Making money around market volatility is a useful tool to have in your portfolio armoury.
And Adam Smears, head of fixed income research at Russell Investments, believes he has an options strategy that can benefit from choppier times and act as a great diversifier for investors.
Smears also manages Russell’s unconstrained fixed income and, along with his team, has been implementing a volatility sleeve for a number of years.
He runs the Russell Global Unconstrained Portfolio in Canada, which benefited from February’s drop, and believes it’s important to use volatility as an asset now and going forward.
He said: “Frankly, markets and economies have become addicted to quantitative easing, so we’ve had a very low rate environment and we’ve had quantitative easing from most major central banks, but that is unwinding.
“At the peak period last year, there was probably around $2 trillion worth of net buying by central banks and that’s expected by the end of this year to drop down to zero.
“So when you take $2 trillion of net buyers out of the market, it’s going to have impact on various different assets regardless of the fundamentals. It’s just going to be a more thinly traded market and, therefore, any time news comes out there is not a buyer of last resort sitting there like there used to be.”
Smears said that investors have to come to grips with the fact central banks are removing their influence from the market. He added that the strategy involves hedging whatever the option is based off so all you have left is the volatility of those assets.
He said: “If the equities go up, the option will clearly go up; if it goes down the option will go down. But if you hedge that equity exposure out, the next most important thing that determines whether your option is worth more of risk is the level of volatility of those equities. What the markets expect volatility will be of those equities becomes a major driver.
“You can use option strategies where you hedge the underlying risk, currencies, bonds or equities, so all you have is the volatility of those assets and so, therefore, you are able to create a strategy that benefits from a rise or fall in volatility.”
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