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SuperSaint
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re: Looking for volatility/tail risk hedged equity fund or etf
I've read every reply in this thread and think I'm more lost than after only reading the OP.

I love Money Talk, but damn I'm a layman.


GenesChin
Army Fan
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re: Looking for volatility/tail risk hedged equity fund or etf
quote:



Those two goals tend to blur together for me.


Try having a zero cost collar on FX and watching profits be handed away while the strike never hits while your put strike doesn't hit

Or having a collar on interest rates in Japan that never pay out as rates slowly crawl to 0

quote:

I suppose some people could have a concrete preference for one or the other in certain situations, but I'm thinking about insurance in terms of utility maximization across a range of distributions.


Utility theory suggests everyone's utility is different though. What you are suggesting though is an extreme risk aversion curve. It's effectively the opposite of diminishing marginal returns in that each marginal $ lost is an even bigger blow to utility

Got to remember you are heavily weighting tail scenarios utility loss in order to justify acceptable high probability minor losses in the leadup to the tail scenario



GenesChin
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re: Looking for volatility/tail risk hedged equity fund or etf
quote:


I've read every reply in this thread and think I'm more lost than after only reading the OP.
I love Money Talk, but damn I'm a layman.


To be fair, I imagine there are very very few people who fully grasp what Doc and I are talking about. Even more fair, I'm sure he probably would run circles around me.

Basic Breakdown

Key Background

- Volatility effectively is "risk" and it is really how much movement is expected. Mathematically it is the dispersion of values around the avg/mean. Basically, say you expected a 5% return if low volatility may say 99% sure it is between 4%-6% returns while high volatility would have 99% 1%-9% returns

- Volatility is a standin for risk. The higher volatility, the more unsure you are that what you expect will happen

- Generally speaking, people are "risk averse" and rather have a sure thing than the chances of a big gain

- This creates the idea of a "risk premium" -> If you want to have higher expected investment returns, you have to accept higher risk/volatility

- So with this in mind, treasury bonds = super safe that's why there are like ~2% while stocks expect 7% because they are more risky

If you want to be safe, you can reduce "risk premium" but that also reduces your expected gains as well

Story
- OP asks about markets that hedge volatility

- I point out that in theory just investing in less risky assets should give you the same expected return. In practice less risky assets give you a better return since hedging usually has transaction costs

- Doc points out the 3 ways to reduce volatility
1) less risky asset portfolio
2) Buy ETF or Stocks + VIX that says "I think market goes up but just in case I'm buying insurance against a huge tanking event
3) Invest in hedge fund with complex tail risk strategy

-Iowa Golfer points out you can by options on volatility instead of the volatility yourself if you only want to protect against huge volatility spikes

-Doc points out if you combine market + hedging against volatility (referring swing downwards) what you set up depends on just how far of a swing downwards you are worried about. Also points out historical notes like Black Friday in 87

-Fenton + Me discussing insurance against downside risk as it relates to a portfolio

Is someone buying insurance to have more stable investment gains or to protect against a big loss event?

Insurance is based on utility theory. That's something worth reading up on and hard to explain on a message board
This post was edited on 10/5 at 10:32 pm


Doc Fenton
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re: Looking for volatility/tail risk hedged equity fund or etf
quote:

What you are suggesting though is an extreme risk aversion curve.


I don't think I am. If you are willing to accept minor volatility in exchange for higher average returns, then it also makes sense that you might want to hedge more against maximum drawdown risk. That's the case for tail hedging.

It's the other sort of insurance (e.g., the ordinary 60-30-10 portfolio) that has more risk aversion.

And if you look at who cares about maximum drawdown risk, it is typically people (PE firms, VC firms, algo traders, etc.) who engage in the riskiest sorts of investments.

quote:

Got to remember you are heavily weighting tail scenarios utility loss in order to justify acceptable high probability minor losses in the leadup to the tail scenario


I would say that deep-OOM options that are regularly rolled over will give you some pretty good returns, even on minor losses. How much depends on the maturity date, of course, but it's not as if portfolio insurance better constructed to capture tail risk is an all-or-nothing proposition on its payouts.


Iowa Golfer
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re: Looking for volatility/tail risk hedged equity fund or etf
Gene - You have a junk email account I can send you an invite on?


GenesChin
Army Fan
The Promise Land
Member since Feb 2012
28870 posts

re: Looking for volatility/tail risk hedged equity fund or etf
quote:


Gene - You have a junk email account I can send you an invite on?



Invite for what?
This post was edited on 10/6 at 9:05 am


Iowa Golfer
Iowa Fan
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re: Looking for volatility/tail risk hedged equity fund or etf
A slack work site. Some investors on here, and formerly on here. You can take your email down now.


GenesChin
Army Fan
The Promise Land
Member since Feb 2012
28870 posts

re: Looking for volatility/tail risk hedged equity fund or etf
Appreciate it. I'll give it a more indepth look at some point today


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GenesChin
Army Fan
The Promise Land
Member since Feb 2012
28870 posts

re: Looking for volatility/tail risk hedged equity fund or etf
quote:

If you are willing to accept minor volatility in exchange for higher average returns, then it also makes sense that you might want to hedge more against maximum drawdown risk.


What you are describing (assuming it is buying options) is effectively a utility cliff point/non continuous curve for unhedged risk scenarios though. I don't know the indepth details of this segment of utility theory, but I don't believe in principle that makes sense for a standard personal investor


For say insurance companies, that have regulated solvency requirements or investment firms that may have disintermediation risk from capital flight, that cliff exists as it triggers downside events correlated to market losses

quote:


I would say that deep-OOM options that are regularly rolled over will give you some pretty good returns, even on minor losses


Depends on what size tail risk hedge in place and investment time horizon.


You may be improving your conditional tail expectation returns, but it is going to absolutely tank your value at risk with this strategy



This post was edited on 10/6 at 9:52 am


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