ther Analytics

Gaviota VII Strategy

Quantitative Long Short Equity Options

ther Analytics Gaviota VII Options Strategy

Gaviota VII Options Strategy
Abstract: A strategy of systematically selling rich implied volatility through the use of high probability
quantitative price inflecting points and equity options vertical credit spreads.
Characteristic

Description

Approach

Credit Spread Option Writing

Process

Quantitative - Systematic

Source of Returns

Implied Volatility Collapse Events

Signal Type

High Rank Extreme Hurst Extension Signals

Max Trade Length

20-30 days

Trade Risk

Capped Risk

This investment strategy is uncorrelated to most other investment strategies. Volatility is a form of risk premium,
higher levels of implied volatility enhance the potential returns. By combining a high probability price DELTA
quantitative signals with options volatility modeling & data mining, the strategy is able to enhance returns
compared to independently trading equity option credit spreads.
The overall portfolio positioning varies from 50% long/ 50% short, to 70%/30% or 30%/70% maximum. The goal of
keeping the portfolio slightly long bias is congruent with historical market data, we can remove the
directional risk of having to be correct in forecasting the overall stocks markets immediate trend. Rather by
only focusing on high probability 20-30 day premium rich option events where the main alpha is through a
mean reversion of option implied volatility not predicting price direction, we can seek better risk adjusted
returns in a alternative space not widely saturated by other managers or funds.

Investors should be aware that trading options involves substantial risk of loss and is not suitable for all investors. Past performance is not necessarily indicative of future results.
Past performance is not necessarily indicative of future results. There is unlimited risk of loss in selling options.

ther Analytics Gaviota VII Options Strategy

Strategy Science
The primary signaling event comes from searching over one thousand of the most liquid optionable stocks in
the US Stock Market every day for high rank ExtremeHurst price inflection points.
ExtremeHurst
ExtremeHurst is a quantitative detector of extreme investor behavior that signals the beginning or end of a
trend. Strong trendpersistent stock price movements are evidence of positive feedback (i.e., investors buying
because the price is rising, driving prices higher), while extremes of mean reversion are evidence of negative
feedback. Extremes of both trend persistency and mean reversion are quantified via multiple measurements
of the Hurst exponent. Parallax found that Hurst extremes coupled with log periodic cycling of price, are high
probability signals of the beginning or end of market trends.
ExtremeHurst signals are fully characterized by the presence of discrete scale invariance, accelerating price,
logperiodic cycles, and volume anomalies. Signals have been found to persist for up to 30 time units from the
zero point. ExtremeHurst exploits the science of nonlinear dynamics and chaos theory to identify unique and
predictive signals occurring in freely trading auction markets. There are two types of ExtremeHurst signals that
we call Extensions and Compressions. These correspond to the extreme high and low ends of the Hurst
exponent distribution.

ther Analytics Gaviota VII Options Strategy

Implied Volatility
Options are often a likened to a 3-dimensional chess game. The three dimensions are price, time, and volatility. The
most misunderstood and neglected dimension, and often the last thing a most traders are aware of is volatility. The
essence of volatility based trading, is buying options when they are cheap and selling options when they are
expensive. In addition to the measurement of how expensive options are priced we also believe that implied
volatility is stochastic process and is mean reverting. The foundations of our strategy are strongly supported by
massive amounts of empirical evidence and research from the academic and private sector.
Implied volatility reflect the markets expectations of what the future volatility of an asset will be, while the realized
volatility is what the actual volatility of the asset turned out to be. Due to emotionally driven behavior between option
market participants there are constant opportunities to exploit these market pricing inefficiency occurrences when
the spread between IV and HV expand. Sell fear, buy hope
The results of most research on this subject confirm our indication that the conditional variance, log-variance, and
standard deviation of option volatility prices are mean revering in the long run and prove robustness of these findings
across different time periods, datasets and distributional assumptions.

Market over price the

underlying options.
Excess Premium

ther Analytics Gaviota VII Options Strategy

Extreme Hurst and Implied Volatility (quantitative fusion of option pricing and stock price inefficiency)
Through very large (hundreds of thousands) sample size data mining of how volatility behaves at and after
ExtremeHurst inflection points, we have found that implied volatility drops on average 30-40%. This unique facet of
our primary strategy signal provides us the ability to first establishing a positive probability edge, or better than
50/50, that the a expected price movement will unfold in a direction that will benefit our trade. Then secondly our
option price modeling enables us to further screen for high probably option trades to compound our expected
probability of profit on each trade. The end result is that with the fusion of price and implied volatility modeling,
every trade we employ is positively skewed in our favor. And creates a opportunity that has a higher probability of
profit versus compared to independently trading the underlying stock or implied volatility mispricing in isolation

ther Analytics Gaviota VII Options Strategy

ther Analytics Gaviota VII Options Strategy

ther Analytics Gaviota VII Options Strategy

Out of Sample Simulation Testing
- Strategy Risk Calibration : Aggressive
- Starting NAV $1,000,000.0 USD
- Start Date March 1, 2016
- Return as of May 21, 2016
- $591,099.44 Realized Profits
- 59% return
- Worst Trade DD 11%
- Worst Account DD 30%**
**Mark to Market not Realized Loss

Strategy Specs
- 6-10% max risk per trade
- Capped risk spreads only
- Min 60% POP requirement
- 30-45 day max time premium
- 50% of Capital usage maximum
- 2% to 5% per month return target
- 30/70 70/30 Long short constraints
- Net short options 100% of the time
- Simulated with ThinkorSwim Platform

Equity Curve Represents End of day Cash Balance

Closed
Trades

Proven
Probability
Edges

Copyright (c) 2016 Aether Analytics, LLC.

aetheranalytics.com
Alex Bernal, CMT, CFTe
alex@aetheranalytics.com
Santa Barbara, CA