick. Same with car insurance, homeowners insurance, etc. It's purpose is to minimize loss. The problem with how the word gets used on ET, it gets used as this magical potion where losses disappear or turn into profits. The other missing part is somehow in the magical world of ET, hedging can be done "after" the fact. With health insurance for example, we have the so called "waiting period". If I get sick, I can't simply go out and buy insurance and then take advantage of the benefits. The insurance has to be bought "before" the fact. Same is true with ALL insurance. But many on ET don't like that, because of the cost. They think they can wait until something bad happens, and THEN go out and get insurance and magically make the fire disappear.

The fact of the matter is, these positions cannot be hedged without either "increasing risk" or simply shifting it. For example, if I sell a naked put 10% down and the market tanks 10% and I sell shares to hedge, all I did was shift the risk from the put side to the call side (short put and short shares = short call). That is NOT hedging. Rolling to the next month by rolling up and out or down and out is not hedging, it's simply doubling down and building a close relationship to God via praying.

The fact is, you have sleep in the bed you make. If you sell this 5 delta crap, that's your bed for better or worse. The absolute best thing to do is if the market moves against you, just buy them back and eat the loss. Because you can't hedge them. This is why insurance companies who specialize in this business and they happen to be pretty good at them which is why Buffet likes to own them, this is why they spend so much time on "pricing" insurance. If you price the risk correctly, then you let the central limit theorem do it's thing. When a hurricane hits south fl and it will, you simply eat the loss because the pricing you built into your policies will cover the loss over the long run.

Would you perhaps propose that if a strategy is exposing itself to delta (gamma) and vega risk, as one would be short convexity, that an equally independent strategy that is long convexity should also operate in parallel - i.e. mutually exclusive but symbiotic?

Naturally, the expectation of net p/l and drawdown during periods of stress are at some level projections regardless of confidence in backtests and statistical models.

At the most remedial level the classic 60/40 stock-bond portfolio is an archetype of one asset class outperforming while the other underperforms. Extending this to strategies would mean if a portfolio manager is selling volatility, he or she should also buy volatility independently too.

 

[Maverick74]

Would you perhaps propose that if a strategy is exposing itself to delta (gamma) and vega risk, as one would be short convexity, that an equally independent strategy that is long convexity should also operate in parallel - i.e. mutually exclusive but symbiotic?

Naturally, the expectation of net p/l and drawdown during periods of stress are at some level projections regardless of confidence in backtests and statistical models.

At the most remedial level the classic 60/40 stock-bond portfolio is an archetype of one asset class outperforming while the other underperforms. Extending this to strategies would mean if a portfolio manager is selling volatility, he or she should also buy volatility independently too.

Yes exactly and this is what I try to do. If I'm selling vol in equities I might be buying vol in bonds. Or I'm long equities I might be long bonds or long certain FX pairs. When I was on the floor and we had exposure somewhere in our book, we did everything possible to avoid simply buying or selling shares to offset delta risk. We looked for real edge in our hedges. If we sold expensive vol we looked for cheap vol somewhere to buy. It makes no sense to me to sell naked puts in SPX and then turn around and buy those same expensive SPX puts to hedge. I mean why would anyone do that? It would be like in 2008 you're buying CDS in mortgages that are about to default and you hedge that by actually buying the actual mortgages that are in default. LOL.

 

[Niten Doraku]

It would be like in 2008 you're buying CDS in mortgages that are about to default and you hedge that by actually buying the actual mortgages that are in default. LOL.

Haha! I hope you don't mind if I steal that example!

 

[ironchef]

Rolling to the next month by rolling up and out or down and out is not hedging, it's simply doubling down and building a close relationship to God via praying.

The fact is, you have sleep in the bed you make. If you sell this 5 delta crap, that's your bed for better or worse. The absolute best thing to do is if the market moves against you, just buy them back and eat the loss. Because you can't hedge them.

Wow! I don't think I ever understood this part. Always thought if I could keep rolling out and up or out and down, as long as I did not lose any additional premium when I did that, sooner or later I would be OK because usually the underlying went through peaks and valleys? I remember Karen said the same thing in one of her interviews: "I hate losses and I do everything I can to not take losses - move out...." And so I used the same strategy on some of my shorts when the market moved against me.

