Hedge Funds Try 'Career Trade' Against Euro

Some large hedge funds started to make bearish bets against the euro, which reminds trading activity at the peak of the financial crisis in the United States.

Great rates occurred at the meetings, such "ideological dinner, which was held earlier this month, brought together such hedge fund giants such as SAC Capital Advisors LP and Soros Fund Management LLC. How to tell people close to the event, during a dinner organized by a small investment bank in a private townhouse in Manhattan, a small group of "star" managers of hedge funds, agreed that the euro could fall to parity with the dollar.

George Soros (George Soros), under which the $ 27 billion of assets, has publicly warned last week that if the EU does not mend its financial situation, the euro will collapse.

Currency pairs signaled that the major financial players are ready to make a few bets to attract a wider boundaries fluctuations in the market. Euro, which traded at $ 1.51 in December, is now trading at $ 1.35. Given that traders use leverage, often borrowing 20 times your investment, increasing profits and losses, the movement of the euro to $ 1 may be a career trade. If investors invest $ 5 million to open a deal at $ 100 million, 5% price movement in the right direction doubles their initial investment.

"This is an opportunity to make a lot of money," - says Hans Huvshmid (Hans Hufschmid), the former head of Salomon Brothers, who now runs GlobeOp Financial Services SA, a hedge fund in London and New York.

It is impossible to calculate exactly the effects of bear bets made by the elite traders, but they were added to the influx of offers for sale of foreign currency, and thus pressed the European Union in order to stop the Greek debt crisis.

There is nothing reprehensible in the fact that hedge funds do the same kind of transactions, if regulators do not deem it a conspiracy. Regulators do not think that all transactions are necessarily such a character.

While small meetings, hedge funds can discuss similar transactions that may affect each other, as do those who have been criticized by some investors and banks in 2008. Once, large managers of hedge funds such as Greenlight Capital Inc., Whose president is David Einhorn (David Einhorn), also attended this month at a dinner and convinced that the fate of Lehman Brothers Holdings and other companies was vague, put more extent against these securities, thereby accelerating their collapse.

David Einhorn, president of Greenlight Capital

Manager SAC, Souen Aaron (Aaron Cowen), hath a group of bearish bets, said he had seen all the possible outcomes related to the Greek crisis, in a negative light for the euro, as handed people familiar with the matter. SAC's position relative to the euro is still not clear.

George Soros, head of hedge fund, under the management of the $ 27 billion, has publicly warned last week that if the EU fails to remedy the financial situation of the euro could collapse. " A spokesman Soros Fund Management, he refused to comment on his words for this article.

Ministry of Finance of Greece refused to comment. A spokesman for the European Commission said he could not comment on rumors in the market, adding that the EU executive body will seek to develop rules to tighten regulation and risk.

Some traders suggest that the euro is fully depreciate in the same way as the British pound in 1992 against the backdrop of major bear bets made by Soros. In this famous transaction, which led to a profit of $ 1 billion, all action-oriented Soros, which pushed the cost of a pound so low that Britain was forced to withdraw from the European Exchange Rate Mechanism, as a result, the pound has fallen even more sharply. Euro - this is a very large market, which operates at least $ 1.2 trillion daily trading volume, dwarfing the daily trading volume per pound in 1992.

Again, derivatives known as credit default swaps have played an important part in the current trading system. Some of the largest hedge funds, including Paulson & Co., Administering $ 32 billion, bought these swaps, which, as traders said, serve as insurance against failure to comply with Greece's sovereign debt. Traders perceive higher credit-default swaps as the warning signs of potential default.

Since December, the value of such swaps more than doubled, causing concern among investors about the Greek default. Paulson has opened a huge bear position in Europe, people familiar with the situation, including swaps, which will be paid if Greece will refuse to pay the debt within 5 years.

As they say, at a time when Paulson closed this position and took the opposite position in the rates, he left the firm in bull positions. In his statement, Paulson declined to comment on "individual items", saying that "does not seek to manipulate the securities or destabilize the securities in any markets."

At the end of last year, hedge funds have bought swaps insuring the debts of Portugal, Italy, Greece and Spain, and began to make bearish bets on the euro-debt. More recently, hedge funds sold these swaps to banks seeking to "hedge" or protect the savings of European government bonds - traders said.

Last year, the total value of the swap, insuring the Greek credit default doubled to $ 84.8 billion, according to the Depository Trust & Clearing Corp. However, the net amount that would actually pays the seller in case of default, grew modestly over the same period, having increased by only 4% to $ 8.9 billion, according to data DTCC. This suggests that banks and others bought and sold approximately equal number of swaps to hedge their positions, traders said.

