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Market Volatility Presents Opportunity for CTAs

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  • Market Commentary

Over the past few months volatility has steadily increased across the board in everything from equities to energies. Long term investors have enjoyed a slow and steady rise in equities over the past several years with only a hiccup here and there. When things are going well it's easy to forget that markets, and volatility, are cyclical and while you may think "this time it's different", it's really not.  As we briefly saw in October and again over the last few weeks, it doesn't  take much to bring fear back to the markets.  Long term investors generally cringe when volatility rises, but there is a group that typically welcomes this volatility - commodity trading advisors. CTAs welcome  the increased ranges in the markets because with volatility comes opportunity, in both directions.

Since the start of quantitative easing, volatility always rises after each QE period:


  VIX after QE end

 

The chart above demonstrates the spikes in volatility on each of the Fed's previous attempts to end quantitative easing.  Based on the chart, we can expect a short-term rise in volatility due to the end of QE3 in November 2014, however, since no further quantitative easing is planned, will this volatility be sustained or will it taper off the same way is has in the past?

While an expected rise in volatility may worry investors, commodity trading advisors tend to favor volatility as it presents more trading opportunities for them to generate a return for their investors.  Since a CTA's risk profile and risk parameters don't change with spikes in volatility, they get more opportunities to participate in the markets when volatility is high, and global commodities are moving back and forth with reasonable ranges. Furthermore, while spikes in volatility lead to poor performance for the S&P500 index, the same may not be true for CTAs:

Let us take a look at a year to date chart of volatility, followed by the S&P 500 cash index performance:


2014 Volatility Index

2014 VIX Chart


 2014 S&P 500 Performance

SP500 2014 Performance Chart

 

As you can see above, the two volatlity spikes in 2014, led to sharp drops in S&P 500 performance.  While the market has rebounded nicely both times, investors were nonetheless concerned while the drop was taking place.

In order to compare apples to apples, below we have 2014 performance numbers for two CTAs that strictly trade the S&P 500 futures.  As you can see, there is almost no correlation to performance OR volatility between the above charts and the performance below of these two CTAs:


  
CTA 1 and 2 Performance 2014



An everyday investor may wonder how a CTA that strictly trades the S&P500 futures can have better risk-adjusted performance in 2014 than the actual index performance? They do so by trading the daily or weekly moves of the index on a short-term basis in an effort to capture moves both long AND short,  and generating a higher sharpe ratio than the index itself (past performance is not indicative of future results).  If volatility rises, and these ranges expand, that will only lead to more opportunities for the above CTAs to participate in the market - hopefully a higher participation rate leads to a higher return!


Disclaimer: Past performance is not indicative of future results. Futures trading involves substantial risk of loss and may not be suitable for everyone. By no means is this newsletter/blog post offering any investment advice or suggesting to make any trade recommendations. Please consult an aiSource advisor prior to opening any managed futures accounts.


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Past performance is not necessarily indicative of future results. Trading commodity futures, options, and foreign exchange ("forex") involves substantial risk of loss and is not suitable for all investors. In no way is the advisor of the month a direct recommendation of aiSource or any of its affiliates. Please carefully review the disclosure documents and any other promotional material prior to investing with any program. Managed accounts and/or managed futures are very risky and may not be suitable for all investors. Please consult with a Managed Futures specialists prior to investing.