Fighting Greek Fire with Fire: Volatility, Correlation, and Truth

Note: The following article is an excerpt from the Third Quarter 2011 Letter to Investors from Artemis Capital
Management LLC published on September 30, 2011.
Artemis Capital Management, LLC | Letter to Investors Third Quarter 2011 Page 2





www.artemiscm.com (310) 496-4526
520 Broadway, Suite 350
Santa Monica, CA 90401
(310) 496-4526 phone
(310) 496-4527 fax
www.artemiscm.com
c.cole@artemiscm.com

Fighting Greek Fire with Fire: Volatility, Correlation, and Truth
The world economy is fighting a fearsome wildfire as the European sovereign debt crisis
burns its way closer toward the tinderbox of a second global recession. The insolvency
inferno has no prejudice and will fuse to the flesh of any asset class fueling a blistering
spiral of correlation and volatility. The third quarter of 2011 was characterized by explosive
movements in equity markets as the S&P 500 index declined -14% in the worst
performance since the crash of 2008. Global indices officially entered bear market territory
with the MSCI All-Country World Index down more than -20% since peaking in May. The
10-year US Treasury yield reached the lowest level on record in September as credit
markets braced for an economic slowdown. Over the quarter implied volatility increased
+96% as the VIX index climbed to 42.96. If you heeded the omens of variance markets
earlier this year you were richly rewarded by this increase in volatility.
A wildfire is blind and cruel in violently transforming the essence of any material to ash. In this sense the end-effect of fire is
always correlation and volatility. The common method to extinguish a wildfire is by dousing it with water but what if this is
not enough? Is it possible for fire to resist or spread through the addition of liquidity? Ironically in recorded history there is
one such type of flame... Greek Fire. Greek Fire was the most feared weapon of the Byzantine Empire because water alone
was powerless against its flames. The composition of the weapon is an ancient secret but modern scientists believe it was
made with calcium phosphide (heating lime, bones, charcoal) which, upon contact with water, ignites spontaneously. Greek
Fire was so difficult to extinguish that it was known to continue to burn even underneath bodies of water. The fire could fuse
to any surface, including the sea, explode and spread uncontrollably. For this reason the ancient napalm was very effective in
naval warfare and saved Constantinople from two Arab sieges. The guardians of the formula were so afraid it would fall into
enemy hands that its secrets were eventually lost to time
(1)
. For those who fought against Greek Fire a liquidity trap became a
liquidity grave.
In the new era of global interconnectedness liquidity alone is not enough to extinguish Europe's Greek Fire. The smoldering
flames of default are spreading impervious to fiat money creation. The unintended consequences of unprecedented
intervention in markets are culminating in higher cross-asset correlations and violent price gyrations. All we left have to show
for our three year liquidity orgy is the most correlated period in modern finance. The propensity for erratic movements in
DJ IA daily lagged returns is at the most extreme levels in over nine decades of recorded data. We are trapped in a binary
market governed by the flip of a macroeconomic coin with deflation on one side and government bail-outs on the other. In this
hyper-correlated market many alpha generating strategies resemble directional volatility trades.
The more global asset classes move in lockstep the more haphazardly the international response to the crisis has become. A
currency war is raging as central banks alternate dousing sovereign insolvency flames with uncoordinated currency
devaluation. Whether this is Brazil unexpectedly cutting rates by 50 basis points despite the highest inflation in six years or
Switzerland pegging the Franc to the Euro to protect exports it is every man, woman, and central bank for itself. Every day we
see new kinks in the armor of prior economic and political alliances that lay vulnerable to surrender in a vicious self-
reinforcing cycle of devaluation. While public opposition grows to bail-out economics the Federal Reserve has very few
credible stimulus options remaining to battle the inferno.
Greek Fire in Europe threatens to ignite a global recession and if you haven't already noticed, your alpha is burning. There are
no safe havens and to survive the flames of the next decade we must embrace and harness their nature.
Fight fire with fire ...volatility with volatility
In markets and in life, to find truth
Artemis Capital Management, LLC | Letter to Investors Third Quarter 2011 Page 3