Big bets against Europe in these days lose their importance for the vast foreign exchange markets, which offer many ways to trade. Attention has focused on the euro on December 4, when the currency fell by 1.5% in response to a report on employment in the United States, which supported the dollar.

In the period between 9 - December 11, some large European and American banks marked the bearish bets on the euro, buying a one-year put option on the euro. These options entitle the holder to sell investments at a certain price at a specified date.

Soon, the euro has begun to press. Currency fell another 1.3% on December 16, when the Standard & Poor's downgraded the rating of the Greek sovereign debt. At this stage, some investors, including asset manager BlackRockInc. made bearish bets on the euro, believing that the situation could not support a sustained level at which the euro was trading earlier, and that the recovery in Europe would slow U.S. recovery - according to the views of the same people who are close to the heart of the matter.

Concern about Greece strengthened on Jan. 20, when investors began to fear that the country will not be able to refinance its huge debt, which led to the fact that the euro fell further by 1.3%.

January 22 Greece said that the planned sale of five-year bonds worth 8 billion euros in the coming days. To get ahead of the speculators, Greek advisers in the investment bank's liabilities that can be allocated to hedge funds - said a person familiar with the sale.

By January 28 the cost of new bonds decreased by 3.5%, leaving investors disappointed.

28 and 29 January analysts from Goldman Sachs Group Inc. sent a group of investors in a trip to meet with banks in Greece. The group included about a dozen different fund managers, say eyewitnesses, including the managers of the Chicago hedge-fund giant Citadel Investment Group, New York hedge fund, Eton Park Capital Management and Paulson, who sent two officers, said people who were there. Eton Park (Eton Park) had no comment.

During his meeting with Greek Deputy Finance Minister and the leaders of the National Bank of Greece, representatives of other banks and some investors have raised sharp questions about the state of the economy - according to the same people.

On the "ideological dinner" on February 8, organized Monness, Crespi, Hardt & Co., Small research and brokerage firms, three portfolio managers said on investment topics related to European debt crisis. During dinner in a private townhouse in Manhattan, during which served fried in a lemon chicken and filet mignon, manager of Soros predicted that interest rates will rise.

Donald Morgan, head of hedge fund Brigade Capital, told delegates that in his opinion, the Greek debt - these are the first chips in a domino whose fall would affect U.S. companies, municipalities, and Treasury securities. Einhorn, meanwhile, who was among the first and most vocal "bears" on Lehman, said that he is inclined to the bullish bets on gold due to inflation fears. Einhorn declined to comment on.

A week later, after supper, the most recent data, the size of the bear's rates against the euro rose to a record level of 60,000 futures contracts, which was the highest since 1999, according to Morgan Stanley. The data represent the volume of futures contracts that pay off if the euro falls to a specific level in the future.

Three days later, after dinner, another wave hit the euro, the currency dropping below $ 1.36. In a special order last week, traders from Goldman, Bank of America Corp. 'S Merrill Lynch unit, and Barclays Bank PLC have helped individual investors to place bearish bets on the euro - traders said.

Trade attracted low-cost contract, which provides the owner with a big payout if the euro fall to parity with the dollar during the year. This type of "low-risk" trade, is known so because the probability of the euro-dollar parity is low and similar contracts provide insurance against the fact that if the euro that will happen sometime during the year, the investor will receive decent compensation.

Price for the current rate is about 7% of the total amount that can be paid in case of parity. Thus, for an investor making a $ 1 million bid, the cost will be $ 70,000. This means that at present the likelihood that the parity will be achieved is 14:1. In November, the chances were 33:1, said the man, who is familiar with contract pricing.

The Wall Street Journal

Hedge Funds: Myths and Reality

Hedge funds initially, since their appearance, were the subject of mythmaking. This happened thanks to a resounding and unusual name, the impact of which is still growing at the expense of the appeal of the action that is meant by this term. As a hedge in the practice of financial management refers to a set of activities aimed at providing coverage of financial risks, it is usually suggested that the hedge fund and is therefore called upon to deal with. This view has created the preconditions for the emergence of the myth of the high profitability of hedge transactions, which was confirmed by records of hedge funds on their activities.

Hard to say what has caused greater harm to the very idea of applying hedge for the purposes of covering the financial risks: lack of knowledge of the foundations of a rather subtle and complex science of risk management or the use of hedge funds used by labels. But the fact remains that most people believe that hedge funds are established and operate in the market solely to comply with the orders of their clients in the area covering the financial risks are: price, interest, currency exchange, etc.

