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Tail protection for long investors: Trend convexity at work

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  • Tung-Lam Dao
  • Trung-Tu Nguyen
  • Cyril Deremble
  • Yves Lemp'eri`ere
  • Jean-Philippe Bouchaud
  • Marc Potters

Abstract

The performance of trend following strategies can be ascribed to the difference between long-term and short-term realized variance. We revisit this general result and show that it holds for various definitions of trend strategies. This explains the positive convexity of the aggregate performance of Commodity Trading Advisors (CTAs) which -- when adequately measured -- turns out to be much stronger than anticipated. We also highlight interesting connections with so-called Risk Parity portfolios. Finally, we propose a new portfolio of strangle options that provides a pure exposure to the long-term variance of the underlying, offering yet another viewpoint on the link between trend and volatility.

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  • Tung-Lam Dao & Trung-Tu Nguyen & Cyril Deremble & Yves Lemp'eri`ere & Jean-Philippe Bouchaud & Marc Potters, 2016. "Tail protection for long investors: Trend convexity at work," Papers 1607.02410, arXiv.org.
    • Handle: RePEc:arx:papers:1607.02410
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    File URL: http://arxiv.org/pdf/1607.02410
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    References listed on IDEAS

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    1. Clare, Andrew & Seaton, James & Smith, Peter N. & Thomas, Stephen, 2014. "Trend following, risk parity and momentum in commodity futures," International Review of Financial Analysis, Elsevier, vol. 31(C), pages 1-12.
    2. Roncalli, Thierry, 2013. "Introduction to Risk Parity and Budgeting," MPRA Paper 47679, University Library of Munich, Germany.
    3. Y. Lemp'eri`ere & C. Deremble & P. Seager & M. Potters & J. P. Bouchaud, 2014. "Two centuries of trend following," Papers 1404.3274, arXiv.org.
    4. Ian Martin, 2011. "Simple Variance Swaps," NBER Working Papers 16884, National Bureau of Economic Research, Inc.
    5. Lorenzo Cornalba & Jean-Philippe Bouchaud & Marc Potters, 2002. "Option Pricing And Hedging With Temporal Correlations," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 5(03), pages 307-320.
    6. Fung, William & Hsieh, David A, 2001. "The Risk in Hedge Fund Strategies: Theory and Evidence from Trend Followers," The Review of Financial Studies, Society for Financial Studies, vol. 14(2), pages 313-341.
    7. Fung, William & Hsieh, David A, 1997. "Empirical Characteristics of Dynamic Trading Strategies: The Case of Hedge Funds," The Review of Financial Studies, Society for Financial Studies, vol. 10(2), pages 275-302.
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    Cited by:

    1. Richard J. Martin, 2021. "Design and analysis of momentum trading strategies," Papers 2101.01006, arXiv.org, revised Jan 2023.

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