www.artemiscm.com (310) 496-4526

Thoughts on Volatility - Omens and Intuition
In my last letter I spoke at length about the abnormally
steep volatility term-structure arguing it represented
structural imbalances in risk driven by the unintended
consequences of monetary policy ("Is Volatility Broken:
Normalcy Bias and Abnormal Variance" Q1 2011).
Earlier this year it was clear the volatility markets were
bracing for a correction following the end of QE2. With
this thesis in mind Artemis recommended shorting the
long-end of the VIX futures curve where volatility of
volatility ("VOV") was expensive and replacing that
exposure with more sensitive volatility positions on the
front of the curve where VOV was cheap. The strategy
was extremely effective when equity markets collapsed
and the VIX futures curve inverted while options skew
flattened.
What happens from here is much more difficult to
understand. The consensus view is that volatility is mean
reverting and when the VIX is above 40 and realized
volatility is only at 30 the implied volatility premium is
very expensive. Nonetheless my intuition tells me that
given the current Euro-crisis, hyper-correlations, lack of
remaining stimulus options, and structural fragility of
markets there are enough catalysts for the VIX to break
even higher in the next few months.
Investors have a limited imagination regarding the
potential for greater realized volatility. Historical realized
volatility data of the DJ IA going back to 1929 shows
volatility climbed to 2008 highs a total of six times in the
past eighty years. If options existed during the Great
Depression we would have seen multiple observations of
50+implied volatility levels from 1928 to 1933 (based on
realized volatility calculated from DJ IA returns). During
the Black Monday crash of 1987 the VIX index would
most likely have recorded levels above 100! That blows
away the intra-day high of 89.53 reached on October 24,
2008 at the height to the last crash. A retest of volatility
extremes last seen in 2008 and 1987 would require an
uncontrolled default on Greek debt (similar to Lehman
2008) in combination with some kind of structural shock
(similar to the flash crash in 2010). This is improbable
but within the realm of possibility so look for signs of
contagion that would spark realized and implied volatility
to break the rules of power laws all over again.
With this uncertainty in mind the best course of action is to play both tails of the probability distribution. Global markets
are now hyper-correlated and therefore asset selection is less important. Look for tail risk hedges in assets that exhibit low
implied volatility relative to realized and cheap skew to the upside and downside. You can use this market schizophrenia to
your advantage by entering long volatility tail positions on both sides of the return distribution during the peaks and the
valleys of the market rollercoaster.

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(normalized by spot VIX / Jan 2011 to Sept 2011
Artemis Capital Management, LLC | Letter to Investors Third Quarter 2011 Page 4





www.artemiscm.com (310) 496-4526

Fire & Water / Volatility and Money
From water comes life and from cash liquidity
comes asset prices. Money itself is not immune to
the laws of supply and demand and we can
measure its volatility. Extremes in the volatility
of the money supply, defined here as annualized
monthly changes in M1 through M3, reflect
important turning points in the US economy. To
this effect we have never
When the money supply is volatile the risk of a
recession grows incrementally higher. The
volatility of M1, defined as physical currency in
circulation and checking deposits, typically
spikes before the onset of a recession because
market participants transfer risk assets back into
physical cash (see graphic). In this sense, money
is one of the only assets whereby volatility spikes
occur in conjunction with high demand (US
Treasury securities also come to mind).
experienced a spike in
M1 volatility as large as what was recorded in
August 2011 without an ensuing recession.
The evolution of cash volatility provides clues to
the mystery of elevated global correlations. The
volatility of the money supply has been climbing
higher since the 1970s and the relationship
between the volatility of M3 and M1 resembles
an expanding sine wave or feedback loop (see
chart). This is indicative of the fact increasingly
violent shifts in the M1 physical cash supply are
not matched by higher volatility in the broader
M3 measurement that estimates credit creation
and animal spirits
(2)
. Therefore it takes vastly
more liquidity today to rouse the shadow banking
system but at the cost of higher potential for
market dislocation.
The ancient weapon of Greek Fire was deadly
because its flames fused to the very liquidity used
to fight it resulting in a larger blaze. Europe is a
perfect example of this paradox. How can the EU
provide unlimited liquidity to a stability fund
backstopping most of southern Europe without
threatening the sovereign credit of stronger
member nations like France or Germany in the
process? What happens if a member nation that
serves as a pillar of that facility in calm markets
is then forced to use it in times of market stress?
In this self-feeding predicament excess liquidity
during a contagion fuels further insolvency and is
arguably the cause of, not the solution to, market
disequilibrium.
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Volatility of Money Supply
(annualized / 1971 to 2011)
Recession (Peak to Trough)
Volatility of M1
Volatility of M2
Volatility of M3 Source: M1,M2 & M3 values from Shadow Government Statistics
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(annualized / 1971 to 2011)
Recession (Peak to Trough)
Volatility of M3 - Volatility of M1
Source: M1,M2 & M3 values from Shadow Government Statistics
Artemis Capital Management, LLC | Letter to Investors Third Quarter 2011 Page 5





