These are irregular, volatile times for investors in the options market—which nonetheless provide windows of opportunity and market dislocations for actively managed Calamos Hedged Equity Fund (CIHEX).
Thursday’s call with Calamos Co-CIO Eli Pars, Head of Alternative Strategies and Co-Head of Convertible Strategies, Senior Co-Portfolio Manager, and Jason Hill, Senior Vice President, Co-Portfolio Manager, featured an overview of the environment less than one month away from the start of third quarter earnings reports in October and two months from the Nov. 3 national elections. (Listen to the call replay here.)
Morningstar Overall RatingTM Among 109 Options-based funds. The Fund's risk-adjusted returns based on load-waived Class I Shares had 4 stars for 3 years and 5 stars for 5 years out of 109 and 65 Options-based Funds, respectively, for the period ended 9/30/2020.
Beyond the calendar events, the market has been dealing with plenty of anomalies. Hill commented on three market dynamics:
“Off-the-charts” retail option activity has been concentrated mostly in very short-term options (less than two weeks), the majority of which are on technology/momentum names.
Softbank, a Japanese conglomerate that had been accumulating options in technology stocks, gained notoriety for having driven the largest ever volumes in contracts linked to individual companies prior to the September pullback.
The team believes the story was “a bit overblown” and that Softbank didn’t have such a large role in the tech moves, Hill said.
“Some of their trades were actually option spreads and were essentially delta neutral—meaning not leaning long or short—so not quite as impactful as originally thought but still relevant from an option activity standpoint. Still,” Hill continued, “Softbank was most likely a contributor to market moves and, more importantly, a provider of upward pressure on option pricing and volatility that we’ve seen.”
Significant political and virus-related uncertainty, prompting investors to continue to bid for downside risk mitigation even while markets continue to climb.
Hill confirmed that the team is seeing option prices being bid up as tensions grow. “There is even an upward kink in the S&P option pricing term structure at the end of September, which is around the date of the first debate,” he said.What’s even more interesting, he said, is that “implied volatility term structure really ramps up near the election date of November 3, but doesn’t stop there as forward vol continues to rise past that date. This is telling us right now that option markets are currently pricing in or implying that we won’t know the results for days or weeks past Election Day.”
All of the above adds up to a more challenging environment for the CIHEX team.
“The more typical market up/volatility down environment is theoretically easier to add hedge and navigate because, simply put, you have option prices cheapening as the market rises. Adding hedge is a lot easier,” Hill said.
“The inverse of that, what we’re seeing right now, has been definitely more challenging and more problematic for us to create the risk/reward that we’re accustomed to, especially on the way up.”
The team likes the trade CIHEX has on today. The fund is managed within a range of 40 to 60 beta to the S&P. Currently, Pars said, it’s at 40—at the lower end of its sensitivity and at the higher end of the hedge.
“The position is partially a function of the straight-up stock market well bid on the volatility side. It’s a little trickier to be opportunistic when you have a straight-up trending market,” he said.
“Normally, with the run we’ve had in the equity market, you’d expect the VIX to be high teens instead of mid-20s like it is.”
What the team likes, Pars said, is that “we do get paid to wait. Options prices are higher, which generates additional return over and above our net exposure so we are appreciative of that.”
With the flexibility to remain opportunistic, the team is on alert to take advantage of dislocations that present themselves—what Hill described as “picking spots to chip away and add layers of hedge in order to have as much of an asymmetric payoff as possible in the current environment.”
One example: recent put spread trades, some near the election and others out past the election.
“These trades are attractive right now,” Hill explained, “because we’re able to mitigate some of the cost of buying a long put by pairing it with a further out-of-the-money put sell, the put sell being executed at what we believe to be elevated levels. Essentially selling an expensive put to finance buying closer to the money puts.”
“Some of the payouts in these recent trades are around 20 to 1, which is very attractive relative to past history,” he added.
While such trades are incremental and not necessarily “big bets,” they help reduce risk and provide incremental downside risk mitigation on the way down.
Most of the hedge runs out to the end of the year. While it’s possible that the events of the next few months could prompt some shifts, Pars said it’s conceivable that the positioning will continue through December and roll forward into 2021.
“An important takeaway about our current environment,” Hill said, “is that it’s temporary—and because of our flexibility and the opportunistic nature of managing this fund—we’ll be there to take advantage of it when it reverses.”
In fact, a reversal has already started, according to Hill.
“One way to gauge the relative level/value of implied volatility or option pricing is to look at the dispersion between actual realized volatility and option implied volatility. At the beginning of September, with the market at all-time highs, we saw 10-day realized historical S&P volatility in the single digits with one-two month implieds in the high teens.
“This has since crossed back over with historic realized vol around 30 and implieds in the mid 20s. So, the landscape has already started to normalize a bit after the recent pullback off our September 2 highs,” Hill noted.
Investment professionals, for more information about CIHEX and the opportunities ahead, please contact your Calamos Investment Consultant at 888-571-2567 or email@example.com.
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Important Risk Information. An investment in the Fund(s) is subject to risks, and you could lose money on your investment in the Fund(s). There can be no assurance that the Fund(s) will achieve its investment objective. Your investment in the Fund(s) is not a deposit in a bank and is not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. The risks associated with an investment in the Fund(s) can increase during times of significant market volatility. The Fund(s) also has specific principal risks, which are described below. More detailed information regarding these risks can be found in the Fund's prospectus.
The principal risks of investing the Calamos Hedged Equity Fund include: covered call writing risk, options risk (see definition below), equity securities risk, correlation risk, mid-sized company risk, interest rate risk, credit risk, liquidity risk, portfolio turnover risk, portfolio selection risk, foreign securities risk, American depository receipts, and REITs risks.
The S&P 500 Index is generally considered representative of the U.S. stock market.
Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.
A put spread is an option spread strategy that is created when equal number of put options are bought and sold simultaneously.
Out of the money means that an option has no intrinsic value, only extrinsic value.
The VIX Index, created by the Chicago Board Options Exchange, is a calculation designed to produce a measure of constant, 30-day expected volatility of the U.S. stock market, derived from real-time, mid-quote prices of S&P 500® Index (SPXSM) call and put options. It is one of the most recognized measures of volatility.
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