What is a hedge fund?
In reality, of the hedge funds, as an organization exclusively engaged in risk management, it is not true. It is likely that for some companies this may be true, but for the most part, the title does not define the terms of transactions that hedge fund performs in the market. Follow-up actions on the market, falling under the concept of hedging is merely an additional element of asset management, and is mandatory for all financial institutions in today's market conditions.

The American understanding of hedge fund is, as a rule, a private investment partnership, to invest primarily in publicly traded securities or financial derivatives. However, some of the funds do not limit their activities to these areas, and also worked in other markets, such as cash. In principle, the market segment, which focused around the interests of financial institutions is entirely determined by their objectives persecuted.

In hedge funds, there are two types of partners: General Partner and Limited Partner. General Partner - is the founder of hedge fund. He maintains all the daily activities of the Fund. The limited partners capital, but did not participate in the trade and the daily activities of the fund. A typical form of organization of the General Partner - LLC (Limited Liability Company - a company with limited liability), while it is unlimited liability partnership. The limited partner of the investment partnership is responsible only to the extent of their investment in the partnership.

For all types of services provided by General Partner, enabling it receives a fee determined by partnership agreements. Usually it is about 20% of net profit partnership. In addition, appointed another, and administrative fees, which typically amounts to 2-3% of net assets. The performance of hedge fund is distributed among all partners in proportion to their shares. All relationships are established in detail Partners partnership agreement, which is the most important part of any hedge fund.

As the hedge fund is a private investment partnership, the U.S. Commission on Securities and Exchange Commission (Securities and Exchange Commission, SEC) limits the number of investors who can enter into it, up to 99. In doing so, at least 65 of them should have a status of "accredited". The status of "accredited" investor is defined by the criterion of net value of the equity contribution, which has a bar. It could be very high and a value of $ 1 million Given that such investments classified as risky, then "accredited" investor may be required to prove their right to dispose of such amount, without prejudice to the family budget. In other words, give the necessary assurances that the million is not the last.

Offshore hedge funds are typically mutual fund (mutual fund), a resident of preferential tax zones - such as Bermuda. They are also available, the same technology investment, and that hedge funds, it is in this perspective, they are related. But nevertheless, there are some differences that are not always easily seen. Basically, it concerns the distribution of income from operations, the principles of entry and exit from the partnership, as well as the transparency of the performance of the business.

How are hedge funds
The difference between hedge funds from other forms of financial institutions is largely in the fact that he is free to choose the investment style. In addition, the investment strategies that hedge fund can practice, are not limited to the purchase of securities, and hedging through stock options, which usually is limited exposure to risk, the residual value which can be substantial. Numerous and extensive opportunities in the market of financial derivatives can be significantly higher degree of freedom used by managers of hedge funds, unlike other forms of investment organizations.

The reason for this situation is that the existing legislation and regulations severely limit the actions of many large investment companies. Paradoxically, but they determine the overall situation in the market. Basically, it concerns the possibility of extensive use of strategies related to the sale of securities without a cover, as well as the use of a large arsenal of strategies and technology options, and futures markets. This is not necessarily "make money" in the falling market. It is in such moments especially evident advantage of hedge funds, have the opportunity to fully apply the full range of trading strategies.

The advantage becomes especially apparent when the market is only vibrational motion in a range of prices. It is in this situation, hedge fund, which could easily apply the options to create different combinations, as well as the use of conversion operations, the nature of arbitration, and therefore a risk in nature, continues to produce revenues that are available other market participants to a much lesser extent.

In addition, the hedge fund has more than free to choose those strategies that give the best effect in the current circumstances. In the face of market volatility as the market gives them continuously in large quantities. For instance, while trade in different markets are often brings a higher income, allowing you to profit from the difference in prices for the same assets. Also, almost constantly, there are situations when it is possible to construct such a tool, which will have the characteristics of the asset without risk, but allows you to generate a significantly higher yield than securities with similar parameters. Typically, the yield is at a level between the rate without the risk and secondary market, ie between 8% and 16%, but sometimes can exceed these values.

It is essential that the requirements on margin is quite different depending on the type of account with which transactions are carried out. In this sense, is quite illustrative example of comparison of alternatives to open a position on the futures on the S & P500 index with conventional investment account, which makes access to the market of securities, and accounts with the brokerage company, servicing operations in the commodity markets:

Also keep in mind that the calculation marzhevyh claims on commodity markets is carried out using the SPAN-Margin, which takes into account absolutely all your open positions, rather than vychlenyaet portfolio only part of them. This leads to extremely inflated values of the margin in the conduct of operations in the securities market are not always exactly meet the real parameters of risk. The result is simple: a synthetic manner generated a portfolio of tools for the commodity market requires 2-3 times less capital than in the case of similar actions in the securities market and options on them. Hedge funds, because of the freedom of determining the direction of its activities, has the opportunity not only to choose the most interesting financial instruments, but use the best opportunities in the field of management by them. This allows to operate simultaneously on different markets with the lowest-cost world, given the resulting balance of the entire portfolio as a whole, regardless of where and how to conduct the operation.