www.artemiscm.com (310) 496-4526

Assets to Ash - Correlation in the Greek Fire
It is not a secret that we are experiencing some of the highest cross-asset correlations in market history rending traditional
portfolio diversification futile. For example in this quarter we recorded the highest realized correlation readings ever for the
50 largest S&P 500 index stocks, S&P 500 sectors, Country ETFs, and in the CBOE S&P 500 Implied Correlation Index. We
have yet to fully comprehend the extent to which bail-out economics, competitive currency devaluation, and unprecedented
global monetary stimulus are contributing to what is now a decade long trend of higher correlation drift.

Volatility of the Fire
If volatility is the heat of the fire correlations are the winds
stirring the flames. The implied volatility of an index, such as
the S&P 500, is more sensitive
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Realized Correlation of 50 Largest Cap S&P 500 stocks
(1 month rolling- 2005 to Present)
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Implied Correlation of S&P 500 Index
(12 month constant adjustement)
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Ranking (Lowest to Highest)
Ranked 21 day Realized Correlations of 50 LargeCap Stocks in SPX
(2005 to Present)
9/7/2011 (Highest Correlation at 0.82)
2008 Crash High (11/13/2008 - Correlation at 0.76)
Bull Market Low (11/3/2006 - Correlation at 0.10)
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when the average correlations
between the components of the index are greater. For
example, if average correlation of index components rises
from 0.35 to 0.70 the volatility of that index should be 45%
more sensitive. Therefore as correlations have drifted higher
over the past decade so has the volatility of volatility. Today
correlation is at all-time highs so it is natural to expect
similar extremes for changes in volatility. This partly
explains why the volatility of the VIX index reached the
highest level in its history at the end of August (see graph)
surpassing readings achieved during the 2008 financial crash
and 2010 flash crash. The trend is troublesome for traditional
portfolio management but presents opportunities for
volatility as an asset class. Look to capitalize on higher
volatility of volatility potential through timely execution of
long vega/convexity positions in the tails of the return
distribution.
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21d Volatility of the VIX Index
(2000 to Present)
Artemis Capital Management, LLC | Letter to Investors Third Quarter 2011 Page 6





www.artemiscm.com (310) 496-4526

Everyone is a Volatility Trader
It is becoming harder and harder to make money
from money. The alpha derived from active
management can be decomposed into two
components 1) asset selection and; 2) volatility bias.
In highly correlated markets the asset selection
component is negated and alpha becomes
increasingly driven by rising and falling vol. When
this happens many classic hedge fund strategies
converge to simple synthetic volatility trades. This
could be one reason why many high profile
managers including Druckenmiller and Soros are
quitting the business while they are still ahead of the
curve. For example strategies that rely upon mean
reversion such as traditional value investing, pairs
trading, and statistical arbitrage become akin to
shorting volatility. The common retail strategy of
buying a stock on dips and selling on strength is
literally part of the process for synthetic replication
of a variance swap (rebalanced to one share every day). Remove the asset selection component entirely and you are
effectively shorting volatility. Likewise investment strategies that rely on trend following such as managed futures and
global-macro are akin to going long volatility. This is one reason why, like everything else, hedge fund returns are becoming
more correlated with one another (see graphic / HFRX indices).
Volatility and the Carry Trade
When Greek Fire fuses to the sea the water itself becomes an extension of the flames. To this effect the daily performance of
equity volatility and currencies is increasingly indistinguishable. I understand that some volatility traders hate currencies on
the basis that you never know when central banks will change the rules of the game. In today's markets currency trading and
volatility trading are being played on the same court with the same unpredictable referees. We can best understand excessive
correlation drift between equity vol and risk currencies as being driven by lower interest rates in developed economies that
provide fuel to the carry trade fire. Since 2008 the VIX index and the J PY/AUD cross has moved in near perfect lockstep
(see below) recording a 0.85 correlation. The trend is also noticeable in the correlation drift between the VIX index and a
cross-section of "risk" currencies. Furthermore the correlation drift between the VSTOXX (European equity volatility) and
the Euro/USD is also at historical extremes. The marriage of volatility and currency is a worrisome devlopment because it
implies the equity risk premium is not about economic fundamentals but instead is a function of global central banks fueling
leveraged carry trades.

