YTD 2014 Short Vega Fund investor letter. Also a look around the world using our Volatility XXX software

YTD 2014 Short Vega investor letter.  Also a look around the world using our Volatility XXX software

We use our volatility software daily to watch the worlds concerns as expressed by vol, they are clearly moving East, however Spain and Italy to some degree are still on peoples radar.  Positioning for a slower China are being expressed in Brazil, Australia, Canada and Korea

Self Inflicted perpetual fear: How quickly things can change?

Self Inflicted perpetual fear: How quickly things can change?



80% chance of QE3, now ~ 30%.  Interest Rates and Stocks are booming, correlation is rewarding stock pickers with multi year lows when just a few months ago, it was at multi year highs.  So what happened, how did we go from headline to headline, 30 handle swings to a parabolic SPX graph that resembles apple?

LTRO, Greece, PSI, EURUSD mentions in MSM have also collapsed.  The spotlight is on global growth, free money til 2014.  Now rate hikes are priced in 2013?  Are we running out of stocks to buy?  Financial stocks have in some cases doubled from the lows just set less then 9 months ago.  We could go on, but we will come back to our core thesis of de-levering and short long dated vol as what we usually do here at PFG.

Some claim the sunshine is to blame for the optimism or the lack of a winter, others point to the great data coming from the US.  Most are skeptical however and looking for the  “I knew it” moment when SPX will fall 15 handles and they won’t be short it or have any gamma on.  It probably will get bought by the dippers and the story will repeat till 2014.  Vol is going to party like it’s 2004.  Welcome.

But wait...Irans oil/bomb/war...Election Year, Greece still has..., where are all these new jobs...., Who will buy the MBS paper....I see line ups at open houses again....everything is over-extended for perfection.  The fact is that it’s been 4 years since Obama came into the Lehman mess and we are well on our way to finally building a foundation and corporates actually are fine and have cushioned themselves well for a possible attack.  Yes, they will still fail, a few might even succeed, but overall the market seems to comfortable with taking risk with a promised low interest till 2014.  Ben has given retail its own version of the LTRO, start reading the memo and use it.

1. The power of the FED is clear.

2. Hey wait a minute, why should I fund the ZIRP?

3.  What seems as optimism might actually be a “I have no choice to buy stocks and real estate”  Mr Black Swan

4. Long dated vols are collapsing 5. Vol traders are having fun playing the slide to take advantage of levered etf flows and perpetual fear in the market

6. But no one is allowed to be short.  This is tough one to take to management, we are approaching last years lows fast
7. The NEW NEW thing in Vol, sell the old problem, buy the new problem.  This trade will be big in the second half of this year.  Sell Euro, Buy Asia vol
8. The challenge the FED faces

Patience: Long Dated Vol will go down, the curve will flatten

Patience: Long Dated Vol will go down, the curve will flatten



In all asset classes, we see the same thing, short dated vols are crushed as the market can’t seem to break out of this low correlation upward drift.  It is the max pain path as everyone loaded up on short dated gamma as it “looks cheap”, except all it is doing is getting cheaper and causing option players to re-think continuously what delta they wish to hold against the cheap baby calls they are long.  This is no easy matter, the upward drift pnl loss is real, the OTM call option gain is a combination of marks.  Gamma and short dated vega is littered all over the street on dealer books.  As nothing happens, it is being puked out to avoid paying anymore theta and we should get a move when they finally decide to get short it.  


1. Interest Rate Vols







2. Recently steepness has picked up, giving long dated vol sellers a great entry point

3. Forward Vols Implied are also very high


4. Term Structure is also at extremes

Could we be entering a 2004-2007 low volatility world? All the graphs say yes, but you have to look a little further back in history, otherwise they are all screaming BUY

Could we be entering a 2004-2007 low volatility world?  All the graphs say yes, but you have to look a little further back in history, otherwise they are all screaming BUY



While everyone is focused on what will happen with Greece, specifically the March 2011 bond, the risk on world seems to have looked passed the drachma drama.  Yes, we may have a few bumps along the way, but money is looking for a much riskier home these days


1. High Yield Spreads have come down really fast


2. Large disconnect between credit and Equity - this is more due to the fed then natural forces to keep cheap money around for a long time




3. Even PIMCO’s Bill Gross has leveraged PIMCO to hold bonds and MBS.  A full 180, but also viewed as short vol trade



4. Does anyone care about the Euro Danger?  Vol has dropped really fast, skew however has not, currently in about the 85th percentile.  Protection via tails is getting expensive again.