And finally, the problem of creating a diversified portfolio, which is virtually impossible for the core number of investors, it is easily solved in the hedge fund. By combining their funds, investors are able to co-sharing the portfolio, which, introducing a set of assets, in very much reduces the risk. Often, the most attractive investment is inaccessible to ordinary investors because the shares may be too expensive. United in a common pool that money hedge fund allow operation with much less risk, reaping significant benefits from this. Because each of the assets inherent in certain indicators of the average yield, deviations from it, the ability to respond to certain external events, etc. Individually, these assets are capable of carrying a high price risk, but collectively they are in a strong degree of mutual repaid. This fact is a cornerstone in the theory of portfolio and is widely used not only in the securities market, but in practice financial management.

Of course, there are options for investment in capital markets through the acquisition of shares of mutual fund, open a separate investment account with a bank or a specialized company. However, all these ways, one way or another, lead to negative results, the effects are often difficult or even impossible to remove.

Income distribution in the hedge fund
Calculation of income in the hedge fund DE produced the conditions specified in the partnership agreement. After deduction of administrative charges and pay the General Partner, the funds are distributed among all partners according to their assessed contribution. In fact, this procedure is not very different from the mechanism for determining the value of mutual fund. It uses the same principles. However, less transparency, compared with hedge funds often misleading investors, and brings them to the disappointment in the outcome of return on capital. After determining the current value of the assets and income, due to each partner of hedge fund, for his contribution prisovokuplyayutsya a "dividend", which is also known as a "paper profit." Despite that designation, they are absolutely real, because the assets can be withdrawn at any time sold or transferred in cash. Defining the same amount that will be received after all deductions and paid partners, carried out by hedge fund at the date of each regularly - so-called "transition date", enshrined in the partnership agreement. Usually this is the last day of each month. The most insightful and literate investors prefer to accumulate this kind of profits accruing in the value of the contribution, as well as over time, begins to work the effect of accumulation, because the fund consistently produces reinvestment. In the small time intervals is not a large profit, but for a sufficiently long period, the effect is manifested in an extremely strong degree and can exceed all the expectations. This fact is equally true for any mode of investment in the securities market, but it is the case with hedge funds is reflected in the best. This is because he has the opportunity to lead a little more aggressive as compared to mutual funds, especially in the case of restructuring of the portfolio.

The tendency of investors to leave their deposits for a sufficiently long period is largely driven by policies of hedge funds on options to exit the partnership procedures. Usually, this requires advance notice of withdrawal with the definition of the term in a rather long range (up to 2 - 3 months). Sometimes provides an alternative - an immediate contribution for the realization of cash, which is ensured by a self-declared hedge funds buy and sell prices of shares. Naturally, the difference between them is very significant.

In the introduction, withdrawal, or withdrawal of a contribution from the hedge fund investments of each partner being revised, and reveals a new share balance. Those partners who do not move their assets, such actions do not affect, and value their contribution in monetary terms does not change. Revision of the subject only to equity ratio of deposits.

Nevertheless, with careful analysis of the consequences of failure of hedge fund investors can be found part of the likelihood of obtaining benefit from these actions, as well as management is able to settle with leaving fund shareholders are not too good investment. Leaving a more valuable asset, hedge fund after a short period of time may show a sharp increase in return on capital, as well as in the creation of income already participated capital, which was withdrawn, but did not manage to get his due share of profits. However, if the hedge fund will begin to leave, all partners, it could have consequences for ordinary cases of capital flight: the fall of the impact on capital and increase the risk of bankruptcy.

Hedge-fund and mutual fund - what is the difference?
There are plenty of differences between mutual funds and hedge funds. The most obvious differences relate to their management and structures. Mutual funds, generally speaking, limited investment in the purchase of "classic" of securities - such as stocks, bonds, mortgages, etc. Hedge funds, in addition to investment opportunities in all the tools available for the mutual fund may also use options, warrants, convertible bonds, commodities, margin transactions and short sales. This explains their ability to work in the falling market.