I always thought the reason I did not do well was because I did not know how to roll.

 

[Chubbly]

Wow! I don't think I ever understood this part. Always thought if I could keep rolling out and up or out and down, as long as I did not lose any additional premium when I did that, sooner or later I would be OK because usually the underlying went through peaks and valleys? I remember Karen said the same thing in one of her interviews: "I hate losses and I do everything I can to not take losses - move out...." And so I used the same strategy on some of my shorts when the market moved against me.

Yes, I have no idea why people think that way. If that was the way it really work people would just roll forever till they win. A roll is nothing more than taking a loss and creating a new option position.

Rolling an option is meant for situations like you are long stock and you buy a put option 3 months out as a hedge and every month you roll it to maintain the same amount of hedge.

 

[ironchef]

Yes, I have no idea why people think that way. If that was the way it really work people would just roll forever till they win. A roll is nothing more than taking a loss and creating a new option position.

Rolling an option is meant for situations like you are long stock and you buy a put option 3 months out as a hedge and every month you roll it to maintain the same amount of hedge.

I remembered Tastytrade, in one of their videos, actually did a backtest on this strategy and I thought it came out OK.

 

[ScalperJoe]

Actually, they did not. Remember, when the first videos came out, they didn't even say her full name or the funds' names. I had to do detective work in the original Karen thread to figure out who she was. Not to mention it is illegal to promote HFs directly to the public.

They knew her because they were her broker from the beginning, and it was a good story to promote TT and option trading, not Karen.

I guess we're playing with semantics. "Featuring", "promoting", "advertising", "interviewing" etc. are one and the same.

They definitely boosted their ratings with the second video, where TT spent a lot more time talking about specifics, including dollar amounts, capital raised, and win/loss metrics at her fund. I think it was mentioned somewhere that her videos had several hundreds of thousands of views.

And it's no longer "illegal" to promote your HF, as long as you only offer the prospectus to accredited investors. The SEC amended the provision regarding the "general solicitation" of investors which became effective in 2013. Her second video appeared in 2014. Karen's firm of course only had accredited investors, according to the SEC complaint.

https://www.sec.gov/info/smallbus/secg/general-solicitation-small-entity-compliance-guide.htm

Check out some of the HF's advertising directly to the public (although, of course, only accredited investors can actually invest in the fund).

http://dealbook.nytimes.com/2014/02...funds-test-waters/?_php=true&_type=blogs&_r=0

 

[Pekelo]

Couple of things I found strange:

1. Her AUM didn't increase after 2012 although she had excellent numbers and now fame. Basically no effect of the videos on her ability to raise capital. Or even negative effect...

2. She did take a 30 million loss, but why? Was an investor asking for the money back so they couldn't conceal the loss? But the "first come first served" stipulation would have let her pay that investor with others' money. So why did she take the 30 mill loss but wouldn't take the 50+ mill? Taking a loss is just bad money management, not fraud.

3. The strange HF set up was there from the beginning. That is a big red flag, almost inviting fraud. Yet investors didn't find it odd.

4. Her strategy's bread and butter was theta and higher volatility. Yet when volatility increased a bit, she suddenly takes a bath.

5. The whole 2014 loss just doesn't make sense knowing her performance in previous years. Unless some of that performance were also faked. But the CFTC investigated her in 2013. Did they only look at compliance and not the numbers?

6. "The HI fund had unrealized losses at the end of every month between 3 and 62 mill for at least 2 years." So she was faking the numbers as early as 2014 May, and her last TT interview was in 2014 Aug, so she was definitely lying in that interview. And it also indicates that rather than having a big event causing a big loss, she was getting losses here and there...
But I am perplexed by the world fluctuated. Wouldn't she take a small loss if it really fluctuates back to single digits from -62? Maybe they should have used the word ranged, instead of fluctuate.

7. Where those earlier losses came from? Were they caused by her unwillingness to acknowledge a negative month? Let's say if a month is slightly negative that is usually no big deal for a HF, but because of her fee structure, she wouldn't get paid for that month and until that loss is made up. This would explain how the fudging of the numbers started.

All in all, the only way this makes sense if she was already fudging the numbers much earlier than 2014 October...