Selling volatility is a unique way to enhance portfolio returns. We have been doing this for years by selling puts in stocks we would want to buy. The way we accomplish this is fairly simple. We look at the price history, determine a suitable valuation for the stock, and sell the put at a strike price that is close to the price we’d be willing to pay. More often than not, we collect the option premium and don’t get put the stock. The Insiders Fund has been doing this strategy for nearly two decades and continues to do it because it works. For a detailed discussion of this strategy, I refer to the blog post, Profiting from stocks you don’t own.
There are other ways to profit from the premium investors pay for insurance. Russell Kellites, our manager for Theta Investments ,excels at this, winning multiple awards and recognition from Morningstar and Barclay Hedge. Theta Investments primarily sells premium on S&P 500 put and call options. Chase Thomas, our manager for the Volatility Advantage Fund has built an entire strategy, buying low cost index and ETFs, and selling options and volatility derivatives such as TVIX Daily VS 2X VIX Short TERM. This product has a natural decay rate that insures the short position goes down in value over time, especially so if there are no abnormal market events. Chase’s investment philosophy is that he is going to be judged on how well he does versus the market so he might as well be the market. He invests in low cost index and ETF funds and adds alpha to it by selling TVIX and covered calls. His timing this year has been exquisite, the Volatility Advantage Fund is up 63% YTD November 30th.
Both of these excellent managers are accepting new investors into their funds and the window for investment for January closes soon.
But like all things in life, there is no free lunch. Selling volatility is not for the casual part time investor. Geopolitical events, market moods and swings can cause significant losses if not carefully monitored. For more on this strategy, this is an excellent article article by Larry Swedroe on selling volatility and how investors can create largely uncorrelated returns by selling it short. Academic theory predicts that the volatility implied by the VIX index will be greater than the realized volatility. That difference can be thought of as an insurance premium investors are willing to pay because volatility tends to spike when stocks crash, as in the last bear market. New research confirms that investors can profit from this and that such a strategy is uncorrelated with other traditional sources of return.
Often volatility is identified as risk but long term investors should look at it differently.Here is an excellent article from the CFA website, When does volatility equal risk? Value investors such as Warren Buffett embrace volatility as it gives them an opportunity to buy stocks on sale. The Insiders Fund doesn’t outperform the market in every time period as insiders historically buy their stock when they perceive it to be cheap, undervalued, or perhaps before it is about to be transformed by new technology, improved business prospects, or even new ownership such as a buy out. The buying doesn’t conform to the investment performance calendar. Patient investors will be amply rewarded, though, as this strategy has outperformed the S&P 500 by over 400% since 2001. Built on a common sense strategy, The Insiders Fund is an all weather diversified portfolio, designed to maximize investment returns in all markets, bull, bear, or stagnant.
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