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3-month Correlation VIX to
Risk Currencies
(AUD.USD; CAD.USD ; NZD.USD; AUD.JPY; EUR.CHF)
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M
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6
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M
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1
0
S
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-
1
0
M
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1
1
S
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1
3-month Correlation VSTOXX to
Euro/USD 0
20
40
60
80
100
120 0
10
20
30
40
50
60
70
80
90
A
p
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-
0
7
J
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7
O
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-
0
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-
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A
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x

%
VIX (lhs) vs. Japanese Yen/Aussie Dollar(rhs)
Correlation = 0.85 since September 2008
-0.3
-0.1
0.1
0.3
0.5
0.7
0.9
J
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-
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8
A
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1
J
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-
1
1
Hedge Fund Strategies 1-month Correlations
(HFRX Equity Hedge, Relative Value, Event Driven / 2-day lag)
Artemis Capital Management, LLC | Letter to Investors Third Quarter 2011 Page 7





www.artemiscm.com (310) 496-4526

40 years of Mean Reversion

The degree of up and down days in the DJIA is at the most extreme level in recorded history representing a pinnacle in an
era of daily mean reversion. It only takes a casual observer of markets to see that the propensity for large-up days followed
by large-down days seems particularly vicious in today's cycle. The excessive intra-day and day-to-day volatility is
nauseating to professional and retail investors alike and multi-100 point swings in the DJ IA are all too common.
On a macro-level changes in the size and volatility of the money supply may be connected to a phenomenon called serial
correlation drift. Modern derivative pricing theory is based on a conceptual idea that knowledge of past prices has no
bearing on future returns (martingales). Despite this fact there is evidence that asset returns show signs of "serial correlation"
whereby past returns are correlated (to some level) with future results. There are two forms of serial correlation 1) Negative
serial correlation measures the propensity for today's return to be the opposite of yesterday's and rewards reversion to the
mean strategies. For example an asset that alternates between being +1% and -1% every day demonstrates perfect negative
serial correlation. 2) Positive serial correlation is associated with consecutive days of asset price movement in the same
direction and rewards trend following models. Both forms of serial correlation can occur in up or down trending markets.
We are going nowhere at the fastest pace in market history. The rolling one year serial correlation of daily lagged
logarithmic returns in the DJ IA reached a generational peak on May 25th, 1971. Less than three months later on August 15th,
1971 President Nixon surprised the international monetary system by cancelling the direct convertibility of the United States
dollar to gold. After the "Nixon Shock" positive serial correlation in DJ IA daily returns began a four decade decline. On
August 11th, 2011 we reached the lowest levels of serial correlation in the 82 year history of the DJ IA almost exactly 40
years to the day that Nixon abandoned the gold standard.
Is this a statistical coincidence? A random coin flip, whereby heads represent a +1%
day on the market and tails a -1%, will also occasionally exhibit serial correlation
extremes on a rolling one year basis. Despite this fact, this coin flip test, run over
100 years through 10,000 simulations shows nowhere near the serial correlation
drift seen in the DJ IA results and has much lower positive and negative extremes
(see one sample simulation to the right).
If DJ IA serial correlation drift is real is it possible that monetary expansion has
artificially rewarded stock market mean reversion strategies (such as value investing
and buying on dips) for the past 40 years? If this is true does today represent the
beginning of the new era of trend following and volatility?
-0.4
-0.3
-0.2
-0.1
0
0.1
0.2
0.3
0.4
0.5
1
9
2
9
1
9
3
2
1
9
3
5
1
9
3
8
1
9
4
1
1
9
4
4
1
9
4
7
1
9
5
0
1
9
5
3
1
9
5
6
1
9
5
9
1
9
6
2
1
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6
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1
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7
1
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9
7
4
1
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7
1
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1
9
8
3
1
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6
1
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9
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5
1
9
9
8
2
0
0
1
2
0
0
4
2
0
0
7
2
0
1
0
Rolling 1yr Serial Correlation of daily lagged returns
Dow Jones Industrial Average (1928 to 2011)
<0 Negative Daily Correlation >0 Positive Daily Correlation
P
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10/9/1931
6mo Return = -51%
11/24/1964
6mo Return = +3%
Lowest Negative Serial Correlation
8/11/2011 6mo Return = ??
9/30/2008 6mo Return = -37%
3/18/2004 6mo Return = -0.1%
8/15/1971
US leaves gold standard
-0.2
-0.15
-0.1
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0
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5
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6
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1
Rolling Correlation Random Coin Flips
(Heads = +1% , Tails = -1%)
<0 Negative Daily Correlation >0 Positive Daily Correlation
P
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Artemis Capital Management, LLC | Letter to Investors Third Quarter 2011 Page 8





