Active management in risk management strategies

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Active management and active managers are often touted for their discretionary abilities when picking stocks, especially in a volatile market. That said, the active umbrella is much larger and can come in many different ways, from simply being independent of the index to combining options and controlling when to exercise them.

Garrett Paolella, Managing Director and Portfolio Manager at Harvest Volatility Management, recently sat down with VettaFi to discuss what active management looks like when it comes to col strategies and risk management and the benefits of use of stock investment options. HMV currently provides portfolio management for Nationwide ETFs line up.

Active management in risk management strategies is not often discussed, and Paolella observed how an active strategy differs from a passive strategy in this area. In the case of Harvest Volatility Management’s approach, it is not about individual discretion, but rather the inclusion of factors and data beyond the index.

“We like to incorporate what we call active risk management into our investment strategy,” Paolella explained. “It’s not just a static index; we look at a number of underlying datasets and a number of different factors to give us what we think our rules-based approach should be.

Collar Strategy Breakdown

A collar strategy involves holding shares of an underlying security while buying protective put options and selling covered calls for the security. A put option allows, but does not oblige, the owner to sell the underlying security at an agreed price on an agreed date. At the same time, a call gives the owner the right to buy the title at an agreed price on an agreed date, but does not oblige him to do so.

Collar strategies are by no means new, but they can be a particularly attractive strategy in difficult times due to their ability to generate income through call selling while offering the potential to reduce volatility and provide a measure of downside protection through puts.

The way Paolella and the portfolio managers at Harvest Volatility Management – ​​the pioneers of some of the first options-based ETFs in 2013 – use tunneling strategies, however, goes beyond the ordinary.

“We wanted to take it a step further and essentially create a net credit collar that not only allows us to generate net credit that can be used as a source of income for investors, but also to take a portion of it and buy one off. money. mis, which could do two things: reduce the volatility of the entire fund, and then also provide a measure of downside protection,” Paolella explained.

As part of this strategy, the portfolio managers of HMV may exit a call at the start of the month window between resets if the markets appear to be moving sharply higher, and this upward movement may continue. By exiting the long position, more of the underlying securities in the portfolio can be engaged in the upside move, thereby capturing more of the price action. It can also leave the portfolio open to more volatility if the markets reverse sharply, but the protective put option still remains.

The other time that exiting a buy position makes sense for the fund is when the market is falling precipitously.

“If the market has a big enough sell-off and we’ve won the majority of our opportunity through the call option and the revenue we might generate, we’ll close that,” Paolella said.

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Break it down further

Modeling this type of data-driven approach to risk management involves a multitude of factors, including examining the price movement of a broad index and comparing it to the volatility index of that sub-index. index, rate of change over rolling periods, options market looks, and much more. All the data is collated into a model which then works to predict what the next month will look like and how to position the collar.

The portfolio managers then look at the model and decide what the optimal positioning is, switching between a little more risk aversion and a little more risk.

“Part of our model is trying to assess the overall probability of what the expected outcome may be and then where we want to attach our collar; a little more risk or a little more risk, but definitely not a binary,” Paolella said. “It’s a very subtle, very subtle change, but we want to have the ability to capture a bit more potential. Other products on the market do not do this.

Market challenges 2022

“This year has been more challenging for strategy because when you look at the model as a whole, what we’re trying to do is play on probability; we want to play with the highest probability of historical market data,” Paolella explained.

From a probability standpoint, this gradual decline in the markets over several months has rarely happened historically. This created a perfect storm for many collar strategies, with markets never falling precipitously enough in a month to engage the protective put options. However, the system can still capture income from covered calls and any dividends earned on the underlying securities.

“You want to see this long-term because we’re going to pay you your monthly distributions regularly because we’ve developed a strategy that we think is appropriate in the rising stock markets; we can deliver your distribution to you in a flat market, we generate net credit plus dividends in a down market. In a bear market, we do the same, and we could also generate value from the put option,” Paolella said.

For more news, information and strategy, visit the Retirement Income Channel.


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