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What is your investment process? Can you describe briefly how you assess whether a particular security presents a trading opportunity? Do you consider your approach “top-down” or “bottom-up”? What are the main risks to your investment approach? What market conditions would affect your strategy adversely? How do your returns relate to the returns of other types of investments? Please address the shorting of stocks Please describe the use of leverage in the fund Talk a bit about your risk management What level of volatility should an investor expect in your fund? You deal in options, which are derivatives. Do you run the risk of blow-up like all the derivatives funds that have made it in the papers in recent years? What would you say your edge is? What differentiates you from other managers? Do you ever sell volatility, or options? How will you address the question of liquidity? You mentioned that leverage grows as positions become profitable. Can you give an example how this works? What is your investment process? Our investment process is highly selective, and involves screening the universe of companies with listed options. We continuously monitor and evaluate the volatility of individual stocks as well as volatility of sectors (e.g. banking, airlines, software, etc.) When our system identifies an opportunity, we check the fundamentals of the company in relation to its volatility characteristics Top Can you describe briefly how you assess whether a particular security presents a trading opportunity? We look at volatility from a number of different angles. We compare implied volatility to actual volatility and to our own proprietary volatility estimate; we perform historical analysis of actual and implied volatility; we compare the volatility of the company to the volatility of the peer group, and the volatility of the peer group to the volatility of the market; we analyze how volatility varies with different expirations (i.e., are short term options more, or less, expensive than long term options?) and with different strikes (i.e., are options at-the-money more, or less, expensive than options out-of-the-money?). Top Do you consider your approach “top-down” or “bottom-up”? Our approach is quantitatively driven but comprises also a fundamental component. The evaluation of the volatility structure is based on quantitative considerations; however, checking fundamentals of a company is a “bottom-up” component. Companies are fluid creatures and their volatility can change dramatically. For example, a company bid for cash will see its actual and implied volatilities collapse but any comparisons with historical volatilities will be misleading. Top What are the main risks to your investment approach? What market conditions would affect your strategy adversely? The investment approach would work well under most market conditions. Adverse market conditions would be a combination of declining volatility a steadily rising market that moves in small increments Top How do your returns relate to the returns of other types of investments? Our approach can produce returns in up or down markets. Our returns are highly negatively correlated with the returns of most major markets or investment strategies: we tend to produce large returns when most investment strategies perform poorly. One can use our returns to diversify risk of long equity portfolios and improve returns. Top Please address the shorting of stocks We never take a view on a stock moving up or down: all positions are always market-neutral with respect to the underlying assets. The core positions are options; we use stocks only to neutralize the exposure of the options to the prices of the underlying stocks. We do not “short” stocks outright: for every stock we are short, we hold an offsetting options position where we are long the stock. Top Please describe the use of leverage in the fund An attractive feature of our approach is that leverage grows as positions become profitable, and leverage falls as positions become non-profitable. We make conservative use of leverage. We do not typically initiate leveraged positions. As positions become profitable and leverage increases, we decrease the leverage by taking profits and lightening positions. Most of the time, leverage ranges between 70% and 125%; it moved up to 300% in two occasions (August 1998 and April 2000) during the Russian default crisis and Nasdaq collapse respectively. Top Talk a bit about your risk management Our strategy is a conservative long-term wealth accumulation strategy. For this reason, we spend most of our time focusing on risk management, which can be summarized in the following procedures: Investments are in liquid instruments (exchange traded options and liquid equities) Each strategy (theme) is implemented through a number of different equity investments Loss limits are pre-determined and tightly enforced for every position The capital at risk in any one strategy does not exceed 15% of fund equity The capital at risk in any single equity investment does not exceed 5% of fund equity Strategies are stress-tested continuously with highly unlikely, extreme scenarios The portfolio is well diversified, and constantly monitored with respect to its risk concentration across underlying economic factors The use of leverage is conservative Top What level of volatility should an investor expect in your fund? Volatility, as an asset, is volatile. Nevertheless, the volatility in the fund has been comparable to the volatility of the equity market as a whole. More importantly, the volatility in our returns comes from large positive returns, whereas for most investment strategies volatility comes from large negative returns. Volatility from large gains, instead of large losses, is highly desirable for any investment strategy. Top You deal in options, which are derivatives. Do you run the risk of blow-up like all the derivatives funds that have made it in the papers in recent years? We deal in derivatives, but our approach is diametrically opposed to the approach of most funds that blew-up. Most funds that blew-up were exposed to unexpected events, or sharp moves upwards in volatility; major surprises were liable to affect them adversely. In our case, losses tend to come during quiet market spells, sometimes over prolonged periods of time, and gains tend to come in large amounts suddenly. Our investors can potentially profit when unexpected events occur. Our approach (investment philosophy and conservative use of leverage) makes a blow-up extremely unlikely. Top What would you say your edge is? What differentiates you from other managers? Our strategy is unique because our investment approach is systematic and highly selective, and blends a fundamental with a quantitative approach. A lot of people trade options, and a lot of people adhere to “event-driven” investing. But most people who trade options rely on black boxes, or on purely quantitative systems; and many people who pursue “event-driven” investing are susceptible to event risks. For example, the best-known “event-driven” strategy, risk-arb, exposes investors to the risk of surprises. We are not aware of many fund managers that capture event risk by being, systematically and selectively, long volatility. Our edge lies in (a) the uniqueness of our strategy, (b) our professional experience and academic credentials, and (c) the rigor and discipline of our approach. Top Do you ever sell volatility, or options? We do not sell volatility, because that would be contrary to our strategy of capturing the effects of events. We sometimes sell options, but we always maintain positive exposure to volatility. Top How will you address the question of liquidity? Liquidity is one of the most distinguishing characteristics of our strategy. We constantly provide liquidity to the market, and, therefore, receive abundant liquidity from the market. In times of extreme market conditions, we tend to move in the opposite direction from the rest of the market. Also, we invest only in liquid assets. Top You mentioned that leverage grows as positions become profitable. Can you give an example how this works? Let’s assume the fund has $100 in equity and makes only one investment: buys an out-of-the money put on a stock. Let’s assume the fund spends $90 to buy the put, and the remaining $10 to buy the “right” amount of stock so that the portfolio is market-neutral. At this point, the fund has no exposure to the price of the stock, has $100 in equity and $100 in assets (the value of the option plus the value of the stock). Leverage is at 100%. Suppose now that the stock moves sharply lower. The value of the put rises (say, to $140) and the fund becomes exposed to the price of the stock (because the option now depends on the price of the stock more than before). The fund has to buy more stock (say, $50 worth) to offset the additional exposure that the option has generated. The equity in the fund is still $100, so the fund has to borrow money to purchase the additional stock. The value of the assets becomes $200 (=$140 for the option + $10 for the original stock + $50 for the new stock), and leverage grows to 150% (because the fund borrows $50). As core positions (i.e., options) become profitable, the fund has to hedge more valuable assets with larger equity positions. Assets grow (both options and equities), and leverage goes up. Top Disclaimer  Past performance is no indication of future performance.