Another important difference: the mutual fund managers are paid exclusively from the percentage of assets under management. This means that the only way for the staff of these financial institutions to raise their income - this increase in size of assets under management. This is a significant difference from the hedge fund, which has a large part of the payment depends on the managers of the benefits fund. Sensibly arguing, you can understand that this situation carries a higher risk, because they do not encourage managers to improve the quality of governance. It is easy to understand that this is one of the reasons that mutual funds are losing hedge fund as a result of yield return, as well as a very great deal of effort spent on working with clients, rather than focus on improving the quality of engagement in the market.

Mutual funds are owned and managed investment companies. Capital for the mutual fund is going in such a way that only a very small proportion of the investment company's own money actually invested. Shares of the same investors involved in the winnings and losses in proportion to their participation, taking into account all costs. At about the same thing happens in the hedge fund, but the difference arises when managers are placing their money in hedge funds (which is normal). Often, the additional payment of managers is linked to the achievement of a certain level of return the fund, according to the formula "no less." The amount of the incentive pay is set in partnership agreements.

Why investors prefer hedge funds?
All the time, hedge funds significantly exceeded both the mutual funds and broad market indicators, not only to return on capital, but also by the criterion of risk, which is characterized by their lower levels. In addition, hedge funds provide better protection for investments in the falling markets.

Published data suggest that for nine and a half years, the average net return hedge funds was 17.6%, while for U.S. mutual funds, it is 14.5%. Here also the values of the following indices: MSCI World Equity Index - 9.6%, Lehman Brothers for the bonds - 9.0%, S & P500 - 17.9%.

Excellent value hedge funds is achieved with good characteristics of risk, which is considerably smaller in comparison with the performance MSCI World Equity Index, as well as in comparison with similar figures for U.S. mutual funds and S & P500. In comparison with an index of bonds with the lowest risk in the market of corporate securities, hedge funds offer significantly higher returns. This is achieved both by the availability of a wide range of strategies, as well as through better diversification. One of the main advantages of hedge fund - work in the market through the investment pool. Depositor it is a double win, which is the ability to pool their funds as with other investors, and is widely diversified assets. By combining their assets, investors receive the services of professional managers, the costs of which are shared among all partner world and for each individual person significantly reduced.

An equally important advantage is the availability of a wide range of strategies. Managers of hedge funds can use such strategies, which are managed by mutual funds are not always available. Consequently, the impact of hedge funds could be much higher. Below are details VAN Hedge Fund Advisors Int. for the third quarter of 1998 to the work of hedge funds.

1. The average value of five best funds do not have losses in the calendar year and the impact of not less than 20%:

* For five years - 30.5%

* Per year - 74.3%

2. The average value of five best funds with losses of no more than three quarters:

* For five years - 23.9%

* Per year - 68.3%

3. The average value of five best funds with the highest absolute returns:

* For five years - 37.4%

* Per year - 97.9%

Many insightful investment managers are considering investing in hedge funds as a pre-statochno promising and interesting, because they can significantly improve the return on capital without significantly increasing risk. Thus, traditional portfolios consisting of stocks and bonds, can significantly improve both the efficiency, as well as the risk when they hedge funds as a separate investment.

What could be the return on capital in hedge funds?
The above rates of return on capital of various hedge funds show very high efficiency of the assets. Even if we take the assumption of the risk level is exceeded, the permissible from the standpoint of an aggressive investor, it might seem that demonstrated the effectiveness of business in the field of investment management is not too true. However, this is absolutely not true. Conducted by research in the field determine the level of profitability from operations in the financial markets suggests that in the case of an unlimited horizon of planning and the availability of capital, over 10 million dollars benefiting asymptotically tends to the level of 110% per annum for sredneagressivnogo portfolio, and for vysokoagressivnogo - to 185%.

These values are obtained as a result of a simple theory for calculating available incoming cash flow resulting from the creation of hybrid financial products, including various financial instruments. In general, hedge funds, regardless of the manner in which asset classes they are formed as the main investment portfolio, and hedge their risks. First producing average returns. The second allows you to derive income from the "no less." In sum, both the portfolio significantly increases the return on capital, while less variability in benefits over time, as very different from common approaches to investment management, which in the modern world should recognize the anachronism.

Thus, it seems the real results are not unusual. Rather, it may be noted that the quality of management is not always the best and has a significant potential for growth. Trying to predict the situation, you must first say that the market in recent years has changed, provide the managers much greater number of financial instruments with high liquidity. The rapid development of communication and their influence on the speed of operation has also made a significant contribution to the process of investment management. All this suggests that the impact of hedge funds tends to increase at the same time as well to increase its variability. However, it is equally true for other principles of management, which in the case of non-hedge instruments will be absolutely clear loss for all indicators.

