Thread by @dampedspring

How the JHEQX roll works 101. I am writing this because I want to bookmark it so I can copy the link to those who think the roll has no market impact because "It's traded delta neutral" While this is 💯 true that the other side of the JHEQX collar is handed a delta neutral trade

That doesn't mean that @JPMorganAM doesn't have market impact in setting up the trade.

There are two possible states to consider regarding the old collar at expiration and one corner case state that I won't clutter this thread discussing

The old collar can have a delta of 100% (like it will if the SPX is here on the roll date of dec 31st or it can have a delta or 0% if the SPX is say 4350.

The counter parties for JPM delta hedge the collar for its life. However JHEQX fund sets the collar and forgets and never delta hedges it. It provides protection for the fund shareholders as specifically outlined in its prospectus.

So let set up the trade assuming current SPX

JHEQX has their normal actively managed portfolio of stocks and the expiring collar which will have a cash settlement to its providers of 4712 (today's spot-4450 the dec 31 strike)

After the roll JHEQX will have their same portfolio and the new collar

Before the roll dealers will have a deep ITM call and 100% short futures. After the rolls they will have a new collar and be short the new collar delta of 58% futures. That it.

The question that this begs is who bought the 42% futures to deliver to the hedge providers. Someone must have because we know what the initial state and final state of both counter parties is and there is a 42% buy missing

Let's look at what the hedge providers actually get. On the roll. The old call is bought by JHEQX and sold by the dealers. The new call is sold by JHEQX and bought by the dealers. The problem is that the dealers are still short futures too many futures

So JHEQX will also sell them a one day call that is deep in the money. In practice they actually can buy back less of the old call by doing this the dealers position is now short 100% futures. Long new call structure and long 42% of the original call which expires on the close

They are hedged. Technically there is a MOC buy in order to replace the 42% call that expires. That needs to be done with a cash basket and then that cash basket gets the EFP'd Exchanged for Physical to end up with futures that covers 42% but I am sure your eyes glazed over

Just focus on the MOC buy. If that MOC buy did not have an offset in that would create an 8BN buy and that would have a huge impact. That impact would be felt by JHEQX because they remain short the 42% old call which would rip in price

So how do they handle that. Well they sell 42% MOC and do the whole EFP to futures. No muss no fuss. No MOC Market impact. Somehow Jelly rolls can be involved on all this MOC/EFP stuff and I don't mean the dessert but I digress

But wait now JHEQX has the active portfolio the new collar (which is what they want) and are short 42% futures that they don't want

The Hedge providers are set and JPM is short.

What does JPM do about this short. The guys there Ham Reiner in particular the PM are seasoned derivatives specialist and portfolio managers. They know they want to do the roll as cheaply as possible from both setting the roll and managing this short delta they end up with.

To minimize the roll costs they provide a delta neutral structure. To minimize the flattening of their delta they start buying ahead of the trade and spread out the impact. This is a trivial exercise in general and is table stakes for any professional money manager. However,

The roll has become extremely visible and the shear size of both the options trades and the liquidity demand for them and the rehedging to get everyone flat what they want is highly followed by a bunch of the sharkiest players in the business

We know what Ham has to do but we also can't be sure of timing exactly. But I must say the shear size of the delta is extremely bad design in part because of the success of the fund. But every quarter either 42% of the funds AUM gets bought over a day or two or 58% gets sold

That means that just to follow their strategy the fund investors pay transaction costs of 200% fund turnover in a year that has nothing to do with beta or alpha but is just a sunk cost.

Really stupid design. But for all of us pure alpha. If call ITM big buy at end of month. Get ahead of it sell as it finishes in easy peasy. If Call OTM an even bigger sell over two days. Hint hint the call was OTM in September and @JPMorganAM essentially caused the low

So Ham manages his delta in the last few days of every month. If well above 4450 he's got to buy 8BN in the illiquid mid holiday end of year market.

The corner case is when the index is at one of the three collar strikes at expiration and damn. That is good times if it happens. Which it essentially did for a bit in September. December looks calm for now and a massive buy is your post Christmas present