www.artemiscm.com (310) 496-4526

Smoke in the Panic Room
As investors sought refuge from crashing markets many "safe haven" assets actually began to appear risky. At alternating
times during the quarter confidence was shaken in established havens including the US dollar, US Treasury securities, Swiss
Franc, and Gold. This was a stark reminder that "risk-free" is a myth.
MBA programs teach their students to use the yield on US government debt as the "risk-free rate" of return in the capital
asset pricing model. The only problem is now "risk-free" is rated AA+. In a bold decision on August 5th, Standard & Poor's
announced that it lowered the United States' credit rating citing political risks and a rising debt burden. Prior to the
downgrade US Treasury Bonds and the dollar were already losing value as partisan bickering over the debt ceiling raised the
specter of an unthinkable US default. Counter intuitively this represented a buying opportunity. In August and September
US Treasury securities rallied on recession fears and the yield on the 10 year fell 84 basis points to an all time low of 1.72%
by September 22nd. Nonetheless our political risk is rapidly becoming credit risk.
Over the past few years the Swiss Franc was a popular safe haven appreciating +28% against the Euro and +50% against the
dollar since 2003 much to a chagrin of the people who export quality watches and chocolate. On September 6th in a surprise
decision the Swiss National Bank devalued the Franc pegging it at 1.20x to the Euro resulting in an immediate +8.9% gain
against the dollar.
The new risks in supposedly "safe
haven" currencies may encourage us
all to become gold bugs, but before
you buy a shotgun and a strongbox
keep in mind that gold also took a
beating this quarter. In September the
GLD ETF was down -11.06%
compared to -7.18% decline in the
S&P 500 index. The thesis for gold
ownership is logical considering
global competitive currency
devaluation but it is always dangerous
to be in the most crowded trade when
the margin comes due. In these
markets gold has behaved like a safe
haven in the good times, and a
commodity during the bad. This is
disappointing if the objective is true
safe haven status.
If recent history is any guide investors
seeking shelter from crisis are finding
smoke in every panic room. The
global financial system seems poised
for monumental changes over the next
decade and there is no telling if today's
safe haven may be tomorrow's risk
asset.
To this effect the importance of
volatility and convexity in a portfolio
shouldn't be underestimated because
they offer protection against risks we
don't yet know or fully understand.


