Investing in corporate bonds may not be optimal compared to alternative portfolios due to negative alpha after accounting for risk factors.
The timing of rebalancing can significantly impact the performance of the put spread collar strategy, with returns varying by as much as 1% annually.
Options tend to be expensive compared to their fair value, but a well-constructed volatility risk premium strategy can provide positive returns and effective downside risk management.
Deep dives
Corporate Bond Risk and Return Profile
The research examines the risk and return attributes of corporate bonds. The study finds that corporate bonds have exposure to factors such as equity volatility risk premium and bond volatility risk premium. However, the alpha of corporate bonds is negative after accounting for these factors, suggesting that investing in corporate bonds may not be optimal compared to alternative portfolios. By constructing portfolios that focus on the positively compensated risk premiums and excluding those that are uncompensated or negatively compensated, investors can achieve higher returns and lower volatility.
Rebalance Timing Luck in Put Spread Collar Strategy
The research explores the impact of rebalance timing luck in the put spread collar strategy. The study reveals a considerable variation in performance and peak-to-trough drawdowns depending on the timing of the rebalance. The difference in returns between the best and worst performing tranches of this strategy can be as much as 1% annually. The findings highlight the importance of understanding the impact of arbitrary decisions, such as rebalance timing, when implementing strategies like the put spread collar.
Volatility Risk Premium in Options Strategies
The research delves into the concept of the volatility risk premium in options strategies. It emphasizes that options tend to be expensive relative to their actuarial fair value and suggests that investors can capture the volatility risk premium by implementing specific option strategies. While acknowledging the potential risks and left tail events associated with volatility exposure, the paper highlights that a well-constructed volatility risk premium strategy can provide positive returns and effective downside risk management.
Decomposition of Corporate Bond Returns
The research focuses on the decomposition of the risk and return attributes of corporate bonds. It reveals that corporate bonds have exposure to various factors, including equity risk, bond volatility, and systematic volatility. The findings indicate that these exposures contribute to the negative alpha of corporate bonds, suggesting that investing in corporate bonds may not be as beneficial compared to alternative portfolios that selectively target positively compensated risk factors.
Customized Portfolio Solutions at Endeavor
The podcast also highlights the portfolio construction and optimization services provided by Endeavor. The firm specializes in delivering highly customized portfolio solutions to clients based on their unique goals, cash flow needs, and growth objectives. By leveraging academic research, technology, and tax efficiency, Endeavor aims to tailor portfolios that offer a balance between cash flow security and portfolio growth, while maximizing personalization and control for clients.
The hedge that carries positively but delivers convex returns during a market panic is about as elusive as our lawmakers coming together in bipartisan fashion. As head of option strategies at AQR, Roni Israelov not only confirmed this but saw in the empirical data distinctly unpromising results for hedging strategies that utilized put options.
Trained with a PhD in Financial Economics from Carnegie Mellon, Roni has spent his career researching complex topics in markets. We explore his paper “Pathetic Protection” and the challenges that arise from paying option premium to reduce risk. Roni sites the path dependency of options as introducing sometimes significant variability in the effectiveness of a program. He also sites the equity risk premium and the vol risk premium as headwinds for success.
Our conversation shifts to another interesting topic, “rebalance timing luck”, work that Roni has done in collaboration with Newfound Research. The finding - that the performance of mechanically rebalanced strategies – can rest heavily on the date of rebalance, is especially the case for option strategies like the giant put spread collar on the SPX that is rolled each quarter.
Roni is now the President and CIO of NDVR, a firm providing optimized portfolio solutions to individuals, using academic research, technology and tax efficiency. I hope you enjoy this episode of the Alpha Exchange, my conversation with Roni Israelov.
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