In 2016 Pension Funds Started Selling Market Puts, Then Last Week Everything Went Wrong

As pension funds and endowments struggled to find yield during an unrewarding decade of historically low rates, several major institutions began dabbling in complicated (and not so complicated) options contracts in order to take advantage of the unusually long period of low volatility since the 2009 lows. In fact, until last Monday, the S&P 500 had gone 404 consecutive trading days without a 5% correction - the longest such streak in nearly 60 years. 

And with what appears to be the return of whipsaw action - as anyone who rode out last week's 97% drop in XIV and record surge in the VIX can confirm..

... bets on low volatility are beginning to look problematic - as the risk of an unwind threatens to derail the 7-8% annual returns required by pensions to meet obligations. 

As we first noted in February 2016, institutions began quietly generating so-called current income by selling market puts as stocks charged ever-higher - the proverbial collection of pennies in front of a steamroller strategy - with such popular names as the Harvard Endowment and state pensions funds for the State of Hawaii and Illinois among the most bizarre offenders.

Overnight, the WSJ reminded  us of this idiotic "strategy":

The $16.9 billion Hawaii fund in 2016 began earning money selling “put” options—essentially a bet that markets would stay calm or rise. When markets fall, Hawaii is on the hook to pay out.

To that end, an increasing number of Wall Street firms have been specializing in volatility-linked strategies for pension funds and other large investors. As an example, Neuberger Berman's U.S. Equity Index PutWrite Strategy is one such product which sells puts on stock indexes.

It wasn't just S&P puts.

“There’s a tsunami of money going into” these types of strategies, said Don Dale, a managing member of consultant Equity Risk Control Group. The firm advises large pension funds and endowments.

Pension funds, endowments and family offices took other steps, including selling VIX futures and options, selling options on the S&P 500 or other indexes and selling options on individual shares or other indexes.

In some cases, pension funds were even long inverse VIX; and last Monday they suffered a loss greater than 90% in one day.

In a document prepared for an Illinois pension, the firm argued that behavioral biases in financial markets mean investors “ultimately overpay for protection.” The Neuberger Berman options products have attracted about $3 billion over the past two years.

"But the strategy suffers losses when stocks fall," The Journal "explains" without an ounce of sarcasm. "So far this month, the fund has lost 4.37%, through Feb 12, though that tops a loss of 4.52% for its benchmark, a mix of puts on stock indexes and compares with a 5.90% loss for the S&P 500 through that date."

Neuberger's not worried though. “The efficacy of these strategies manifests itself over months and quarters,” said Doug Kramer, who oversees the PutWrite strategy. “Everything’s functioning as designed. We’re happy to have higher volatility and be able to underwrite higher option premiums.”

That said, as the chart below illustrates, bets on low volatility - estimated by Alberto Gallo, a portfolio manager at Algebris Investments in London, to be over $500 billion, and by Fasanara Capital to be as much as $22 trillion, may leave quite the mark as markets grapple with "exciting" returns that saw the Dow Jones travel more than 22,000 cumulative points last week when you add up each day's trading range:

It's what happens when volatility is unleashed that is the greatest risk: "Our fear is when these strategies unwind,” said Algebris' Gallo.

Last week's we got a preview of just that.

* * *

Meanwhile, whether due to prudent asset management or blind luck, Harvard University appears to have been spooked out of a bet against volatility - as the Harvard Management Co. sold 121,000 shares of the ProShares Short VIX fund SVXY before the end of 2017 - after holding it just one quarter. (they notably also sold out of HYG, the infamous junk bond ETF which is next to blow up after the market's next mini crash).

Perhaps last November's 5% drawdown in two weeks was a bit too spicy for crimson portfolio managers:

With central banks gradually withdrawing their financial safety nets and interest rates looking like they're on the cusp of another march higher - volatility may be back for a while, and with it, a $500 billion (or much higher) unwind of low-volatility strategies that would make last week's "historic" Dow crash seem like a dress rehearsal.

As with most "great" strategies, it works until it doesn't. 

For now, however, it's clear that nobody has learned any lesson.

