Junzi Capital Engineering, LLC : Tang Gamma Opportunity (Aggressive)

Summary

This program implements a volatility arbitrage strategy in the commodity futures markets. The objective is to produce attractive absolute-returns uncorrelated to equity and commodity market price levels. We seek to exploit systematic mispricings in the option prices of exchanged-traded commodity futures, by actively trading the underlying futures contract on an intraday basis.

Investment Strategy

A comprehensive volatility model based on extensive statistical research and extensive backtesting is used to identify option mispricings, both long and short. Positions are selected on a discretionary basis. A proprietary, fully automated black-box application then monitors price/volume movements in the underlying instrument. As long as electronic markets are open, the application makes hedging decisions on a minute-by-minute basis; completely automated trades may be placed up to 23 hours a day, 6 days a week. The strategy is designed to be price neutral: profits and losses are determined only by the realized volatility of the underlying commodity.

The Manager believes that a unique opportunity exists in the futures markets; statistical research indicates that, at certain times and for certain instruments, highly liquid exchange-traded options can be mispriced by as much as 10%-20%. This mispricing is exposed using a proprietary dynamic active-frequency delta/gamma-hedging strategy to exploit the statistical differences between intra-day and multi-day volatility.

Fully automated trading algorithms monitor the underlying instrument as long as electronic markets are open and adequate liquidity is available. In the case of some products, that means trading up to 23 hours a day, 5 days a week. Depending on intra-day and inter- day price and volume action, our live volatility model, and other relative factors, hedging decisions are made dynamically: underlying instruments are bought or sold in a fully systematic process. This hedging occurs until option expiration.

Risk Management

Investments are made in a diverse set of uncorrelated commodities. Long option hedges are used aggressively when electronic futures markets are not available for trading (weekends/holidays).

Instruments are grouped into rough correlation categories, on the basis of price and volatility correlation (crude/refined product group being the most obvious example). No single category will consume a majority of portfolio risk capital.

In order to avoid “iceberg” or hidden risk, deep out-of-the-money strikes are avoided. Options sold are limited to strike prices within one standard-deviation of current underlying price. Protective long option positions are used to hedge against jumps in the underlying.