Equity Volatility Trading:

Contact:

David Hamilton

t: 212.217.1556 m: 917.499.7331

davidehamil@gmail.com

Diversified Proprietary Strategies for Alpha Generation & Portfolio Hedging

Strategy Defined

Volatility Arbitrage is designed to produce absolute, market-neutral returns.

• Strategy continually looks to exploit pricing inefficiencies in various

options classes to generate consistent profits.

• Trade duration might vary from a few weeks to a few months.

• Strategy uses only exchange-listed options on US stocks.

• Strict execution and oversight guidelines ensures:

– Reduced transaction costs and market impact (Proprietary trading

technology utilizes all available liquidity to ensure positions are initiated and

closed in the most efficient manner possible).

– Increased speed and effectiveness of Risk Management

(Proprietary tools also designed to identify and rapidly reduce risk across both

strategies).

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Relative Value Arbitrage (1 Month Maturity)

10-Year Backtested Returns, Jan 2002-Jan 2012

2002-2011 2010-2011 Average (vols x 100) 0.0300 0.0151 Sharpe 2.2601 1.3197 Stdev 0.0459 0.0395

Bin Frequency -0.06 5 -0.04 5 -0.02 15

0 30 0.02 50 0.04 40 0.06 42 0.08 25

> 0.08 28

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Relative Value Arbitrage (3 Month Maturity)

10-Year Backtested Returns, Jan 2002-Jan 2012

2002-2011 2010-2011 Average (vols x 100) 0.0283 0.0286 Sharpe 1.8259 1.9300 Stdev 0.0537 0.0513

Bin Frequency -0.06 6 -0.04 13 -0.02 21

0 28 0.02 39 0.04 38 0.06 30 0.08 25

> 0.08 31

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Strategy Defined

Portfolio Insurance is a vitally important, yet often overlooked, element of

traditional and quantitative Long/Short equity strategies employed by

hedge funds.

When used properly, it should serve as a key component of the risk

management process, seeking to preserve investor capital by locking in

gains and preventing/minimizing any potential drawdowns.

Design and use of Portfolio Insurance can be outlined in the following steps:

• Identify Hedging Needs

• Hedge Valuation/Optimization

• Hedge Implementation

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Hedge Identification

Determine key underlying risk(s):

• Entire/partial portfolio

• Net Beta exposure

• Volatility/Correlation risk

• Binary Event risk

• Tail risk

Underlying Strategy Time Horizon:

• Short Term (1-2 days)

• Medium Term (3 days – 1 week)

• Long Term (1 week+ )

Additional Consideration Factors:

• Momentum/Mean-Reversion Indicators

• Directional Indicators

Identifying all contributing factors in systematic fashion allows for efficient pricing,

construction and optimization of strategy hedges.

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Hedge Valuation/Optimization

Valuation

• Determine prevailing levels of implied volatility in the marketplace.

• Can use simple comparisons to historical means or multi-factor valuation model, using both technical and fundamental inputs.

Optimization

• Develop Optimal Hedge given market levels, strategy timeframe, available liquidity (stock-by-stock, group of underlyings or Portfolio-wide) and additional indicators.

• Simple Hedges (Fixed-Strike Index Collar, Put Spread Collar).

• Complex Hedges (Dynamic Index/Sector ETF Collar, Index Variance, Futures and Options on Volatility (VIX), Synthetic Correlation Plays, Customized OTC Instruments).

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Hedge Implementation

Example – Ratio Collar on SPX

BUY: 1 6mo 98% Put

SELL: 1.5 1mo 101% Calls

BACKTEST PERIOD Jan 1999 – Jan 2010

SPX Level at Start: 1,234.40

SPX Level at Finish: 1,150.23

PERFORMANCE Avg. Return (monthly): 0.30%

Standard Dev. (monthly): 1.28%

Avg. Return (annualized): 3.60%

Sharpe: 0.81

TOP GRAPH:

Absolute returns, SPX + Collar v. SPX(in SPX points)

MIDDLE GRAPH:

Annualized volatility (SPX + Collar, SPX, Collar/SPX)

BOTTOM GRAPH:

Monthly returns, SPX + Collar v. SPX(in SPX points)

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