Invest or not to hedge funds?
It is believed that one of the best ways of investing in foreign capital markets is to enter into a hedge fund on the rights of a partner. By combining their financial resources for investment purposes, came in the hedge fund people are a significant cost savings, significantly reduce risks and have full access to information on the status of their assets.

All these points are very important and attractive to investors, as well as provide a net gain, as opposed to other options for placement of funds in capital markets (investments in mutual funds), as well as opening their own investment accounts for investment companies to make their own management . Given the fact that the spectrum of available services in any investment of almost the same, the best choice for the discriminating investor can safely call it hedge fund. For a second, hedge funds are often able to offer a much wider range of services than other professional organizations working in the market, particularly with respect to securities.

All of these circumstances is very attractive to investors, pre-start up an additional measure of risk in exchange for higher profits. This provides a large influx of capital into this industry, as well as the rapidly growing number of hedge funds. No wonder the bulk of the investments of the United States in the Asian market took place in the channels by the hedge funds. To use or not to hedge funds as a tool for investment - an issue for individual permits each investor. Counsel in this case can not be, especially when it comes to this type of investment, where the timing should be long enough. It should also be taken into account the fact that the contribution to the hedge fund is not freely traded on the market of the securities. Naturally, it can not be purchased by none other than near the foundation. In addition, the necessary information about the interests of financial institutions can be found only by direct contact.

Naturally, all this can be extremely burdensome, which is generally not too encouraging investors. Nonetheless, modern communication capabilities, and especially the Internet greatly facilitates the task of finding and providing contacts.

How can I use hedge funds?
First of all, hedge fund was interesting channel resource allocation in the market from the viewpoint of the ordinary investor does not want to burden yourself worrying about the decision-making. This question is quite clear: entered into a partnership and can only monitor the status of your funds.

Nevertheless, for the Russian reality, there is another point which is quite important not to walk past him. The fact that a hedge fund Russian enterprise - an important and integral element of modern business to meet the huge number of non-solvable at the current time problems, such as the question of risk management related to the implementation of export-import operations of nature. Now, these issues remain outside the attention of managers of domestic companies, or depend on the complexity of the legislation in this area.

Legitimately established hedge fund in this case is able to solve many problems, leaving it under control the whole chain of operations that can significantly improve the productivity of the operation of the core business. Especially this type of financial institutions should be of interest to businesses operating in the area of financial services, and in the first place - the banks. Having at its disposal effectively acting hedge fund as a valuable investment institutions, skilled labor, any banking institution or investment company can offer significantly more services, not only in quantity but in quality than that observed in the current time.

Some banking institutions, as far as known to the author, it do. But the whole problem is that the use of foreign financial institutions operating in order to conduct operations in the capital markets is limited only to the management of cash resources, in one way or another abroad. In terms of operations, mainly investments in restricted securities. It should be recognized that it is much better option than to leave them just in bank accounts or investment trust managers, whose only advantage is that they live and work abroad.

There is no doubt that a hedge fund, subject to the formation of its structure as a full-fledged business - a very promising, especially when it fits into the overall context of business. Given that the modern diversity of financial instruments traded in the market, requires considerable effort, if necessary, simultaneous operations, it is simply a necessary element of modern financial management. Moreover, hedge fund, with more freedom in the choice of governance principles, can best solve a problem in the field of financial engineering, which is today the driving force in the market of services in the management of assets and liabilities.

Michael Chekulayev

Options: three ways to hedge

Read a book Connolly «Buying and selling volatility» [1] know what the delta-neutral hedge separate option or option position. This method of trade was bought or sold the option underlying asset hedge their risks in such a way that the total delta position is always equal to zero. However, in practice, many traders to hedge their risks are not options for the delta, and after a fixed price of underlying asset. Finally, many do not hedge their risks, and sell or buy a «naked» options. The article compares these strategies.

Random Simulation
Especially for the solution of the problem through a package Excel file was created, in which the simulation of random motion of the price of a stock within 10 days. For simplicity, its current price is set at $ 100. The user enters the annual volatility of stock and its expected annual revenue, and the program on the basis of this information builds a random minute price series length of 10 days. It is expected that the share is traded around the clock. Thus, the length of the created-minute price series of 14,400 values. To understand better the program schedule is displayed price movements. For simplicity, we assume that we sell 100 call options (ie one full lot), which expired after 10 days, and within 10 days hedzhiruem options by buying and selling shares. The method of hedging is determined by the user in the program - either for hedging the delta, either through a fixed price range, or the lack of hedging at all. After starting the program creates a random number and price hedging transactions being sold option in accordance with established rules. Automatically calculated financial results of operations, which is included in a special table. Then create another random price series, again carried out by the hedge and the financial result is calculated, which also entered into the table. The number of random simulations of possible share price may be as high as, say, 500. In each case, the program performs all the necessary hedging and calculates profit or loss. As a result, we obtain a table containing the results of each experiment. On this basis, calculated automatically generalize indicators - the average financial results and its standard deviation (ie this will be just below).

