Minyan Mailbag - Volatility
Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.
A bit frustrating watching vol take a beating, but I guess the key is
You must have a diversified portfolio of long volatility in individual names: unsystematic risk is under-priced in general because tail events are underestimated, while day to day volatility is properly priced. Therefore, in any period there will be a few number of stocks that will exhibit tail events (Anadarko Petroleum (APC) up 8% in a day makes a lot of money) to offset decay in many number of names that are trading with normal volatility. Having a portfolio of only a small number of individual names is ineffective in capturing tail events.
Conversely, systematic risk (index options) is consistently over-priced. We will either be short index options (when they are priced richly) against a basket of individual long volatility names or have no position in them (when they are relatively properly priced).
Right now we are not short index options. Right now we are long a diversified (200 names) basket of individual name volatility.
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