New strategies:
#346 – Commodity Option Implied Volatility Strategy
Period of rebalancing: monthly
Markets traded: commodities
Instruments used for trading: futures, CFDs
Complexity: Moderately complex strategy
Bactest period: 1991 – 2014
Indicative performance: 12.66%
Estimated volatility: 18.48%
Source paper:
Gao: Commodity Option Implied Volatilities and the Expected Futures Returns
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2939649
Abstract:
The detrended implied volatility of commodity options (VOL) forecasts the cross section of the commodity futures returns signi cantly. A zero-cost strategy that is long in low VOL and short in high VOL commodities yields an annualized return of 12.66%. Notably, the excess returns based on the volatility strategy emanates mainly from its forecasting power for the future spot returns, di erent from the other commodity strategies examined so far in the literature which are all driven by roll returns. Natu- rally, this strategy demonstrates low correlations (below 10%) with the other strategies such as momentum or basis. The VOL strategy performs especially well in recessions and outperforms most other strategies. The VOL measure is associated with hedging pressure on the futures and especially on the options market. News media also helps amplify the uncertainty impact.
#347 – Mispricing of Equity Options With Different Time To Maturity
Period of rebalancing: monthly
Markets traded: equities
Instruments used for trading: options
Complexity: Complex strategy
Bactest period: 1996-2014
Indicative performance: 9.40%
Estimated volatility: not stated
Source paper:
Eisdorfer, Sadka, Zhdanov: Inattention in the Options Market
http://www.business.uconn.edu/wp-content/uploads/sites/969/2016/01/InattentionOptionsMarket.pdf
Abstract:
Options on US equities typically expire on the third Friday of each month, which means that either four or five weeks elapse between two consecutive expiration dates. We find that options that are held from one expiration date to the next achieve significantly lower weekly adjusted returns when there are four weeks between expiration dates. We argue that this mispricing is due to investor inattention and provide further supporting evidence based on earnings announcement dates and price patterns closer to maturity. The results remain strongly significant controlling for a large set of option and stock characteristics, and are robust to various subsamples and estimation procedures. Our findings have potentially important implications for calibrating option pricing models as well as for extracting information from option prices to forecast future variables.
New research paper related to existing strategy:
#224 – Profitability Factor Combined with Value Factor
Blackburn, Cakici: The Magic Formula: Value, Profitability, and the Cross Section of Global Stock Returns
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2956448
Abstract:
Value and profitability, both determinants of the cross section of returns, are complimentary characteristics as investors prefer to buy profitable, undervalued stocks and short unprofitable, overvalued stocks. Greenblatt (2006, 2010) proposes a methodology, referred to as the “Magic Formula”, for combining the two characteristics into a single measure. We test whether the magic formula (MF) explains the cross-section of global returns using a sample of equity returns representing twenty-three countries divided into the four regions of North America, Europe, Japan, and Asia over 1991-2016. We find that MF fails to generate significant abnormal returns; however, a slightly modified version of the magic formula that uses gross profits instead of EBIT as the measure of profitability yields economically large and statistically significant risk adjusted returns in all regions. Moreover, portfolios constructed using MF lead to significantly negative market betas. Equal-weighted portfolios comprised of the value-weighted market portfolios and the MF portfolios yield Sharpe ratios that are twice those of the each region’s market portfolio. Double sorting MF with size and with book-to-market produces return differentials that are significant for all size and most B/M groups, and Fama-MacBeth regressions reveal that MF explains the cross-section of returns in addition to size, B/M and momentum thus demonstrating that FM captures a dimension of returns not explained by the widely used characteristics.
Two additional related research papers have been included into existing free strategy reviews during last 2 week:
An important academic paper which raises several interesting questions about suspicious behavior of VIX Index:
Griffin, Shams: Manipulation in the VIX ?
https://westernfinance-portal.org/viewpaper.php?n=491456
Abstract:
At the settlement time of the VIX Volatility Index, volume spikes on S&P 500 Index (SPX) options, but only in the out-of-the-money options that are used to calculate the VIX, and more so for options with a higher and discontinuous influence on VIX. We investigate alternative explanations of coordinated liquidity trading and hedging. Tests including those utilizing differences in put and call options, open interest around the settlement, and a similar volatility contract with an entirely different settlement procedure are inconsistent with these explanations, but consistent with market manipulation. Size and liquidity differences between the SPX and VIX markets may facilitate the sizeable settlement deviations.
Are portfolio managers skilled in stock-picking? It is a popular subject for academic research and majority of papers show that active funds underperform their respective benchmarks. But… It doesn't mean professionals do not know how to pick stocks. It can simply mean that a lot of managers are too afraid (or are limited by risk or fund size) to increase their funds' active share. Seems like there is a subset of stocks where fund managers picks tend to outperform the rest of the market – the lottery stocks – low price, high idiosyncratic risk and skewness stocks:
Stein: Are Mutual Fund Managers Good Gamblers?
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2919410
Abstract:
I investigate the skill of mutual fund managers by focusing in their holdings of a special type of stock. Kumar (2009) classifies low price, high idiosyncratic risk and skewness stocks as ‘Lottery Stocks’, and shows that these securities severely under-perform. I look at the effect that these investments have on the performance of U.S. equity mutual funds, and how they reflect on the skill of the manager. As part of this analysis I introduce the ‘Lottery Score’, the percentage of equity assets invested in Lottery Stocks. I find that the Lottery Stocks that fund managers pick tend to outperform the rest of the market, and the funds themselves persistently outperform similar funds that don’t invest in these stocks. An investable strategy that buys Lottery Stocks held by the funds and sells those ignored by them attains a monthly alpha of 2%. The Lottery Score is shown to be a good predictor of fund performance, even after controlling for a number of previously introduced measures of skill. Since the funds’ out-performance cannot be fully explained by their allocation to Lottery Stocks, this behavior uncovers a more general ability for asset management.