-
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A
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a
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GLD ETF - 120 Day Volatility Skew
June 24 to September 30, 2011
-0.20x
-0.15x
-0.10x
-0.05x
0.00x
0.05x
0.10x
0.15x
0.20x
Jun-11 Jul-11 Aug-11 Sep-11
GLD 20% OTM Vol Skew
-
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UUP ETF ($USD Index Bullish) - 120 Day Volatility Skew
June 24 to September 30, 2011
-0.60x
-0.50x
-0.40x
-0.30x
-0.20x
-0.10x
0.00x
Jun-11 Jul-11 Aug-11 Sep-11
UUP 10% OTM Vol Skew
-
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0.80x
0.90x
1.00x
1.10x
1.20x
1.30x
1.40x
1.50x
1.60x
1.70x
2
4
-
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TLT 20+ US Treasury ETF- 120 Day Volatility Skew
June 24 to Sept 30 2011
0.17x
0.19x
0.21x
0.23x
0.25x
0.27x
Jun-11 Jul-11 Aug-11 Sep-11
TLT 20+ US Treasury ETF - 5% OTM Vol Skew
-
5
0
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-
4
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1.10x
1.15x
1.20x
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2
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-
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FXF ETF (Swiss Franc Bullish) - 120 Day Volatility Skew
June 24 to September 30, 2011
-0.15x
-0.10x
-0.05x
0.00x
0.05x
0.10x
0.15x
0.20x
Jun-11 Jul-11 Aug-11 Sep-11
FXF Swiss Franc 10% OTM Vol Skew
Evolution of Implied Volatility Surface for Investor Safe Havens
Third Quarter 2011
Artemis Capital Management, LLC | Letter to Investors Third Quarter 2011 Page 9





www.artemiscm.com (310) 496-4526

Fighting Greek Fire with Fire
Fight volatility with volatility and take advantage of
the erratic movements in markets to strategically
establish long tail risk positions on both sides of the
return distribution in asset classes with competitively
priced skew and vol. The strategy is effectively a
global macro-straddle that is long volatility and
convexity. As world draws closer to a second
recession the unpredictable rising and falling tides of
liquidity will either lift or sink all ships. Owning a
small amount of volatility in both tails of the
distribution gives the potential for exponential profits
during the next deflationary crisis or shock-and-awe
government intervention. The table to right presents a
multi-asset comparison of volatility risk premiums
that will serve as a starting point. For example during
the next vicious short covering rally you may consider
buying competitively priced far-OTM put options in
emerging economies or Asian equities. In the event
developed economies like the US and Europe fall back
into recession there is little reason to believe equity
volatility in China, J apan, South Africa, or Chile will
be immune given trends in correlation. When equity
markets are oversold protect against surprise monetary
intervention using unloved far-OTM call options on
financials, high yield debt, and OTM puts on the Yen
and US dollar index. With a small amount of risk
capital you can win on both sides of the
macroeconomic coin toss.
Monetize Volatility of Volatility
VIX options provide attractive opportunities for
sophisticated investors to hedge against global
contagion risk. Although the VIX index is currently
elevated the skew, or spread between the local
volatilities for VIX options (adjusted by historical
standard deviation moves) is extremely flat. When the
VIX index increases the option skew typically
pancakes as volatility of volatility shifts from OTM
calls to OTM puts reflecting higher probability of
mean reversion (see chart). Hedgers can monetize this
flat skew by executing a reverse ratio spread that will
protect a portfolio in the event of cataclysmic decline
in markets. To execute this trade sell OTM VIX calls
at +1 or +2 standard deviations above the respective
November or December VIX futures price and
purchase 2x the number of further OTM calls. This
"Euro-apocalypse" hedge will provide an exponential
payoff in the event the VIX increases above 50+but
will otherwise result in a small loss of capital.

0.60x
0.70x
0.80x
0.90x
1.00x
1.10x
1.20x
1.30x
1.40x
V
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a
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i
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i
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y

o
f

V
I
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F
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s

a
s

a

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a
t
i
o

t
o

A
T
M

V
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l
VIX Strike Price Expressed as Standard Deviation of VIX future
Volatility Skew of the VIX Index
(VIX options at 30 days to expiry)
Current Skew VIX@ 42
Average Skew Since 2004
Average Skew for 1yr
Average Skew for 6mos
Post-Lehman Sept16 2008
OTM VIX Puts OTM VIX Calls
0.00x 0.20x 0.40x 0.60x 0.80x 1.00x 1.20x 1.40x 1.60x
SPY
QQQ
IWM
^VIX
XLY
XLP
XLE
XLF
XLI
XLK
XLB
XLU
EFA
EEM
FXI
EWH
EWY
EWA
EWJ
EWZ
ECH
EWW
EZA
EWG
EWI
EWP
EWU
TLT
IEI
IEF
LQD
HYG
JNK
PFF
TIP
BND
AGG
UUP
FXC
FXA
FXF
FXE
FXS
FXY
GLD
SLV
USO
GDX
UNG
DBA
MOO
DBB
JJC
Volatility Insurance Ratio
E
x
c
h
a
n
g
e

