What to do with FCI? The on again, off again love affair with the diversified option seller has pushed back into off again territory over the last week, as the sharp moves in Crude Oil, Bonds, and Gold have pushed the popular OSS program down approximately -45% from its recent highs and CPP -18%.
While painful, this isn’t new territory for FCI – and as callous as it may sound – is to be expected from their type of strategy given the sharp increase in volatility we’ve seen over the past few days. As an option seller, FCI bets against the very thing happening right now. They bet against outlier moves happening across asset classes at the same time.
To see this graphically, take a look at the volatility indexes of Gold and Crude Oil per the CME below. Gold’s volatility has spiked about 40%, while Crude’s is up over 100% since the beginning of July. It’s hard to expect a program which is selling this volatility to do much better given the circumstances.
The question investors in the program have right now, however, is not, how did we get here….but where do we go from here?
In looking at where they go from here – we’ll take a peak backwards to similar volatility spikes, the drawdowns they caused, and time to recovery:
|Date||DD Amount||Time to Recover|
Those are month end drawdowns, not intramonth – where the 2008 DD may have been more like -50% during some of the intraday lows experienced. But you can still see quite plainly that FCI has been down this road before, for better or worse – and come out on the other side eventually [Past performance is not necessarily indicative of future results].
We don’t know where their drawdown will stand by the end of August (it is only the 10th day…), but several signs show to FCI’s ability to claw back some of the losses by the end of the month. One, time is on their side. Each day they survive is a day closer to expiration, which can lower the price of the option. Two, they have approximately -25% of the -45% in losses still in open trades on OSS and roughly 75% still open on CPP – meaning the best case scenario for them is to end the month at down -35% (better result than -45%) on OSS and -4.5% on CPP (much better than -18%). The amount they can earn back from current positions isn’t equal to the loss because they have exited the bond position already and locked in those losses.
And while the magnitude of this loss is similar to past losses during volatility spikes, they have actually performed better, in our opinion, during this volatility spike than previous ones. In particular, the CPP program, which is designed to operate on a fixed risk per trade via “credit spreads” has had the ability to hold on to its current trades and even eliminated much of the current risk in markets like bonds and gold (until the expiration dates where they may be forced to exit exercised trades).
From that experience, they sharpened their models and now do two things differently. One, they don’t chase markets, meaning if a trade is stopped out, they don’t try and reengage that market right away to capture the premium back – they wait for the next opportunity. Two, they now trigger loss controls upon the price of the option they sold eclipsing 5 times the premium they received.
Unfortunately, given the speed at which these markets are moving, the exit price on some of their positions resulted in losses beyond that 5x level. Is this poor management on FCI’s part, or an unlucky result? We tend to think the latter, and are reminded of one of the investment tenets of one of our favorite bloggers – Barry Ritholtz – who says to focus on process, not outcome.
I want to be focused on creating a reproducible methodology, regardless of luck or misfortune in any given quarter. Investing is a probabilistic process, and performance can slip for a quarter or wo even when the manager is doing everything right.
In this case, FCI has followed their process, yet not gotten the desired outcome. We would much rather be invested in such a manager, as painful as it is right now, versus one who had a good outcome, yet no process (or a lucky process). The former is repeatable- the latter an unknown.
So – while it looks pretty bad for FCI right about now, the losses are well within their historical norms and above our ‘line in the sand’ for the program where we would recommend stopping. They bet against volatility for a living, and every so often will be on the wrong side of that bet. How well they contain losses in that scenario and how well they do coming off the spike are the measure of the manager.
FCI exhibits the classic option seller profile – of 1 step forward, 1 step forward, 1 step forward, 1 step forward, 1 step forward, 1 step forward… then 3, 4, or even 5 steps backwards in one move. We’ve just come through the backwards move, and look now to see how many they can string together moving forwards.