In a May 2014, Vintage Freak said this this about the write up of the Gargoyle Hedged fund which was than a River Park Fund
"Also, you don't sell call options to nervous investors unless one is talking about investors nervous that the market will go up! You sell it to bullish investors that want to bet on the upside so you can hedge your downside as you keep the premium if the market falls or remains the same. The more you sell, less exposure to the market's upside as you have to pay the increase over the strike price + premium.
You sell put options to nervous investors as insurance who are trying to hedge their downside and so not what the fund would want to do since the fund also wants the same protection. The fund could buy put options for downside protection but then it would land up paying the premium.
The write up is a bit confusing on what they are actually doing because of the above."
The same write up is included in the Sept 2015 write up, and the same confusion exists. If they are selling calls to nervous investors, the nervous investors must be buying out of the money calls to so they can buy the index at a lower price. The more likely scenario is that a nervous investor would buy a put option to guard against a losses on his existing portfolio. I have zero experience with the options, but I don't think the explanation is clear. Anyone know for sure what the fund actually does?
Comments
In the September 2015 update, I left the description of the two portfolio sleeves alone since they haven't changed and I thought they were reasonably clear. The most substantial parts of the rewrite were my attempt to explain that the options part of the portfolio does not transform this into a low-vol / market neutral fund. The managers believe in value investing and have construct a reasonably risky portfolio of value stocks. If in the short-term those stocks go down, the fund goes down. The effect of the options is to generate income which partially offsets the downside; the best explanation I've got is that the long portfolio + options should decrease in value less than the long portfolio alone would.
I understand that the options strategy is complicated, all the more so become there are many types of options. The shortest explanation for what exact the Gargoyle folks do comes from their website: "The long portfolio is complemented by a highly-correlated short portfolio of relatively overpriced near-term call options on various equity indices." If you're interested in the under-the-hood part, that is, the detailed description of the function of the various sorts of options, you might read the Equity Options Primer. If you Google the phrase "selling options to reduce portfolio volatility," you'll find explanations from Russell, JP Morgan, Eaton Vance and BlackRock that all attempt to explain, and occasionally quantify the effects of, the strategy.
There is a buy-write index (BXM) that's tradable. If you go to the CBOE's microsite for the buy-write index, you'll find links to the research on the strategy. The shortest version is this: a passive S&P 500 buy-write strategy is about 30% less volatile than the S&P 500 but, over the long term, returns just a bit more than the S&P. As a result, its various risk-return measures are significantly higher than a long-only portfolio's.
For what that's worth,
David
Thanks for the references. I was actually thinking about the fund and the write up you did while I was out walking this morning. I rationalized a scenario which would fit the selling call options and being a nervous investor. Here is how the element comes in to play. Lets say I'm a nervous investor who wants to buy an index fund, but I'm nervous about buying at the current price. I might buy call options at a price lower than the current index ( an out of the money call ). If the price of the index drops enough, I will be able to buy the index at a price that is lower than the current market price even after accounting for the price that I paid for the call option(s). Gargoyle will get to keep the option premium if the price doesn't drop enough for the call buyer which is where they pick up the monthly income. Maybe this what Gargoyle does.