My @Quora comment on an answer to What does it mean to short the volatility index?

My @Quora comment on an answer to What does it mean to short the volatility index? :

My @Quora comment on an answer to What does it mean to short the volatility index?

Don't You have a better bad idea ?

Get a better bad idea


If You ask this question, it means one thing: You are an amateur and You are not worthy of trading it.
VIX is one of the hardest instruments to make money on. I know only one person who can make money out of VIX, my ex-boss. That is not because he is a spectacular investor (sorry dude). That is only because VIX is the ultimate mean reverting instrument. It is like Harry Potter’s philosopher’s stone. Only those who are pure mean reverters at heart can touch it. The rest, they may suffer from some reverse Midas curse, they touch it and they turn to sh!t…
I have watched the skew on it [silently swallowing my saliva] . It mean reverts by definition. This means You Long it when no-one wants it and You sell it when people panic. OK, easy so far. The problem is how do You size it and where do You stop it ?
My ex-boss showed me how he does it. He milks it well on his PA account. He has tripled his size, but it was funny to watch how scared he got when i asked him if he would like to do it as a job. He said no 8 times in a row, waving hands and getting all agitated (he had to be sedated with some Pinot Noir thereafter), and the guy tripled his account… I can’t do it and I am a professional short seller: Babylon on the markets like now, and I am ridin’ that bus (so much for slow humble start…) . But VIX you said, why don’t you go first ? I am too scared
Jon Cooper
+1; this is pretty much the consensus view among successful structured index vol traders I’ve known. Also, you really want to do this on a portfolio and cross-market basis if possible for diversification’s sake. Some people use various flavors of vega weighting but the most successful ones I’ve known use simple, old school  breakeven and max loss analyses.
Gopher Lee
So trading the VIX is stupid? Okay. What about trading regular european options?  Where do I go to learn to short sell? How can I trade individual stock options on the Taiwan & Korean stock exchanges? Nagoya Stock Exchange?  There are A lot of opportunities in overlooked exchanges.
Laurent Bernut
Hello Gopher, I have been invited to post a trading journal on Whotrades. I will post signals, my trades on my website: Alpha Secure Capital | Alpha Secure Capital as well. I am honest about the stuff that I trade, how I do it, how i approach risk and so on. Is this the kind of stuff You would like to read ? Trading Journal 2016/01/20
Yesterday I went Long IAU, the ETF for gold. I go out of my way not to know what i trade but when something comes with a Buy signal amidst capitulation, something tells me the inverse correlation force is strong with that one. It turned out to be gold. OK, so I placed a limit order and then realised i could do something better with the remainder risk budget. I bought April calls OTM 12 for 0.20. There is a lot of theta there still. Plus, with my trading style, I will sell some underlying to cover the cost. In fact ETF needs to move less than 3% to get there. OTM reward to risk is 7:1 + underlying to compensate. Well, it has a lot of kick for not much. Doe sit help ?
Now if you want o short using options, I would buy put spreads or sell call spreads. It caps the risk neatly. You may even go as far as 3 by so as to have a bit more juice. Makes sense ?
And yes VIX is stupid for those reasons:
  1. Let’s say You short around 40. Every now and then it shoots up to 60. Well You are forced to close unless You wait until it comes down again.
  2. Meanwhile, it drills a very visible hole in your portfolio
  3. Since the key to raising AUM is to perform when no-one else does and You just got bitch slapped twice, investors rightfully conclude You don’t know what You are doing and pull the plug.
  4. OK, round 2. You got burned once and decide to wisen up next time: size position a little more conservatively Well, if it does not hurt in the first place, how could it contribute then ? It is not a hedge, it is a “feel-good hedge”
  5. Meanwhile, it is expensive
  6. Bottom line: get a better bad idea

The Habit of Short-Selling

Selling short is not antipatriotic. It most certainly is not a hedge to Long. The only commonality with art is that 90% of artists starve. Short-selling is not some shadow conspiracy undermining the economy. No short sellers seats on any board on sinking ships. Short-selling is none of that.
Short-selling is a habit, just like exercise, healthy eating of brushing teeth. t may be mundane and boring, but eventually it is something that makes You healthier, stronger and eventually happier.
I have been a 100% systematic quantitative short-seller in a prestigious bottom-up fundamental house for 8 years. My mandate was to underperform the inverse of the longest bear market in modern history: Japan Equities. Every day, I woke up -100% net short, welcome to my world.


