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Tail Risk Strategy

Objective

  • Seeks to provide protection during broad market and certain factor stresses without the typical burden of large carry/theta bleed.

Process

  • Logica’s Tail Risk Portfolio systematically combines Logica’s Volatility Arbitrage Strategy (which is never short vol/gamma) with two other defensive and “risk-off” strategies. The result is a portfolio that consists of the following 3 components:

    • Volatility Arbitrage – Seeks to take advantage of significant moves in the market through exclusively long vol and long gamma exposure (long S&P options)

    • Defensive Market Neutral (DMN) – a dollar neutral portfolio consisting of ~200 long/~200 short positions, DMN seeks to profit when strategies/trades that may be described as “crowded” go out of favor. DMN seeks a positively skewed return distribution, achieved by creating minimal returns during normal market/factor regimes, and profiting during stress regimes for certain factors and strategies.

    • Safe Haven Non-Equity Market Assets (EXX) – EXX, named for the “X factor" that can bring turmoil to equity portfolios, seeks to provide broad market protection via non-equity global macro assets, such as gold, currencies, and treasuries (through ETF instruments). Logica combines and dynamically trades these assets through time to target a positive overall return, with greater upside during times of broader market stress.

  • The Tail Risk Portfolio dynamically trades the above 3 strategies in order to be constantly exposed to ideal levels of protection. For example, when the Vol Arb signal is weak, the protection mandates increased exposure to the other portfolios.

Pros

  • Seeks to protect against broad market, and some factor, volatility

  • Positive Gamma positions = convex upside against downside moves in the S&P 500

  • Seeks to be highly liquid

Cons

  • Dormant during times of low/no market volatility

  • Can under perform in periods of runaway upside market/factor regimes

  • May not be tax efficient

Instruments

  • The portfolio trades options on ETFs, which track the major indices. It trades both puts and calls across varying strikes and expiries.

Why Tail Risk? Why Logica?

Our Tail Strategy seeks to provide protection against not only market stresses, but protection against crowded trades. For those running active strategies, long-biased strategies, or even beta-neutral, broad market hedging is necessary, and sometimes, not quite enough. Often, a specific factor will experience a stress event while the broader market will go unscathed (or lose much less). According to our research, when a typical long-only strategy that is biased toward the momentum factor experiences a daily return of -1.00% or worse, around 7-8% of those times, broad market indices do not experience a concurrent drawdown. This is most notable in the momentum factor, but also applies to other factors, popular levered beta neutral portfolios, and a handful of other strategies.

The majority of tail risk funds utilize a risk-on short volatility trade to subsidize the cost of long volatility time decay (theta). The problem is that this short volatility income reintroduces a large “back-door” risk: these “tail funds” only hedge a market drop up to a certain point – past that, the strategy is in the red, and sometimes very much so. The best case is that you’ll never experience this hidden risk. The worst case, though, can result in a spectacular blow up.

We complement our long vega/gamma Volatility Arbitrage strategy (which aims to be a pure broad market hedge) with two strategies (DMN and EXX) that seek to accomplish two things: help offset theta bleed via positive returns over time, and, just as importantly, hedge against factor sensitivities which are often outside the broader market, and/or expressed in the form of crowded trades.

For Performance/Fact Sheet and presentation material, please contact us.