As we first reported over the weekend , the ProShares Short VIX fund, which posted a 97% drop in net asset value last week from its high price in January, has since rebounded. On Tuesday, it closed at $11.29, up from a low of $9.58 on Feb. 8, and its market value is now nearly $800 million, up from $300 million just last week.

“People are jumping back into this product again,” said Pav Sethi, chief investment officer of Gladius Capital Management, an investment firm focused on volatility strategies, “despite the clear structural risks."

Of course, with central banks now "certain" to bail out the market after even a modest 10% correction, can anyone blame them?


chubbar Arrowflinger Thu, 02/15/2018 - 21:07 Permalink

OK, does anyone else think this is just pure gambling? How the fuck does a pension fund manager get away with that type of investment strategy, which basically is nothing more than a bet that nothing rattles the market? This is about as irresponsible as going down to a roulette table. If I was a pensioner who lost his pension because a manager pulled this shit I'd go postal on him and his family. What fucking assholes.

In reply to by Arrowflinger

glenlloyd shuckster Fri, 02/16/2018 - 00:28 Permalink

Precisely. It's hard to fault them for trying to find income in the Fed suppression environment. If the Fed hadn't intervened a decade ago things would have repaired themselves by now and all the people who made bad bets back then would have gone belly up.

But those who did hold hugely bad bets were, via the good graces of the fed, able to offload them and avoid the consequences.

Companies, like Principal Financial, who was heavily into CMBS back in the early days of the crisis, was graciously allowed to unload all those poor choices and avoid going under.

Some people made out like bandits...others not so lucky.

This all comes down to changing the rules of the game during the game itself. I would be pissed as hell if someone stepped in and protected some groups, which prevents an investment strategy that I believed in from paying off.

In reply to by shuckster

zebra77a glenlloyd Fri, 02/16/2018 - 02:54 Permalink

Selling puts is generically brilliant as long as you position the strike on the edge of the liquidity pool and buy them back one day before expiry so they can never be assigned. The OCC HATES it when they have to share the profits.

Lots of people living millionaire lives by selling Wednesday puts then buying back on the Thursday. And avoiding weeks where the FOMC creates volitilty.

Eventually the OCC decides to clean out the premium seller pool so it hammers vix to the moon on zero news just to take back the pot. They will never do this until the naked shorts are out of the way aka (nobody is buying puts)

All you have to remember is the OCC moves the price of the underlying for maximum pain. If  everyone is short they will raise the price. if everyone is selling short they drop it. 

it looks interesting that people are starting to spoof option algos to their advantage as the OCC will move the table from a potential bid. To shake them back off expect huge volatilty spikes.

Vix is always double topped to burn repeat shorts. Study vix it shows the hand..

In reply to by glenlloyd

rockstone chubbar Fri, 02/16/2018 - 00:54 Permalink

It was either that or you lose your pension because it’s a broken down Ponzi scheme to begin with. You have virtually nothing at risk. So...why not? Any of the above mention funds are akin to sitting on the Vegas strip with $8 bucks and no way home. Might as well play the $8 bucks the hardest, fastest way you can. Nickle slots ain’t going to do it.

Much like a pension plan, you’re fucked anyway.



In reply to by chubbar

hawaiian waverider Arrowflinger Thu, 02/15/2018 - 21:43 Permalink

When that news came out that our fine state ERS was deploying that strategy I told all that would listen that it was going to blow up spectacularly. 

Hawaii state employees vs. UBS et. al. Hawaii will always come out on the wrong end.  Our state got taken down hard by the floating rate debacle as well.  When will these dipshits in government learn that they aren't ever going to come out ahead vs. large brokerage firms err.. banks.

In reply to by Arrowflinger

Lore Thu, 02/15/2018 - 20:48 Permalink

Doug Kramer: "Everything's functioning as designed." 

Traffic cop standing in front of gory multi-vehicle pileup: "Nothing to see here, folks."

oddjob Thu, 02/15/2018 - 20:56 Permalink

Back in the day I sold some $15 puts on Golden Minerals for $2.75, I bought them back for $11.25. Only 20 contracts, but fuck did that hurt.

