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Collaring Equity Market Volatility
Calamos Hedged Equity Income Fund
Interview with: Eli Pars

Author: Ticker Magazine
Last Update: Apr 27, 9:50 AM EDT
With decades of experience in convertible bonds and options, the Calamos Hedged Equity Income Fund came in 2014 as a natural extension for Calamos Investments. The fund has two distinct parts – equities and options. While the equity investment represents a low-risk portfolio, closely based on the S&P 500 Index, the alpha generation comes mainly from trading options and constructing the best possible hedge for the specific market environment.

“This strategy is a great tool to take some risk off the table while staying in the equity market, or to increase equity exposure in a risk-managed way.”
Our sensitivity to the market went down and we were making a lot of money on these long calls. Every time the market moved up, we would pocket some of the cash and use it to either roll up the strike of our puts or buy additional puts or put spreads. By the end of January, we captured a relatively large share of the upside move in the market. When the market reversed, our hedge became quite high, our beta to the market became quite low, and we were able to protect a lot of the downside.

Year to date, the fund is up 4.3%, while the S&P 500 is up 1.3%. You wouldn’t normally expect a hedged strategy like ours to outperform the equity market in an upward case, but it happened because we captured a big piece of the upside in January and didn’t capture a lot of downside.

It is important to understand that this is not a market timing strategy. It is all about how we construct and trade the hedge. In the case we discussed, we were somewhat forced to sell as the market went up, and that allowed us to deliver that performance.

Q: Would you sketch another scenario that illustrates your hedge strategy?

A: We had no opinion on Brexit, but we saw a potential major market moving event and the volatility was relatively cheap. We did some incremental hedging both to the upside and the downside and we traded around that event. It worked really well.

Another example is the third quarter of 2015 when there was a scare related to the Chinese currency and the market sold off fast. At that time, our trade was very similar to the baseline trade. We had some put spreads on top of it, but we didn’t have any long calls. Going into that period, the index was about 2,100 and we sold calls that were 2100 and 2150 and 2200 strike. Over several days, the market sold off several hundred points, so the calls we had sold for $20 became $3. Typically, we would try to buy back a good part of those calls if we’ve captured more than 75% of the value. In that case, we captured 90% of the value.

Q: Is your main focus volatility, market direction, or price?

A: We don’t have much of an opinion about the market, but we do have an idea where volatility normally trades. The tricky part with option volatility is the realized volatility and where we think it is going. We don’t make big bets on the direction, but we are certainly aware of what’s cheap or expensive.

Last year is a good example of low absolute volatility in the option market and even lower realized volatility in the equity market. We are aware of the historical option volatility, but we also focus on reasonable price for the specific environment. Our strategy is more about the best trade we can get based on the volatility regime that we are in.

Q: How do you define and manage risk?

A: For us, risk management is about dampening volatility and providing downside protection. The challenge is that retail investors tend to chase performance when the market is doing well and to get out of the market when things are doing poorly and after they have realized losses. That’s just human psychology and our goal is to dampen that volatility.

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