The hero’s journey of short-selling
“Too many people look at what is from a position of “what should be”, Bruce Lee
We, human love stories. We relate to the hero’s journey, because we aspire to be one. Now, ask yourself: do You want to retire on stories or on healthy returns ? If You still cling on to the story, then read no further and see You in the octagon of the markets…
Short-selling is a hero’s journey, but the story of redemption is unappealing. The journey is about unlearning, calculating, mastering emotions, baking the daily bread. Even if You choose never to sell short, that process itself will make You a stronger investor.
Please subscribe to my website. It is completely free and there are useful resources for serious market participants: Alpha Secure Capital | Alpha Secure Capital
The myths of short-selling
“The usefulness of a cup is its emptiness. Empty your cup”, Bruce Lee
  1. Unlimited downside: would You floor a Maserati knowing it has no brakes ? Well, if You can answer this question, either You can’t afford one or You have just fixed their notoriously bad brakes. Rule 0 of short-selling: set your stop loss before entering a position.
  2. Structural short: structural shorts are just like stupid people: they are everywhere. Profitable structural short is The Unicorn of short-selling (capital T, capital U). By the time the word structural short is associated with a stock, Borrow cost, short squeeze frequency, volume etc all suggest that the Long side is no longer the wrong side. More importantly.
  3. Fundamental shorts: Fundamentalist grieve their way into Short-selling (The view from the short-side: how we process emotions and the market signature of the 5 stages of grief Kubler-Ross by Laurent Bernut on Alpha Secure ). This is an expensive process: every bit of information that ultimately leads to a short has a price-tag. Everyone gets burned while short-selling. So, next time around, we take precautions. We want our story straight, our numbers squared, our facts checked and our boxes ticked. Well, if that is what You want: join the crowded short crew
  4. Contrarian shorts: there are two ways to kill bulls: either in 1. a  triumphant corrida with a colorful display of courageous faena as the bull bites the warm dust or 2. zapping them in a slaughterhouse while listening to cheesy pop songs. Second option does not get the glory but does not get the horns either. Selling short is done along Long selling.
The dynamics of Short-selling

1. Structural shorts are a form of a laziness

Back in hedge fund days, My manager took notice of my keen interest in selling-short but also took umbrage at the accompanying trading activity. He then proceeding to instruct me to look only for structural shorts. What he really meant was:
  1. I don’t want to bother with shorts: they are not fun. They are complicated, unsexy and messy
  2. I just want to go Long, have fun, find 2-3-4-10 baggers and be a rockstar, but:
    1. This is a hedge fund: so we need to hedge, right ? But also I want to:
    2. Charge big fees: no-one is stupid enough to pay 2-20 if I just sell futures or buy ATM puts
  3. So, I need to find shorts (… so as to generate cash and buy even more Longs…)
  4. Then, find me shorts i can SHORT & FORGET: throw away the key, they go down nice and easy. I can forget about them and then I can focus on finding 2-3-4-10 baggers and be a rockstar
Well, the fund went bust. This is not character but myth assassination here. There is no such thing as a structural short. The short book shrinks when successful so it requires more attention than the Long book. That is just a plain arithmetical truism.
2. The curse of successful shorts: the Short “magic skin” (peau-de-chagrin)BalzacMagicSkin01
Successful shorts are the “magic skin” of the markets: they shrink as they are successful. This means their good attributes such as Beta, sector  country, currency, market cap bracket, exchange exposures contribute less and less. It means You have less of a good thing when it works. This entails three things:
  1. Successful shorts must be replenished
  2. the Short book needs constant attention: shorts have naturally shorter cycle and shorter lifespan. So, they need constant attention
  3. Unsuccessful short must be weeded out: unsuccessful shorts balloon. So, You are left with more of something undesirable
This leads us to the secret behind successful short-selling. It is a simple yet powerful “haha” moment question that will alter your reality
A suivre…, to be continued…
If You want part II, III and IV, please subscribe to my website. It is completely free and there are useful resources for serious market participants: Alpha Secure Capital | Alpha Secure Capital

