Volatility management, the bread and butter of derivatives traders, is gaining ground as a tool for more traditional money managers to manage portfolio risk and boost returns.
Money managers more often are seeking ways to profit from volatility, rather than to avoid it.
GTE Investment Management Corp., Stamford, Conn., and Alliance Capital Management L.P., New York, are among the firms applying volatility strategies for traditional money management portfolios.
GTE created a volatility strategy as an outgrowth of its philosophy to seek to add incremental returns in down markets, even at the cost of upside returns, said Michael deMarco, director-portfolio analysis and product development.
Previously, GTE had a call writing program in place for 10 years that didn't completely meet GTE's goals, Mr. deMarco said. The call writing program underperformed in strong markets and didn't add as much value as GTE desired in down markets.
Consequently, GTE implemented an options strategy to buy and sell both, puts and calls. In order to implement the strategies, GTE's staff had to make assumptions regarding expected interest rates and volatility, Mr. deMarco said.
Using those assumptions, a variety of different choices became available, offering varying levels of return under different scenarios, and carrying varying certainty.
GTE chose to get as close as possible to its investment target in down markets, and possibly give up expected return on the upside, Mr. deMarco said.
One way GTE implements the strategy is through put and call spreads that target different levels of stock prices.
The spreads generally enhance returns if stock prices don't move beyond a specified level, higher or lower depending on the strategy. But if prices move farther in the same direction, beyond another specified point, the spread again begins to enhance return.
GTE's new options program overlays between 5% and 10% of its U.S. equity exposure. Because the program just began this fall, no conclusions can be drawn regarding its success. But if it is deemed a success, GTE may decide to apply the strategy to some of its non-U.S. exposure, such as equities in Japan, the United Kingdom, Germany and France, Mr. deMarco said.
Meanwhile, Alliance Capital soon will offer a mutual fund that will seek to wrap a volatility-management strategy around a core investment portfolio of large-capitalization stocks. The fund will combine the use of short selling, futures, options and leverage with investment in 25 large, high-quality stocks, to take advantage of rising and declining markets.
Steven Reynolds, senior vice president for Alliance, said the bulk of the fund will look just like Alliance's large-cap institutional accounts. But wrapped around that will be derivatives investments and short selling that further implement Alliance investment strategies, Mr. Reynolds said.
For example, a large company that Alliance follows very closely might suffer from a temporary event that depresses the stock, but doesn't affect Alliance's long-term view of the stock. Alliance might then load up on the company using options, he said.
The fund, the Alliance All-Market Advantage Fund, is still in registration with the Securities and Exchange Commission, and will be managed by Alliance's large-cap growth team in Minneapolis.