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  1. 1. The BlackScholes Option Pricing Model is not always effective for equities indexes Eganov Asset Management Partners Denis Eganov & Alexander Kurguzkin www.eampartners.com 1 24
  2. 2. Introduction An idea that is not dangerous is unworthy of being called an idea at all. Oscar Wilde 2 24
  3. 3. About the Company Eganov Asset Management Partners (EAMPartners) is an investment company that was founded in 2012 EAMPartners manages a hedge-fund Eganov Asset Management Stocks&Derivatives Strategies S.P. (EAM Strategies), using option strategies with high levels of return/risk The company provides asset management services exclusively to qualified investors The company doesn't offer services to residents of the USA 3 24
  4. 4. Denis Eganov Partner, Director and Marketing Strategist Since 2012 he has created and developed EAM Strategies hedge-fund From 2003 to 2008 he created and managed the biggest fund family in Russia From 1999 to 2003 Denis was a Head of an Asset Management Company From 1997 to 1999 he was a Fixed Income Trader 4 24
  5. 5. Alexander Kurguzkin Partner, Chief-trader and Risk-manager Since 2012 he has developed algorithmic trading systems and estimation methods for options Since 2012 he has managed a web-site for traders: www.long-short.ru Alexander is the author of Exchange Trading: Playing the Game by its own Rules (2009) He created algorithmic trading strategies for the trading of equities in the Russian stock market from 2002 to 2012 5 24
  6. 6. Problem The first step in solving a problem is to recognize that it does exist. Zig Ziglar 6 24
  7. 7. The Mathematical Formula linked to the Financial Crash In 2012 the BBC published an article Black-Scholes: The maths formula linked to the financial crash In 1997 Myron Scholes won the Nobel memorial prize. The next year, his hedge fund Long-Term Capital Management crashed and it lost almost all its assets, about 4 billion dollars Nevertheless the model Black-Sholes is still installed in all computer programs for estimating the value of derivatives in banks and investments companies 7 24
  8. 8. Why does the Formula Black-Sholes result in Losses? The BlackScholes Option Pricing Model supposes future changes in prices obeys the law of normal distribution (Gaussian distribution). But in real trade in options, for the majority of classes of assets the assumption of normal distribution of future price changes is often ineffective for the following reasons: significant asymmetry - prices is far more volatile in a falling market than in a growing market strong volatility clustering can be observed heavy tails in price returns distribution - there is an increased probability of strong price movements 8 24
  9. 9. EAM Strategies used the Black-Sholes Option Pricing Model We used the formula Black-Sholes in trading in the Russian stock market from 2013 to May 2014. Our hedge fund earned nothing! 65 75 85 95 105 115 Jan 2013 Apr 2013 July 2013 Oct 2013 Jan 2014 Apr 2014 July 2014 The performance of EAM Strategies hedge fund The performance the index RTS 9 24
  10. 10. The problems of using the Black-Sholes Option Pricing Model Most funds use the Black Sholes Option Pricing Models and the result has been major losses in periods of high price volatility If we examine the performances of hedge funds in the periods of autumn 2008 and August 2011, we see the funds lost about 80% of AUM during these periods 10 24
  11. 11. Decision You can never solve a problem on the level on which it was created. Albert Einstein 11 24
  12. 12. Problem-solving in Valuation of Options We have created and are using an alternative option pricing method which allows us: to get quantitative estimations which takes into account the price features of the equities indexes to use historical data to reconstruct price returns distribution for option price valuations to use volatility normalization which takes into account volatility clustering effect 12 24
  13. 13. Results of Backtesting of our Strategies We have backtested our option pricing method. The graph provides a comparison with index S&P500: 80 120 160 200 240 280 Jan 2011 Apr 2011 Jul 2011 Oct 2011 Jan 2012 Apr 2012 Jul 2012 Oct 2012 Jan 2013 Apr 2013 Jul 2013 Oct 2013 The results of the backtesting of the strategy of EAM Strategies: The average annual profitability +59.42% The maximum drawdown 11.10% The standard deviation 7.68% The performance the index S&P500: The average annual profitability +13.68% The maximum drawdown 16.90% The standard deviation 3.52% 13 24
  14. 14. Performance on August 01, 2015 This graph presents the current performance of EAM Strategies, as confirmed by administrator Apex, using our option pricing method in comparison with the index S&P500: 14 24 100 110 120 130 May 2014 Jul 2014 Oct 2014 Jan 2015 Apr 2015 July 2015 The performance of the EAM Strategies The annual profitability +20.28% The maximum drawdown -10.02% The standard deviation 10.79% The performance of the index S&P500 The annual profitability +10% The maximum drawdown -3.10% The standard deviation 3.59%
  15. 15. Our trading breaks down into three complementary strategies: 1. Long option call has to earn a lot of money in the rising market. This strategy gives a controlled loss in the flat and in the declining market 2. Long Treasuries stabilizes exposure to market which arose in the first strategy and makes up the risks of the bearish market 3. An accumulation of put option prices should make a profit in the all slow market movements 15 24
  16. 16. Investments Process Before the beginning of a trading session on the CBOE a chief-trader makes a valuation of options for index S&P 500 The chief-trader calculates the sizes of positions using the Kelly criterion. The current level of drawdown is taken into account for the purpose of controlling the maximum level of drawdown In regular trading, portfolio positions are adjusted in accordance with calculation data In cases where stock market is unfavorable to our short position in options, these options will be closed 16 24
  17. 17. Conclusion Of course it is just a trifle, but there is nothing as important as the trifles. Arthur Conan Doyle 17 24
  18. 18. Conclusions Using the BlackScholes Option Pricing Model for equities indexes is largely ineffective In our model of valuation options we calculate option prices taking into account a wide range of value criteria, such as underestimating and overestimating options out of the money for equities indexes 18 24
  19. 19. Conclusions Our strategies develop options positions taking into account market volatility. This allows us to protect assets in unfavorable markets and use the opportunities created by a rising market On this basis, we expect our methods will have a better return/risk ratio than hedge-funds using the traditional ways of dealing in options 19 24
  20. 20. Why do you think you are better than the funds in your asset class? Our team doesnt use the BlackScholes Option Pricing Model in our trading of options. We created our own model of evaluating options for equities indexes. It helps us to make more precise valuations of option prices and it has shown to be more effective than funds with option strategies using the BlackScholes Option Pricing Model We buy Treasury ETF to diversify the risk in the trading of options Portfolio managers make their own personal investments in the fund 20 24
  21. 21. Who are your Business Partners? Our fund conducts business with the leaders of world financial industry, such as: Broker companies: Interactive Brokers Group, Inc. Exante Bank: HSBC Audit company: Deloitte Independent accounting, money transfer and administration: Apex Fund Services 21 24
  22. 22. A Hedge-Fund Eganov Asset Management Stocks&Derivatives Strategies S.P. Foundation January 17, 2013 Jurisdiction Cayman Islands Initial stock price $1 000 Subscription amount $100 000 Subscription period Monthly Redemption period Monthly Redemption notice 5 days Performance fee 20% High Water Mark Management fee 2.0% annually Lock-up period No Ticker in Bloomberg EAMDSSP KY ISIN KYG1988M1657 22 24
  23. 23. Subscription Enter a subscription to EAM Strategies using the administrator Apex Fund Services: Exchange House, Athol Street, Douglas Isle of Man, IM1 1JD Telephone: +44 1624 630400 Fax: +44 1624 630401 www.apexfundservices.com 23 24
  24. 24. Contacts Thank you for your attention! If you have any questions ask Denis Eganov Email: info@eampartners.com www.eampartners.com 24 24