Preface xi
Acknowledgements xiii
About the Author xv
Chapter 1 Introduction 1
The Airplane Ticket Trade 1
The Bull Cycle 2
The Renegades 3
Claws of the Bear 3
Zugzwang 4
The Sceptics 5
A Sad Truth 5
Common Mistakes 6
Imprecise but Effective 7
Hedging Against Implausible Scenarios 8
A Black Swan in Correlation 8
Taking Profits 8
The Good, the Bad and the Ugly 9
The Great Escape 9
Having a Plan 10
Trend Following as a Defensive Strategy 11
Taking the Offensive 12
The Pre-Conditions for Market Crises 12
Banks: The Great Multiplier 13
A Change in Risk Regime 13
Chapter 2 “Safe” Havens and the Second Leg Down 14
The Matterhorn 15
Mrs. Watanabe’s No. 1 Investment Club 18
The Risk of What Others are Holding 19
The Risk of What Others are Likely to Do 22
Here We Go Again 24
Summary 28
Chapter 3 An Overview of Options Strategies 29
The Building Blocks: Calls and Puts 29
Why Buy a Call or Put? 34
The Black–Scholes Equation and Implied Volatility 36
The Implied Volatility Skew 38
Hedging Small Moves 38
Delta Hedging: The Idealised Case 39
Practical Limits of Delta Hedging 41
Hedging Options with Other Options 43
Put and Call Spreads 43
Straddles and Strangles 44
The Deformable Sheet 46
Skew Dynamics for Risky Assets 48
The 1×2 Ratio Spread and Its Relatives 50
The Batman Trade 53
Implied Correlation and the Equity Index Skew 56
From Ratios to Butterflies 59
Calendar Spreads 65
Summary 67
Chapter 4 Hedging the Wings 68
Taking the Other Side of the 1×2 68
Comparing the 25 and 10 Delta Puts 69
Hedging Sovereign Bond Risk 78
Selling Put Ratio Spreads on the S&P 500 83
The Hypothetical Implied Distribution 83
Our Findings So Far 84
Back-Tests: A Cautionary Note 84
A Short Digression: Delta-Neutral or Comfortably Balanced? 87
The 665 Put 87
Implications of the Square Root Strategy 88
Futures vs Spot 89
A Dramatic Example 89
A Cross-Sectional Study 91
The “New” VIX: Model-Independent, Though Not Particularly Intuitive 94
The Spot VIX: Oasis or Mirage? 94
Migrating to VIX Options 98
Reflections on Figure 4.36 101
Migrating to Different Markets: The V2X 103
Risk-Regime Analysis 104
Conditional Performance of Hedging Strategies 106
Summary 109
Chapter 5 The Long and the Short of It 110
Short-Dated Options 110
The Physicists Weigh In 112
Buying Time 117
Long-Dated Options 119
Far from the Madding Crowd 121
R Minus D 122
The Lumberjack Plot 125
Selective Application of the Weekly Options Strategy 126
Summary 127
Chapter 6 Trend Following as a Portfolio Protection Strategy 128
What is Trend Following? 128
Trend Following Dogma 130
The Crisis Alpha Debate 131
An Aside: Diversifying Across Time 134
Taking Advantage of a Correction 135
The Niederhoffer Argument 135
Chasing 1-Day Moves 138
Pushing the Analogy Too Far 139
Analysing the Data Directly 141
LEGO Trend Following 142
Summary 143
Chapter 7 Strategies for Taking Advantage of a Market Drop 144
The Elastic Band 144
Trading Reversals 147
More Texas-Style Hedging 149
Selling Index Put Spreads 151
Breathing Some Life into the Equity Risk Premium 152
Buying VIX Puts 153
Selling VIX Upside 154
The Remarkable Second Moment 155
Summary 158
Chapter 8 “Flash Crashes”, Crises and the Limits of Prediction 159
Lord of the Fireflies 159
Cascading Sales 160
A Concrete Example 162
An Aside 162
Paths, Prints 163
The Role of the Central Bank 164
Credit Cycles at the Zero Bound 164
The Monetary Policy Palette 165
Reading the Tea Leaves 168
Summary and Conclusion 169
Glossary 171
References 173
Index 177
HARI P. KRISHNAN, PHD, is a fund manager at Cross-Border Capital, where he runs systematic macro and volatility strat-egies. Cross-Border is a London-based hedge fund with roughly US$300 million in assets. He previously managed a CTA for a London-based asset management bou-tique, and he was an executive director and co-head of alternative asset allocation at Morgan Stanley (Chicago and London). In addition, Dr. Krishnan has worked as an options trading strategist and as a senior economist at the Chicago Board of Trade. He received a PhD in applied math from Brown University, and he was a post-doctoral research scientist at the Columbia Earth In-stitute, Columbia University, before moving into finance.
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