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Wizard of Ops Articles

Another Backtester Bites the Dust

8/27/2019

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This post is in response to the article "UBS Faces Client Backlash Over Options Strategy".
https://www.wsj.com/articles/ubs-faces-client-backlash-over-options-strategy-11566552600

Here is a synopsis of this article as the options trader sees it:
  • Someone at UBS read something about premiums always overpricing options.
  • They backtest an at-the-money condor that yields x% and sees that it succeeds most of the time!
  • They bring the statistics to their boss, and the boss signs off on it.  We'll call it the "YES" fund. It is bringing home small, but consistent returns.
  • As implied volatility (IV) drops and returns wane, the fund manager is faced with a choice. Do I narrow the condor, or do I apply leverage? The fund manager decides to apply leverage, and continues to sell the condor.
  • Then the fund manager learns a valuable lesson: IV does not give warnings for market volatility!
  • The market starts swinging, and the fund manager loses the fund. 
​
Investment banks are always looking for a silver-bullet strategy that is repeatable and profitable with outsized gains. It is something may work for a while, like this condor strategy, but eventually the math catches up. Repeated processes ignore the fact that market dynamics and options dynamics change, and you need to change with them as well as sufficiently manage risk. 
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