The correlation of stock moves, versus option activity, has become more pronounced over the past few years, and even more so after the pandemic sell-off.
This comes as the demand for options is transmitted to underlying stocks via the risk management of market makers who, during outlier events, are short so-called gamma or convexity, the sensitivity of an options risk to the direction, given underlying price changes.
With option volumes now comparable to stock volumes, related hedging flows can represent an increased share of volume in underlying stocks.
The reflexive response by the opposing side of options trades — a result of regulatory frameworks, the low-interest-rate environment, as well as growth of the derivatives complex — causes a cascading reaction that exacerbates underlying price movements.
In a move to understand who is capitalizing on the aforementioned volatility dislocations, as well as how, Benzinga spoke with Kris Sidial, a former institutional trader and the co-chief investment officer of the Ambrus Group, a volatility arbitrage fund that looks to exploit changing market structure dynamics.
Context: “Live, breathe, eat, sleep trading…. Nothing else I rather do. This is like the NBA for me.”
That’s from a 2019 Tweet by Sidial, a rising fund manager, in his late 20s, that merges humility from a tough but religious upbringing, with experiences working under Wall Street veteran Robert Kanter, Chimera Securities, Xanthus Capital Management and the Bank of Montreal.
“I think my experience, in all these areas, was the best thing that could ever happen to me,” he explained. “All those roles helped gauge my understanding of what was a very complete view towards one, trading and two, how the market functioned, and how other participants think and react in certain moments.”
Having served in different capacities, Sidial is better able to spot and take advantage of what many construe as complex mumbo jumbo.
“Everything that transpired played exactly into our firm’s thesis,” he said in reference to recent single-stock volatility and the stability of the broader market during events like the equity bust and boom in 2020.
Recently, Sidial left BMO to co-found Ambrus alongside Sal Abbasi, Bret Lannert and William Wise. The founders believe that increased fragility, in regards to off-sides positioning, specifically in single-stock names, presents an opportunity too great to pass up.
Differentiator: “What makes a great business is when all of the partners see the same thing without them being pitched at.”
All of Sidial’s partners – Lannert who ran the interest rates derivatives desk at the Chicago Trading Company, Abbasi, the ex-head of quantitative credit and fundamental credit technology at Citadel, and Wise, who is an independent trader – noticed dislocations, throughout their years of trading, happen at an increasing pace.
Sidial, who was the last to convince to join Ambrus, said the final straw was the COVID sell-off, prior to which he and Wise thought it would be a good time to buy wings or downside protection.
“It’s not that we knew the pandemic was coming,” Sidial explained in reference to dynamics of dealers’ risk exposure to direction and volatility which can cause violent crash dynamics to transpire. “We understood that positioning was very one-sided; people were very complacent and it looked like there could be an unraveling.”
Further, it’s not that institutions wanted to sell Apple Inc AAPL stock at a 20% discount, he said. Instead, to blame was forced liquidation and hedging by yield-seeking participants – funds which sell far out-of-the-money puts on the S&P 500, for example – and customers looking to buy puts for downside exposure.
Pictured: SqueezeMetrics highlights implications of volatility, direction, and moneyness. The left orange marker is reflective of a basic reaction to call-buying (as observed during the rise of meme stocks). The right orange marker reflects a reaction to put-buying (as observed during the COVID-19 sell-off).
How Does The Fund Work: Typically, a large institution will provide Ambrus an allocation for protection. Unlike standard tail-risk funds which systematically buy equity puts, Ambrus’ approach is bespoke, cutting down on negative dynamics like decay with respect to time.
Given dislocations across single stock skew, term structure, and volatility risk premium, Ambrus will position itself in options with less time to maturity, buying protection up to six weeks out.
“The market will underestimate the distribution,” Sidial said in a conversation on Ambrus’ internal models that spot positional imbalances to determine who is off-sides and in what single asset. “We’re buying things that have happened before and we’re looking for it to carry a heavier beta when the sell-off happens.”
So, by analyzing flow, as well as using internal models to assess the probabilities of deleveraging in a risk-off event, Ambrus is able to venture into individual stocks where there may be excess fragility; “I know if stock XYZ goes down five percent, it’s going to go down 10% because this fund needs to deleverage.”
To aid the cost to carry, Ambrus utilizes defined-risk, short-volatility, absolute return strategies.
“I’m basically giving you a free put on the market – with a ton of convexity – with something that offers a payout that’s just more than a regular put,” Sidial summarized. “If the market doesn’t do anything, and we do an amazing job, we’re flat and you made money on all your long-only equity exposure.”
“You had a free hedge the entire time.”
Takeaways: Without looking at complex data, it’s clear that day-to-day variance has increased. As a result, hedging through classic methods – the 60/40 portfolio, for instance – is naive.
“We’re living through a time where there has not been as many cross-asset correlation breaks as this time, and the only true hedge is volatility,” Sidial explained. “It is shocking for me to see how many people, who control money, are dislocated with the day-to-day market moves and potential hazards at bay.”
Advice For Newbies: Sidial urges readers to expand their knowledge base with texts like Positional Options Trading by Euan Sinclair, as well as focus on edge.
“Your first focus should be, where can I find an edge? That edge is going to be off the dislocation, whether it’s analyzing a time series, flow, imbalance, … [or] technical analysis.”
Then, use options to structure trades around that edge.
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