The Habit of Short-Selling

3 reasons why selling futures is a not a hedge to the Long book

out_of_balance_-_Google_SearchIn the Long/Short equity space, managers find it difficult to find “good shorts”. So, they resort to selling futures in order to reduce the net exposure (Long – Short exposures). With low net exposure, volatility comes down, VAR is apparently low, so it is possible to leverage up again; problem solved, or not ? Selling futures solves only one of the five major hedges: gross, net, Beta, market capitalization, concentration. Selling futures is an implicit bullish bet on the market. It all works well, until it doesn’t. In this article, we will look at three reasons why selling futures is not an all-weather hedge to the short book. We will also look at other ways to hedge the short book.

On January 24th, 2006, the arrest of Horie-san, president of LiveDoor, sent the Japanese market into a tailspin. Despite our collective best efforts to reassure investors that we were properly hedged, our performance suffered. On the surface, it seemed like we had low net exposure, reasonable gross exposure (Long  + Abs(Short) exposures or leverage). Yet, we were caught like deers in the headlights, watching our performance inexorably sink day after day. The source of our problems to one big position in the short book: March 06 futures.
Selling futures is not a hedge for three reasons
  • Selling futures as a form hedge is an expensive form of laziness
  • Short futures is an implicit bet on market cap
  • Short futures is an implicit bullish bet on Beta
Selling futures as a form of hedge is an expensive form of laziness
Investors do not need to pay 2% & 20% for something they can do themselves. In fact, many investors are already natural hedgers. For example, insurance companies routinely trade futures and index options. Selling futures in lieu of single stocks unfortunately shows lack of skill in the Long/Short craft.
Some managers argue that net exposure management is an important tool in their arsenal. Managing net exposure is vital to deliver superior returns. When investors hear this, they understand “Beta jockey”. At 40%+ net Long, this is no longer a hedge, this is directionality. During the GFC, directional hedge funds did not bring the net to -30%, or at least -10% net Short. Net exposure continued continued to hover about +10/20%, sometimes neutral at best. Managers may have said they wanted to be positioned for the rebound, but in reality they were just scared. They did not know how to hedge and it was the wrong time to learn.
Hedging is a delicate craft that must be honed during bull markets. Those markets are more forgiving. As long as performance goes up, mistakes can be forgiven. When the going gets rough and patience of investors wears thin, hedging mistakes can be deadly.
There is one exception where selling futures as a hedge shows superior skill. When net exposure remains below +/-10% throughout the cycle, performance comes from the excess return over the index. This is as close as it will ever get to pure alpha in the equities world. This is a rare skill: managers understand they are not good at short-selling, so they concentrate on delivering excess returns, only partially juiced up by some residual market exposure. Managers who can deliver genuine excess returns deserve recognition and unsurprisingly see their AUM grow over time, survive and thrive through the thick or thin.
Long Stocks/Short future is an implicit bet on market cap and exchange
Managers like to invest in small/mid caps.  This is where the fun and the gold nuggets are. Small-mid caps tend to have better upside potential than large caps during bull markets. Besides, stories are interesting. It is easier to have access to senior management. Uncover a few 3-4 baggers and a new stock picking star is born.
On the other hand, futures are a reflection of the underlying large caps in the index. For example, Topix Core 30 accounts for more than half of Tokyo first section market capitalisation. So, performance of the index is driven by its top caps.
Then, selling futures and buying small-mid caps is an implicit bet on market cap: Long small/mid caps, Short large caps. It goes even one step further. It is often a bet on the exchange: small/mid caps are often listed on different sections of the exchange. So, it can take the form of Long Nasdaq/Short S&P 500, Long JSDA / Short Nikkei, Long Kosdaq / Short Kospi etc.
As usual, it all works well until it doesn’t. Small/Mid caps do better than large caps in bull markets. In bear markets however, small/mid caps fall faster and harder than large caps. This is what happened to us in 2006. Our Long book fell -4-5% everyday. Liquidity evaporated. We could not get out of stocks without pushing them even further down.  Meanwhile, our short book only fell by 2%, leaving a gap of -2-3% every day. Selling futures is an implicit bullish bet that works as long as the market stays bullish.
The psychological implications are even worse. As much as waiting for the first heart attack  is not recommended to start living a healthy lifestyle, waiting for a bear market is a bad time to start learning the discipline of short selling. Selling short is a muscle that atrophies when not flexed. Managers grow complacent during bull markets. They believe “good shorts” will be plenty available when the market turns bearish.
