Artemis on Hedging the Wrong Tail Risk

April 17, 2012


‘Volatility will be the most important asset class for the next few decades: it alone can protect you from both the fire and the waterfall.’ Chris Coleman

"Volatility-of-volatility microstructure is now calmer than at any point over the past six years of data." ~ Chris Coleman

Chris Coleman sees volatility as underpriced, but on the upside. This is what I wrote last year:  “Are Far OTM (Call) Options Underpriced? Contemplating Upside Skew Amid High Inflation.” Coleman, the volatility derivatives expert, goes into much more depth. He also posted a history of VIX movements. Below that are highlights from the outstanding reports available on the Artemis website.

On Printing and the Market:

  • "On days without debt purchases the VIX index was up +2.14% and the S&P 500 registered a slight decline."
  • "On days with debt monetization the VIX dropped -0.45% and the S&P 500 index increased." (2011 report),
  • 14% of the largest upward % movements in 10-year UST yields over 48 yrs. happened after the $Fed starting buying bonds"
  • "Collectively global central banks have created enough fiat money to buy every person on earth a 55′ wide-screen 3D television”

Overpriced Deflationary Risk:

  • "Since the 2008-crash the SPX options market has consistently assigned a 21% probability of a -50% or more crash."
  • "The realized historical probability of a -50% or greater crash is only 2.93% (using DJIA data to extend samples to 1928)."

Inflation and Weimar Germany :

  • 1921: Germany seemingly had one of the healthiest economies in Europe; a booming stock market; briefly strongest currency in the world
  • "In 1919, uncapped 4-yr. variance swap at $1 million notional on the German stock rose to an estimated $417 billion at expiration"
  • In Weimar Germany there was no surface inflation and prices were stable between 1920 and 1921 as the government doubled the money supply.

If you purchase long dated calls, you get an interest rate hedge by inexpensive cheap Rho. Additionally, if you get an internet bubble like explosion in upside volatility amid high inflation, the returns rise exponentially. The downside skew in the market was magnified only after the 1987 crash; it’s feasible that we get an asset bubble, and over time, a large positive skew will exist as well.

Source: PDFs available on Artemis’ site

Deflation as a Leading Indicator of Hyperinflation

Dylan Grice on Hyperinflation in Japan

Adam Ferguson on Life in Hyperinflation

John Mauldin Ponders Hyperinflation

The Supply of Money and Reichsbank Financing of Government

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