INVESTMENT PHILOSOPHY
The Universality of Short Volatility Across Asset Classes
The strategy is centered around the belief that most investment strategies are inherently short volatility (i.e. buying equities). Equities behave like short volatility strategies, underperforming during market stress and excelling during periods of confidence. Essentially, most are short volatility, but not everyone is getting paid for it....
Equities as Implicit Short Vol
Equities behave like short volatility strategies, underperforming during market stress and excelling during periods of confidence.
Credit Markets and the Merton Model
Long credit exposure resembles shorting a put option on a company's assets, with credit investors taking on corporate volatility risk like short vol strategies.
Mortgage-Backed Securities
MBS returns, driven by embedded options, are inversely correlated with volatility, making them vulnerable in high-volatility environments, similar to short vol strategies.
Variance Risk Premium (VRP)
Implied volatility consistently exceeds realized volatility, creating a persistent inefficiency. By writing options, the fund capitalizes on this disparity, turning market fear into a source of alpha.
Buffet is Criticizing Long Volatility Traders
In 2010 Letter to Shareholders Buffet Writes
“Both Charlie and I believe that Black-Scholes produces wildly inappropriate values when applied to long-dated options.
To summarize:
Buffets explains that the valuation method for options is absurd and produces “inappropriate values”. Therefore, he sells put options as essentially a value investment.
Our Approach
We avoid shorting volatility on individual equities, focusing instead on shorting broad market volatility to provide greater diversification by profiting from the consistent overpricing of options during volatile periods.