5. No demand for term structure for the front months.  Record spreads over the last year.  So why does no one “need” vol for anything imminent?  Is the market simply trying to move vol demand forward and into lower strikes with Euro Bailouts?


6. The risk EM/DM/VIX world also screaming to buy vol?  But wait, look to your right and you can see that before all the Euro Drama, the 2004-2007 vol world, post Dot-Com and World Com, the vol markets did nothing for 3 years! and risk on was “ok”



7.  Everything is saying buy vol if we just focus on the last 12 months?  Is the risk on rally finally sending a message to the vol world that things are going to be fine?  
8. According to UBS, global asset class vol viewed in a distribution format shows just have far vols have dropped.  So this is not just a VIX story, in fact risk on this YTD is everywhere, except USTs, as the fed is keeping ZIRP 2014 and keeping the back -end kink in check to get people back into the housing trade (twist) - Remember this includes the risk-on in EUROPE, yields have fallen, buyers have shown up to buy bonds and European Banks stocks have boomed.

9. If we widen the horizon, look at post 2003, is post 2011 going to be the same?.  Most people are looking at these graphs post 2008 and come up with “vol is cheap”



10. Interest Rate world sending same message - Long dated vol is to high and the story is the same, short dated vol smashed, long term vol has very little supply or courage to push it down.

We continue to believe that long term volatility is very overpriced, probably has a few suppliers and holding term-structure trades are the best way to position for the current environment.  No one has any edge over the Euro headlines, as they flip-flop and shake people out of positions.  However, we cannot ignore the massive flow into risky assets and markets making large bets that long term vol will go lower.  Everyone is waiting for a “whale event” to feel better about selling vol, we are not sure they are going to get it or long vol holders will get the expected outcome.

Technically Speaking

We typically don't look at charts for our vega book, but this is interesting as we are showing a 2 for 1 payoff at current spot.  The market is fully priced for perfection.

With the current boom in spot with a boom in vol, we believe a serious payoff is in store for short vol, short delta.  We understand at the recent lows in vol, the marginal buyer will set the price as supply will simply vanish.  However, it seems both cash and vol have over-extended.

Why am I not long Apple? Take risk, it’s ok. Buy upside calls and dump your longs.

Why am I not long Apple?  Take risk, it’s ok.  Buy upside calls and dump your longs.




You are probably reading this because you are not long apple, short the market or pulled your money out - our recent market survey confirms to us the continuation of equity outflow data.  Everyone is bearish, neutral and upset.  Small volume rallies continue to move the marginal price higher.  What feel’s like an amazing rally, is in-fact only taking the vapour out of recent fear that was priced in.  The equity markets maybe a touch ahead of themselves, but as we will see from the charts below, still plenty of upside is left.



People simply don’t trust the market and have piled into bonds.  PIMCO’s Bill Gross has even leveraged PIMCO to hold bonds and MBS.  A full 180.

It’s hard to take risk when see pictures like this below, markets seem to be over-extended and risk premia to low.  This is why we feel it’s better to hold upside calls Still plenty of upside left.

Taking ⅓ off the table: Party Continues, we are sneaking out early.

Taking ⅓ off the table: Party Continues, we are sneaking out early. Also a look at the PFG VIX Model vs VIX Futures



We are going to unwind our second ⅓ of our gamma fund and keep our vega fund the same, currently with average short vega of duration of 2.5y.

Fund Changes by 1/3	YTD Performance
XFN/XLU	14%
EEM/SPX	7.5%
Long/Short	5.3%
Bond	2.7%

Our thesis continues to be the same, we still believe in the positions, however still want to keep bullets in our pocket.  A couple of points

• The rally is so narrow and only paying the beat up stocks of 2011.
• Correlation has collapsed, Long/Short funds are finally getting paid
• Bad to mild news continues to fuel a income targeting rally
• No one is bullish

We are now ⅔ cash, ⅓ is still invested in our gamma fund and our vega fund is unchanged with a thematic short vega position.  Both funds are in positions of strength, taking out healthy gains in January and well funded to add good risk/reward trades. If correlation is a guide and we are moving towards any sort of normality, we expect our PFG VIX Model to be a good guide for us.