Ansbacher Investment Management (AIM), the general partner of ELIZAVILLE PARTNERS LP, engages in a program of selling (or writing) out-of-the-money (OTM) put options on S&P 500 futures and Delta hedging the puts with short S&P futures contracts. Additionally, the strategy vega hedges with VIX Futures.
U.S. equity index options have been consistently overpriced relative to the realized behavior of the underlying index. That is to say, Implied Volatility (a major determinant of option pricing) has exceeded the Realized Volatility of the underlying investment. This is due, in part, to the widespread and ingrained practice of purchasing out-of-the-money (OTM) index puts for portfolio insurance. As with most forms of insurance, OTM index put buyers want to have their policy expire without being exercised; and put writers can demand a premium for assuming risk. The huge growth in indexed investments represents a very large supply of natural put buyers, while there are a much smaller number of uncovered put sellers.
AIM currently uses a unique, methodical approach, incorporating the manager's discretion and judgment, to trading the put skew in the S&P 500 options. This methodology, first instituted in January 2003, is market-neutral in terms of portfolio delta and gamma risk. The implementation of this program, i.e., selecting how many puts to sell and at which prices and maturities, as well as how many short futures to use as a hedge, relies upon a robust risk management program which includes, but is not confined to: limiting the number of puts that can be written and gross position Delta, and 24-hour stop-loss orders in place through the S&P futures. In addition, trading is reduced or halted if the fund loses more than a certain percentage of its value. The manager of the fund utilizes a wide variety of quantitative, fundamental, and technical information to make his trading decisions.