A Different World
Editors note: With this column, we introduce John Succo, co-founder of Victus Capital, a multi-strategy hedge fund, where he manages overall risk and a portfolio concentrating in volatility extraction by opportunistically trading derivative instruments. He welcomes your comments and feedback at Succo@minyanville.com.
The world of derivatives is not like the world of stocks and bonds. It is a foggy world where price levels are less important than how those prices are realized. I am more concerned with the rate of change, or how fast things move, than in what direction they move. I don't particularly care if stock and bond markets go up or down, but I care a great deal about to what magnitude they go up and down: Are prices gapping from day to day, are they in a trading range, or are they trending? These are all factors in pricing and trading derivatives and this is where I make my bets.
I am neither a speculator nor investor, as you would be, but a trader in derivatives. I seek high derivative prices to sell and cheap ones to buy and then hedge out as many ancilliary risks as possible, things like price direction and interest rates. There is no true arbitrage, or risk-less profits, left anymore in these markets, so I make a lot of assumptions in building portfolios of derivatives. But these assumptions have a much higher probability of success than trying to determine whether the markets or any particular security is going up or down in price. I ultimately care only about the price of derivatives: I am able to make a profit because other participants, such as speculators and hedgers, are less sensitive to price.
Derivatives such as options on stocks and bonds or longer term structures like convertable bonds are very useful tools for investors and speculators both, as long as they are used properly. The key to using them properly is the understanding of the leverage they introduce, which can be dramatic. Derivatives allow flexibility: for an investor to alter or hedge a current position in a designed way or for a speculator to access leverage for a fee. I will in the future describe and educate on many of these strategies.
One key element about derivatives, especially the short-term options market, is that because they introduce leverage, market information often is manifest in this market first. Option prices, therefore, often indicate sentiment in stocks and bonds before the cash prices react. In general, low option prices indicate high leverage and complacency and high option prices indicate low leverage and fear.
I have written several pieces that detail these ideas and others and introduce some basics about the derivatives markets. Check back here for them in the coming days.
I am very happy to be a part of Minyanville and look forward to learning along with you, for the markets are constantly teaching us new things.
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