NOW STREAMING: We have begun releasing Season 3 of our podcast Flirting with Models. We'll be releasing episodes every Monday, Wednesday, and Friday throughout July. We hope you enjoy!
Hedging solutions are a trade-off of three considerations: degree, certainty, and cost. Given their contractual certainty and high degree of protection, put options are often considered to be prohibitively costly.
In practice, tail risk funds employ a number of strategies to reduce this cost, including carry strategies, pro-active monetization, taking basis risk, varying positions based upon market conditions, and swapping between non-linear and linear hedges.
In this week's commentary, we explore the application of tactical signals to a standard far-dated, out-of-the-money put index. In applying tactical signals, we seek to reduce long-term costs without sacrificing too much certainty in the protection achieved. We find that certain signals (e.g. those based upon price trends) are less effective, while others (e.g. those based upon volatility) appear more effective. (PDF)
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What We're Reading
→ PRINCIPAL PORTFOLIOS: "We propose a new asset-pricing framework in which all securities’ signals are used to predict each individual return. While the literature focuses on each security’s own-signal predictability, assuming an equal strength across securities, our framework is flexible and includes cross-predictability [...]" Principal Portfolios