Manipuflation Thu, 02/15/2018 - 21:15 Permalink

My Crimean Russian guy finally brought me some coins from Russia most of which I have but the problom is that they have been cleaned and poorly so.  These are all metal detector finds.  The one I am most interested in(1924 20 kopek) is the worst example of cleaning that I have ever seen.  I have a good example of one of those.  I guess I might as well clean it the rest of the way properly if there is such a thing.  Russians like to clean coins that they find.  I would leave it alone as it is but they never document where they found the coins so that the story can be told.  Maybe that IS the story?  The rest is all Imperial and that is common.

That's cool though that he thought to buy and bring them for me.  It make you wonder who lost 20 kopecks back in 1924 because that is a more scarce coin and date.  Who dropped it I wonder?  20 kopecks back then would get you a good meal.

Scuba Steve Thu, 02/15/2018 - 21:33 Permalink

How is writing Puts a "bad" strategy if you write far out of the money Puts on companies you'd like to put in portfolio ... and then Sell calls on the portfolio?

It reduces cost basis in worst case scenario and getting premium on both ends of writings.

Whats all the hub bub, bub? caveat being writing Puts on ghost products of course.

hawaiian waverider Scuba Steve Thu, 02/15/2018 - 21:50 Permalink

when you're short puts, and they come in the money and you don't have the funds to buy what you didn't ever think you would have to buy.  It works well.. until it doesn't.  There are numerous stories of put sellers getting cleaned out after years of harvesting premium.  Happens every cycle.  Are you the next story?  Study the past.  What is thought of far out of the money can be in the money in a blink of an eye.  Best of luck.  

In reply to by Scuba Steve

Scuba Steve hawaiian waverider Thu, 02/15/2018 - 23:12 Permalink

Only because they looked at the premiums and not the companies themselves, purely technical instead of a bigger plan. jmo.

If you start far out of the money on companies youd like to own, selling premium

is a great tool.

The only reason this is even a question is because of the gyrations in manipulated volatility by the bank algos currently going on. jmo.

Sell the option premium to buy the physical PMs is how I ride.


In reply to by hawaiian waverider

Manipuflation Thu, 02/15/2018 - 22:20 Permalink

Hah, my guy in Crimea is full of shit.  Every coin he gave me is faked.  It only took a few minutes to figure it out and didn't have to even use the loupe.  I didn't pay anything for that tourist shit.  Pretty interesting that they bother to fake some of the dates they do.  At least I have some fakes to compare and contrast.  Metal detector finds my ass!LOL  

I told Mrs. M that her Ukrainian buddies were disingenuous and not reliable.  Now she is sitting there trying to figure out how I know it is fake.  If you buy a coin from me you will know that it is the genuine article.  I really hate people that try to fake coins. 

Cutter Thu, 02/15/2018 - 22:35 Permalink

Why do these pension funds pay these so called "advisors" so much, when they come up with insane ideas like selling VIX puts--sounds like they might even be naked--on a market that has gone straight up for ten years?

Why not just pick out a construction guy flagging traffic, he would most certainly have better ideas than this.

Nelbev Thu, 02/15/2018 - 22:37 Permalink

Tyler, you write too fast ... need edit
"As we first reported over the weekend , the ProShares Short VIX fund, which posted a 97% drop in net asset value last week .."

NO, that was Credit Suisse on ETF XIV imploding 97%, not Proshares SVXY Short Vix.  It did fall, but not as much, and was not "reported" prior, and rebounded good from lows last week.  Ah dah, drink more coffee or read own columns.

The pensions funds are so underfunded, so what is a bit more before SHTF and they cannot pay retirees?, and state and local worse than private, PBGT the next FDIC/S&L bailout down road.

LeftandRightareWrong Thu, 02/15/2018 - 23:16 Permalink

Stupid article.  Accept assignment, collect the divy, sell calls. Or roll the puts out and down until they expire with a profit.  Rinse and repeat. Unless you think the S&P is going to near zero in which case the game is over for all anyway.

Rex Andrus Fri, 02/16/2018 - 02:28 Permalink

The pension plan is to make sure only your cronies survive to collect their pensions, while you skim the rest. Same racket as the "basket of IOUs" that is SSI.

Check out the USPS. Now there's a racket.