In a random simulation is a prerequisite, which is based on the most common model for evaluating the options - black Shoulza - and many other models in the field of investment. The premise is that the stock price is log-normal distribution. It should be noted that this is one of the most objective methods of mathematical modeling of price movements.

Analysis of results
So, turn to the most interesting - the analysis of results of different methods of hedging.

The testing was as follows. Sell 100 call options with страйком $ 105 and the implied volatility 50% who either do not hedge, or hedge by buying shares through the fixed price range, or the delta.

Within each of the three options were tested with varying volatility of stocks, namely: 30% (volatility, which is moving action below implied volatility of an option), 50% (volatility of stocks is exactly the implied volatility of an option) and 70% (volatility of stock exceeds the implied volatility of an option).

Thus, only 9 tests conducted in each of them made 500 simulations random traffic campaigns. Note that in all cases, the expected profitability of the price was set at 0%, which implies the existence of a lateral trend - namely, in those circumstances, traders seek to sell the options.

The lack of hedging
To start with the first series of tests, when the sold option does not hedge at all, that is, any transactions with no underlying asset. Test results are given in Table 1. It clearly shows that when the volatility of shares was equal to 50%, that is exactly coincides with the implied volatility of option sold, on average, produces a loss of $ 11.05, which is very close to zero. With the volatility of shares equal to 30%, the average profit was $ 98.58, with volatility of 70% of an average loss of $ 110.45. The value of standard deviation of profit / loss, we have considered not going, but this information is useful to us in the future.

Thus, one can conclude that if the action will move to greater volatility than the implied volatility of the sold option, on average, we get a loss, if less - profitable. But how exactly to define the value of the average earnings or average loss? More specifically: if the volatility of the sold call option is equal to 50%, and the action moves to the volatile x%, what is the expected result of the financial position?

This can be calculated mathematically. It is necessary to calculate the models for Black-Shoulza premium call option with volatility 50% (respectively, valid till the expiry of 10 days, страйком $ 105; stock price in this case is $ 100, while the interest rate we take for 0%) and subtracted from the calculation of similarly premium exactly the same option, but with volatile x%. Expected financial results will be exactly equal to the difference between the two prizes.

Check this on our example. Prize option volatility to 50% is $ 145.43, with volatility 30% - $ 43.81, with a volatility 70% - $ 264.84. According to the above reasoning, when the volatility of shares equal to 30%, average income must be equal to $ 145.43 - $ 43.81 = $ 101.62, with volatility of 70% to a loss of $ 145.43 - $ 264.84 = - $ 119.41.

It is evident that these figures are very close to the results obtained during testing. A slight deviation is due to the fact that we did just 500 tests. If you do not 500, as, say, 10 thousand simulations, the calculated on the basis of that sample numbers would be closer to the results calculated by mathematical.

In a fixed price range
Consider now how our results change if we sold the lot of options to hedge equity base through a fixed interval.

Specific ways of hedging via fixed-price range, there are many. In our case, at the level of $ 101, $ 102, $ 103, $ 104 and $ 105, we will buy 20 shares. That is, once the price reaches $ 101, we buy 20 shares. If the price rises to $ 102, we will buy another 20 shares. And so up to $ 105 - it страйк our option.

By the time will be purchased for a total of 100 shares which, when further growth of prices will be fully sold to hedge the option. If, however, after growth, for example, up to $ 101 price will revert back, we are at $ 100 sell previously purchased 20 shares and Fix loss. Unfortunately, any hedging of underlying asset implies a loss - this will not деться.

So, what results were obtained when hedging the option, through a fixed interval? The table shows that when the volatility of shares 30%, on average, had a profit of $ 101.56, with volatility of 50% - profit of $ 3.79, with a 70% loss of $ 111.28. Just shows that the average financial results very close to those obtained with a simple sale of the call option without hedging.

In fact, if the computer power and time are not allowed to make 500, but, say, 1 million of testing, we have found that the average financial results in the two cases are to each other even closer. Although it may seem strange, but in the general case of selling the call option with the transaction of its hedging and selling similar option, followed by hedging with the same expected financial results. Does this mean that all the efforts of hedge option does not have any meaning? No.

Let us analyze the second important indicator that we have not yet been considered. This is the standard deviation of the financial result. It is a measure of how far away from the value of its average value. The larger the standard deviation, the greater dispersion of values around the mean value, the smaller - the smaller the variance.

