If you run a portfolio (no matter what you trade) the most important question you need to ask yourself is "in what situation this portfolio blows up?)

I recently took some time off the market, and besides doing a lot of housework and renovation I ran complete scenario analysis,
backtest, and stress test to my portfolio.

We tend to think that we know our strategies in-and-out and we know that in scenario X the performance will be x1 and in scenario Y the performance will be y1, but we tend to neglect the crucial part of cross effect
of the individual strategies on our entire portfolio:
1. Are there correlated strategies (either positively or negatively) ?
2. How are the greeks on the portfolio level move with respect to spot/vol? are we happy with our gamma/vega at X% move? should we mitigate some of that?
3. How did our strategies (and overall portfolio) performed in major/extreme events like GFC, European debt crisis, Taper tantrum, Volmageddon, March 2020?

4. Assuming hypothetical break in historical correlation, how will our portfolio perform?
Obviously there are many unknowns here that we need to make assumptions and simulate, but understanding the pitfalls of our strategies is the key to keep our returns steady and have very few surprises in our day-to-day trading activity...
Any quant/trader that will say his/her model/strategy is bulletproof either lies and don't understand their own strategy to perfection.. took me years to realize that the only bulletproof strategy is a pure arbitrage..
Obviously sound portfolio construction art as much as it is science, but my experience has taught me that diversifying my exposures so that a single exposure will not exceed 20% of my total risk can go a long way in keeping my returns steady will relatively small drawdowns..

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More from @VolQuant

22 Mar
Let's talk FX funding..

Today's move in $TRY is a great opportunity to talk about a rather niche segment of FX trading which is the funding cost..

Generally speaking, when we trade any FX spot (buy CCYx/ sell CCYz) the trade settles in T+2 days (except TRY and CAD who are T+1)
So if we want to keep the trade alive we need to roll the trade forward. When we roll the trade we basically borrow in CCYz and lend in CCYx. If we borrow at a lower rate and lend in a higher rate we will earn the carry (and vice versa...)
In EM, in addition to the rate differential between the key rates the market prices in additional basis in most currencies to reflect the funding risk premium of these market.

Low risk EM (CZK, ILS, PLN, CNH) will price a moderate, while premium, while market like ZAR , TRY
Read 7 tweets
15 Mar
1/n

Let's talk Realized Vol...

If there is one single most important number that we, as volatility traders, look at, it's realized vol.

The problem with realized vol is that it's one of the most biased estimators... Give two traders identical time-series and get 4 RVs
2/n

The reason this estimator is so biased is because it's highly sensitive to both sampling frequency and size (window).

Also, we can get very different result if we sample based on close-close or OHLC (open-high-low-close).

medium.com/swlh/the-reali…
3/n

So why do we use such a biased estimator, as it tends to over/underestimate the "true" realized volatility in most cases?

Over the years I came to a realization that although possible to come up with an unbiased realized variance estimator

aip.scitation.org/doi/abs/10.106…
Read 7 tweets
25 Feb
1/n

A shift in volatility/correlation regime has been boiling beneath the surface over the last few weeks, and while many are solely focused on one market segment, my mandate of cross-asset volatility comes in handy watching this situation unfolds
2/n

Let's start by stating the obvious - the narrative right now is driven by the steepening of the yield curve (led by the selloff in long-end bonds). I will not make any argument whether this is justified or not, as I'm a very bad macro trader, but this steepening governs
3/n

the market dynamic for two reasons: 1. it correlates to forward inflation expectations (some reflexive dynamic is definitely going on there), 2. it accelerates the rotation trade in equities (and overweight growth stocks).
Read 8 tweets
19 Feb
Gamma-Theta-Vol triangle

The entire concept of volatility trading can be simplified into a triangular relationship between Vol-Gamma-Theta.

Although it might seems oversimplifying a rather complex dynamic of option trading, your realized pnl will be determined by that triangle
Let's understand how this three-way relation affects your option trading pnl...

We know that volatility determines the cost of the option, so to have a profitable option strategy we first need to be on the right side of the trade (buying cheap vol, and selling rich vol), but
once we traded the option we enter the gamma-theta phase of running the day-to-day risk of our strategy...

Our premiums (paid or received) are given at inception, and we can think of the option premium as a series of T interval straddle breakeven, so to be profitable we need
Read 8 tweets
15 Feb
What drives the $EUR?
cc @o_wutang

FX risk-on/risk-off drivers might be misleading when it comes to $EUR. While long-lasting correlations (such as the JPY,CHF/risk-off) might play role in FX drivers, the EUR correlation is probably the biggest misconception
practitioners have. imo EUR drivers are more funding related than risk-on/risk-off (if anything it's negatively correlated to equities, or positively correlated to vstoxx/vix movements).

The root of this misconception lies in the fact that traders/investors have a long
memory, and remember how EUR behaved after the GFC and through the sovereign credit crisis.

Since then, both the ECB and the European Council have done a lot to safeguard the EU (or at least kicking the can down the road), so the EUR became less risky currency
Read 5 tweets
13 Feb
Crash Course in Risk Management

My affair with quant finance began back in 2007. Back then I was a BA student who just started his first steps in the derivatives market. Needless to say that I was about to witness a defining moment in financial markets, as the GFC was just
around the corner. In 2008 I was already in my transition from the pricing side to the trading side. Although I always thought I will end up being a risk manager, my career was stirred toward trading.

I started trading (not officially though) two weeks before Lehman went
under. That period was crazy, but not because of market volatility, but because we were witnessing something that was unthinkable - banks that are unwilling to trade with each other (and betting on their peers to go under).

To understand financial markets we need to look beyond
Read 5 tweets

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