Unfortunately, bear markets are harder to trade. Volatility increases, volume drops, bid/ask spreads widen, borrow becomes harder to source and squeezes can be vicious. Small caps may drop and look like great shorts, but in practice, they are hard to sell short. Obvious shorts quickly become crowded and once they do, they rarely fall as fast as the market.
On top of this, investors are risk-adverse and prone quick to redeem. So, trying to learn a difficult skill in a tough environment, without being allowed the luxury to make mistakes is hardly a good recipe for a lasting business.
Long Stocks/Short future is an implicit bet on Beta
The index has a Beta of 1. Since futures are a reflection of the index, they have a beta of 1. Small/mid caps outperform the index during bull markets. They therefore have a Beta above 1. So, Long small/mid caps/Short futures is therefore an implicit bet on Beta.
The difficulty comes with the first derivative of Beta, or speed. When the drop comes, it is sudden and violent. In our 2006 “soft patch”, one investor noted that we had a beta of 1.5 on the way up and 3 on the way down, after which he proceeded to redeem his investment. The only way to manage the short book via futures is to turn Beta neutral to negative. All things being equal on the Long side, that means large negative net exposure, something that traditionally net long managers are not comfortable doing.
A classic solution is to replace small/mid caps on the Long side with Low Beta stocks such as utilities, pharmaceuticals, food stocks. Net Beta can be negative, or below while net exposure can stay marginally positive. It works, but this is a reactive move implemented only after the reality of bear market has settled in. That usually comes after a drawdown.
How to edge properly then ?
Are VIX options a real hedge ?
Every time there is an earthquake, earthquake insurance sales go up. They then peter out over the next few years. Every time the market tanks, VIX goes up and investors rush to buy VIX options. VIX options become rapidly expensive. Besides, VIX is the only true mean reverting asset class. Trading VIX options is therefore an expensive form of hedge, hardly profitable in bear markets.
Absolute versus relative series
Analysts often complain that  short ideas are hard to find in a bull market. This is true, but only if they look at absolute series. If one is to divide absolute prices by the closing price of the Index (relative series), then quite a different world starts to emerge. There is ample supply of underperformers out there, matched by an abundance of outperformers. This is however a paradigm shift. The objective is no longer to generate money in absolute terms. In fact, the true meaning of Long/Short is excess return over the index on the Long side and excess return over the inverse of the index on the short side.
All of a sudden, it becomes much easier to hedge the Long and Short side. Furthermore, competition is not as intense as in the absolute world. Shorts are not as crowded, because in absolute terms, they still look like they are going up, only slower the rest of the market. So, one would enter a short, knowing it would probably lose money in absolute terms. That is a challenging psychological hurdle. Years into it, It is still hard to intellectually reconcile positive performance, despite a full red inked absolute P&L column.
The main drawback of the relative series is the added complexity of calculation. Everything has to be divided by the index: charts, stop losses & target prices, risk management, even performance. The architectures of portfolio management systems radically differ. Imagine sending a limit order in absolute (try and send your favorite broker) a relative currency adjusted  but managing stop losses in relative terms. It takes time to getting used to it, but the reward is well worth the effort. Short and Long candidates are abundant. Volatility is much lower, which makes it more commercially attractive to investors. Institutional investors prefer low volatility consistent returns over highly volatile performance. For example, the largest hedge funds in the equity space do not shoot for the moon, they do want to beat the market, they just aim to deliver high teens performance year after year.
Selling short is a muscle that atrophies each time futures are sold in lieu of stocks. As much as waiting for a heart attach is not the best time to start exercising, waiting for the bear market is the wrong time to learn the discipline of selling short.  Investors are not dupe: they see through directionality and large futures positions on the short side. They have been there before and they did not like it then.
Shorts are plenty available all the time. They are just not going down in absolute terms but relative to the index. It implies a complete rethinking of both sides. It takes practice to learn but over the years investors have rewarded managers who deliver low volatility consistent returns from stocks on both sides of the book. As John F. Kennedy said, The time to repair the roof is when the sun is shining”.