Simplicity Is The Ultimate Sophistication

MDP was established in 2020 with the aim of becoming a trusted partner for portfolio managers in the often-opaque world of financial derivatives. Options markets, our area of expertise, are currently awash in overly complicated hedging strategies, many of which are brilliant in theory but inefficient in execution.

Like the great Leonardo Da Vinci, we believe that “simplicity is the ultimate sophistication.”

Our strategy uses liquid options to achieve an equity-like return with lower volatility, allowing investors to confidently stay in the market during the most uncertain of times. In this blog we’ll outline what distinguishes our product from our competition in the hedged equity space.  

Similar to novice chefs who strive to impress their patrons with novel and complex combinations of obscure ingredients, overly confident portfolio managers often get out over their skis when venturing into tail risk hedging or trading volatility. This naiveté was on full display in options markets during 2022’s broad-based market selloff. In our view, volatility is not an asset class, and options should be used as tools to manage specific concerns in portfolios. To put it another way, if you don’t own any stocks, you don’t need any puts! 

Our proprietary strategy, which we liken to “owning equities with guardrails,” adjusts to the market volatility regime on a monthly basis. Unlike the elephant in the room, J.P. Morgan’s Hedged Equity Fund (JHEQX), we don’t believe that a one-size-fits-all solution is appropriate when it comes to employing volatility strategies, despite its seemingly simple elegance. To us, volatility is a living and breathing entity, and an optimal hedging strategy in a low volatility environment can become suboptimal if fear and uncertainty start to escalate. That said, our four-quadrant approach is disciplined, rules-based, straightforward, and in stark contrast to many “free range” volatility funds which lack transparent and consistent approaches to mitigating volatility.  

"We don’t believe that a one-size-fits-all solution is appropriate when it comes to employing volatility strategies, despite its seemingly simple elegance."

Depending on our reading of the volatility environment, we will employ one of four options strategies: Collar (13% of the time historically), Put Spread Collar (62%), Put Spread (22%), or Long Puts (3%). Our assessment of market volatility is dictated by two factors: the level of the VIX (also known as “The Fear Index”) and to a lesser extent the skew, as measured by the Credit Suisse Fear Barometer (CSFB). 

We aim to provide attractive risk-adjusted returns with low fees, daily liquidity, and limited counter-party risk. To accomplish this, we use vanilla and highly liquid options that can be easily valued in most risk systems.

Additionally, we avoid single-stock securities and exclusively utilize S&P 500-related ETFs and options to construct our portfolios. A number of unsuccessful short volatility strategies have shown to lack liquidity when it’s needed the most, as result of using either thinly-traded single-stock options or volatility (VIX) ETPs with significant embedded leverage.  

In conclusion, like the most successful French chefs who rely on the five French mother sauces (béchamel, velouté, espagnole, hollandaise, and tomato) as the building blocks for every recipe, we think options market participants searching for predictable and reliable outcomes should return to the fundamental, time-tested options strategies we employ at MDP. Simplicity, after all, is the height of sophistication.