T
r
a
d
e
d

P
r
o
d
u
c
t
Cross-Asset ETF Volatility Insurance Ratio
Ratio = Avg. 12 Month Volatility Skew & Implied Vol / Historic Vol
Higher Ratio = Higher Cost for Protection against Loss
Domestic Equity
Volatility
Domestic Equity - Sectors
Intl. Equity - Index
Intl. Equity - Asia
Intl. Equity - Americas & S. Africa
Intl. Equity - Europe
Domestic Fixed Income
Currency
Commodities
Source: Ivolatility.com Ratio= Average of [(10% OTM Put Vol - 10% OTM Call Vol) / ATM Vol] and [1m Implied Vol/1m Historic Realized Vol]
Artemis Capital Management, LLC | Letter to Investors Third Quarter 2011 Page 10





www.artemiscm.com (310) 496-4526

Volatility and Truth
It is becoming harder for markets to deny the existential state of the global economy. The large banks that were too-big-to-
fail are now even bigger than before the crisis. Unemployment is an epidemic and will result in a lost generation for millions
of Americans and Europeans. The middle class is under significant pressure with 14 million Americans officially out of work
and another 16 million underemployed which in combination would form a state with the population of Texas. In Spain
nearly half of the people under the age of 25 are unemployed and in Greece, Italy, and Ireland nearly a third. The number of
unemployed youth in OECD countries is higher than at any time since the organization started collecting data in 1976
(3)
.
These are the lost children of the global economy.
Things are likely to get worse before they get better. As we move closer to a second global recession it is highly questionable
whether or not the European and domestic banking systems can withstand another systemic shock. The difference this time is
that Main Street is ready to revolt against any new round of bail-out economics. A movement called Occupy Wall-Street that
opposes corporate greed, financial bail-outs, and the political influence of banks is attracting hundreds of grass-roots
followers and conducting protests in lower Manhattan and across the country. As I write this letter 700 people were just
arrested for blocking traffic on the Brooklyn Bridge. This movement is spreading and has held demonstrations in Boston, St.
Louis, Chicago, Philadelphia, and Los Angeles. The group is similar to protests across Europe including the indignados ("the
outraged") movement in Spain and escalating strikes and sit-ins in Greece. A recent poll shows that two thirds of German's
believe their parliament should block any more demands for euro bail-outs
(4)
. The question we should ask ourselves is not
whether policy makers can or cannot orchestrate another massive bail-out of the global banking system, but whether or not
the citizens of developed countries are going to allow it. How this will end is impossible to predict, but in the next decade
we are about to learn a lot more about volatility.
Volatility as a concept is widely misunderstood. Volatility is not fear. Volatility is not the
VIX index. Volatility is not a statistic or a standard deviation, Black-Scholes input,
GARCH model, or any other number derived by abstract formula. Volatility is no
different in markets than it is to life.
Volatility is an instrument of truth. Regardless of how it is measured it reflects the
difference between the world as we imagine it to be and the world that actually exists. It
is the fire in Plato's cave that illuminates the shadows of reality for those chained to the
darkness. It is as global as a violent revolution resulting in social change; or as personal as
an exhilarating relationship with a complex woman who is very there and then
inexplicably gone. Volatility hurts but is necessary for growth. In nature volatility is so
fundamental that the trees of the great sequoia forest will not release their seeds without
first sensing heat from wildfires. It is from the flames of change that we derive the
potential for healthy resurrection and birth. In markets and in life if we don't recognize the
truth in each moment, deny revolution, suppress volatility no matter how painful, we will
not allow ourselves to prosper.
Volatility is change and the world is changing. The truth is that Greece will default. The truth is that if our leaders continue to
deny our problems history tells us the US will eventually default. These shocking events will hurt many people, markets will
collapse, life savings will be lost, there will be violence, upheaval, and massive political change but you know what? The
world will not end. When it is all said and done people will work, they will spend time with their children, they will cry,
laugh, and love... life will go on. We will find a way to prosper if we relentlessly search for nothing but the truth, otherwise
the truth will find us through volatility.
Vive la vrit Vive le volatilit
Artemis Capital Investors, L.P.

