Welcome to the introduction of the BGA proprietary managed volatility strategies.
Description: The index is designed to track the performance of a basket of cash and/or derivative instruments that rise in value while general stock market volatility stagnates or falls. Chart will be updated weekly.
Disclaimer and statement of risk:
The behavior of S&P option volatility can vary from predicted norms or past behavior. Returns as achieved in the past by the index may not be achievable in the future. Replicating these returns requires a higher level of trading activity and is only suitable for certain investors.
Additional information: Volatility is one of the variables of an option price. Volatility rises and falls due to many factors but the overriding characteristic is that it is range bound and doesn't rise and rise like an equity or real estate or a long duration bond can. With the advent of derivatives which are based on volatility as the underlying risk, a trader can profit from the relative predictability of its range-bound nature.
Another distinctive characteristic of S&P Index option volatility is that it can spike by large factors during times of market turmoil, usually brought about by a sudden drop in the stock index. This behavior means that without a compensating factor it would be easy to buy the volatility derivative when it's low and wait for the market event. The compensating factor is a very high "cost of carry". The high cost of carry makes is impossible to profit from continually holding the volatility contract year after year and potentially profitable to do the opposite. The risk to staying short volatility are the market-event-induced spikes. This risk is managed through the proprietary mixture of elements comprising the short volatility index graphed above.
In summary, in the opinion of Brampton Gillow Advisors there are two preferred ways of profiting from volatility, namely, earning the cost of carry, and selling as it nears the higher end of the then-current volatility regime. Buying volatility during times of distress is possible but difficult to time and reproduce consistently.
Additional definitions: People refer to volatility as a variable that will "revert to the mean" which is true but I prefer to think of it as reverting to the base. There is some certainty that from time to time (although at times that are unpredictable), S&P option volatility will decline to equal the lowest levels seen in the past. I make this distinction to imply that averages of index volatility aren't important, it's the maximum and minimums that carry the importance.
Volatility resides within regimes. It's true that the lowest levels of S&P index volatility are around 10, but that low number was an extreme of a regime that might be considered 10-20. Volatility can spike as previously mentioned though, and then settle into a higher regime of 20-30 or higher. It's convenient to think of volatility regimes in 10-figure increments. As I write this volatility is at 23 even though the S&P is at its all-time high. The COVID19 pandemic has pushed volatility into a higher regime. It's hard for volatility to stay above 30 for very long but it has in the past and there are certainly events in our future that will cause volatility to stay at high levels for longer periods of time.
During a market crash and coincident spike in volatility the cost of carry can turn upside down meaning spot volatility will be higher than the more distant futures. The managed index is designed to compensate for this.
If you have more questions about the BGA Managed Short Volatility Index please contact us the number below.