In the area of investment, the standard deviation of return on investments is a common measure of risk. The high standard deviation indicates that it is very difficult to estimate in advance what will be return on investment. If the attachment has a small standard deviation of returns, we can much more accurately predict in advance what profit the investor will receive (it is located far from its expected value).

So, back to the financial results. The table shows that in the first case, when we sold the call option, and not to hedge it, the standard deviation of the financial result was higher than in the second case, when the sold option hedging. Thus, when the volatility of shares equal to 30%, standard deviation for the case without hedging was $ 146.50, and for the case of hedging - $ 100.55.

It is easy to see that the same pattern seen in two other cases. You can make an important conclusion that the option hedging leads to lower standard deviations of the profit / loss strategy. Moreover, any hedging has this and only this goal. Hedging does not affect the amount of expected profit, it only reduces the risk of the strategy (standard deviation).

Hedging on the delta
Finally, consider what we will, if the option to hedge in the manner described in the book, Connolly "Buying and selling volatility" [1], namely - on the delta. This method of hedging a trader buys and sells shares in a manner that the total position delta has always been zero. In the program we have produced almost continuously hedge, buying and selling shares every minute. What does this lead? As expected, the average value of the financial strategy of the result received very close to the results obtained in the first two cases. However, the standard deviation of the financial results were significantly lower than in the first two cases, and ranged from $ 1 to $ 3!

In fact, if the hedging on the delta was carried out not every minute, and indeed continually, the standard deviation would be zero! This means that irrespective of which way she went to stock price, the strategy of selling the call option with hedging of delta would the same financial result.

For example, if the action moving with a constant volatility 30%, we would have a profit of $ 101.62 - regardless of the dynamics of the share price. The last statement may seem surprising, but it is actually true.

Interestingly, the continuous delta hedging an option on the profit or loss depends only on two parameters: from the implied volatility of the sold option and the volatility of equities. Selling an option, call implied volatility of 50% and hedzhiruya him to the delta, we have, according to Connolly, sell volatility, as we will always make a profit, if the action will move with volatility less than 50%, and loss - with the volatility of over 50% .

Moreover, we can advance to say what the gain or loss shall receive at a given volatility of equities. So, what exactly will share the road - will it grow, fall or stand on the spot - we are not interested. Our financial results will be determined solely by volatility.

Therefore, continuing a strategy of hedging options in the delta can be truly called a trade volatility. It should be noted that many sources of the term is used more broadly to refer to any strategy aimed at changing the volatility (eg, buying and selling straddle), which is actually not quite correct.

To calculate the delta requires knowledge of the volatility. Usually used by the current implied volatility of an option. But in fact want to use the true volatility of equities. It may not match the implied volatility of option.

We sell the call option implied volatility of 50%. However, delta hedging calculated based on the volatility of shares 30%, 50% and 70%. If we used the delta, based on implied volatility of option (50%), we would not have achieved this result, and the standard deviation of profit / loss is not equal to $ 0.

In reality, the problem is that to estimate the true volatility, which is moving action at this time, it is very difficult. The historical volatility, which represents the average volatility for some historical period of time, an inaccurate assessment of the current volatility.

Therefore, to calculate the delta of traders, in most cases use the implied volatility of an option. More experienced players use "empirical delta, which is based on" empirical volatility - that is, their own assessment of the volatility of equities. In any case, you have to say that for the delta hedge - even if it is not quite accurate - has meant that the standard deviation of the financial result of the strategy is less than with alternative methods of hedging. Consequently, the delta-neutral hedge is still the preferred way to hedge stock options, reducing the risk to the minimum possible level.

Conclusion
It should be noted that when testing does not take into account the commission for the transactions, which can be great, especially when using a continuous (or near-continuous) on the delta hedging. It is clear that this is adversely affect the final result.

Also worth mentioning that in the ho-de tests, we assumed that the expected return on equities is equal to 0%. This premise is quite natural because traders usually sell options in terms of lateral trend. However, with a positive expected return on equities in the case of bovine market, or negative in the case of Bear - the results will be different. In this article, this is not taken into account.

Finally, despite the fact that the article dealt with the sale and hedging the call option, the findings are true also for the purchase of call option, as the buyer's financial results are always exactly equal to the financial result of the seller, taken as negative. Also, all the conclusions are valid for the put option - short or long.

The reader can check all of the findings in this article, as well as to test any other ways to hedge by using the CD-ROM magazine, a description which can also be found on the disk.

In conclusion would like to add that, perhaps, someone will be able to open up new ways to hedge or to find other parties to this very interesting question.

Michael Glukhov