Christopher R. Cole, CFA

Managing Partner and Portfolio Manager
Artemis Capital Management, L.L.C.
Artemis Capital Management, LLC | Letter to Investors Third Quarter 2011 Page 11





www.artemiscm.com (310) 496-4526


THIS IS NOT AN OFFERING OR THE SOLICITATION OF AN OFFER TO PURCHASE AN INTEREST IN ARTEMIS CAPITAL
INVESTORS, L.P. (THE FUND). ANY SUCH OFFER OR SOLICITATION WILL ONLY BE MADE TO QUALIFIED
INVESTORS BY MEANS OF A CONFIDENTIAL PRIVATE PLACEMENT MEMORANDUM (THE MEMORANDUM) AND
ONLY IN THOSE JURISDICTIONS WHERE PERMITTED BY LAW. AN INVESTMENT SHOULD ONLY BE MADE AFTER
CAREFUL REVIEW OF THE FUNDS MEMORANDUM. THE INFORMATION HEREIN IS QUALIFIED IN ITS ENTIRETY BY
THE INFORMATION IN THE MEMORANDUM.
AN INVESTMENT IN THE FUND IS SPECULATIVE AND INVOLVES A HIGH DEGREE OF RISK. OPPORTUNITIES FOR
WITHDRAWAL, REDEMPTION AND TRANSFERABILITY OF INTERESTS ARE RESTRICTED, SO INVESTORS MAY NOT
HAVE ACCESS TO CAPITAL WHEN IT IS NEEDED. THERE IS NO SECONDARY MARKET FOR THE INTERESTS AND
NONE IS EXPECTED TO DEVELOP. NO ASSURANCE CAN BE GIVEN THAT THE INVESTMENT OBJECTIVE WILL BE
ACHIEVED OR THAT AN INVESTOR WILL RECEIVE A RETURN OF ALL OR ANY PORTION OF HIS OR HER INVESTMENT
IN THE FUND. INVESTMENT RESULTS MAY VARY SUBSTANTIALLY OVER ANY GIVEN TIME PERIOD.
CERTAIN DATA CONTAINED HEREIN IS BASED ON INFORMATION OBTAINED FROM SOURCES BELIEVED TO BE
ACCURATE, BUT WE CANNOT GUARANTEE THE ACCURACY OF SUCH INFORMATION.

The General Partner has hired Unkar Systems, Inc. as NAV Calculation Agent and the reported rates of return are produced by
Unkar for Artemis Capital Fund. Actual investor performance may differ depending on the timing of cash flows and fee structure.
Past performance not indicative of future returns.

Footnotes and Citations:

Notes:
Unless otherwise noted all % differences are taken on a logarithmic basis. Price changes an volatility measurements are
calculated according to the following formula % Change = LN (Current Price / Previous Price)
Greek Fire / from Madrid Skylitzes / public domain
Flaming globe & Sequoia Tree photographs reproduced with rights from Istockphoto.com
Liberty Leading the People by Eugne Delacroix / public domain.
Security price data from Bloomberg and Yahoo Finance
Implied volatility data from IVolatility.com

Footnotes:
(1) "Greek Fire" from Toxepedia.com http://toxipedia.org/display/toxipedia/Greek+Fire
(2) The Federal Reserve ceased reporting M3 in March 2006. This report uses estimates of M3 provided by Shadow Government
Statistics which uses Fed reporting of major M3 components and SGS modeling of missing components. See
www.shadowstatistics.com for more information.
(3) "It's grim down south" & "the jobless young Left Behind", The Economist September 10th, 2011
(4) "Angela Merkel denies euro bailout backlash was cause of election defeat" The Telegraph September 5th, 2011