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SPYGLASS TRADING, L.P. RISK-ADJUSTED RETURNS & MANAGING VOLATILITY TRADING MODEL • 90-95% of trades are in options • Most opening positions are selling option wings expiring in the spot month – Routine and systematic in equity names we know – Also sell some index options – Expectation is for option to expire worthless • Some short term trades using long index options or long put or call equity spreads • May execute long or short positions in stock BENEFITS • Large cash credit balances • Creates lower cost of capital for stock positions • Increased return in a range bound or gradually trending market • Do not have to be exactly right to profit • Required to frequently re-evaluate portfolio CONSEQUENCES • Event risks, e.g. mergers or crises • Substantial directional moved based on skewed market psychology • Lost profit when directional bias is correct • Potential loss in any given position can significantly exceed potential gain • Highly intense, requires constant monitoring, and may generate higher trading costs RISK ADJUSTED RETURN STRATEGIES • Selling the wings • Covered writes to exit long or short stock positions • Converting to strangles • Diversification SELLING THE WINGS • Assumes same risks as covered write position • Requires less margin • Eliminates need for market movement to make money • Sells in spot month only – Lessens time window for negative events – Increases return based on premium decay rate COVERED WRITES • Used solely as an exit strategy for long or short stock positions • Sell in-the-money puts against short stock or in-the-money calls against long stock • Benefits: – Forces elimination of the position within weeks – Captures additional gain up front – Reduces some risk of a directional change CONVERTING TO STRANGLES • Opening position in a stock or index of a short put or call • Later add a short of the opposite option • Little to no additional margin required • Risk needs to be low to be effective DIVERSIFICATION • Large number of different positions • Have to sell both puts and calls • Trade in a variety of unrelated market sectors • Utilize index options • Carry bonds, bond funds, reits, and listed funds to add stability; i.e., reduce overall portfolio risk MANAGING VOLATILITY • Roll – Same month if time and premium at desired strike – Calendar if late in month • Buy long spread – Spreads in out months – Buy same strike, sell next strike – Ratio • Buy or short sell stock • Sell in-the-money offset option • Taking advantage of volatility – an earnings play Final Thoughts • Technical versus fundamental • Time and labor intensive approach • Has the potential to under perform in strongly trending markets • Greatest risk is being out of the market