Volatility Investors Beware: A Storm is Brewing

Volatility Investors Vulnerable to Losses

Just as hurricane Dorian has devastated parts of the Bahamas, retail investors are potentially facing a volatility storm. Indeed, UBS and Merrill Lynch investors whose portfolios are exposed to volatility sensitive yield enhancement options strategies are particularly vulnerable.

Volatility investors may be glad to see the wild swings of August go, but history says that September might be worse.

Since World War II, the average move for the S&P 500 across all months is a gain of 0.69%, but the average September move is negative 0.54%. The market has been down 55% of the time in September, making it the worst month of the year. And October, although up 61% of the time, is an even more volatile month with historically steeper losses.

There are plenty of factors that could wreak havoc on the market: the Federal Reserve, the trade war between the United States and China and the global slow down. If there is one thing that markets dislike, it’s uncertainty.

Volatility could well spike in September and October, according to CNBC.

“If history repeats itself, we could see a selloff in September and then we have some sort of capitulation,” said Samuel Stovall, chief market strategist with research firm CFRA. “We’re in the midst of what I call a pullback. The line in the sand is really 2,800. If we break meaningfully through that we could end up having a sharp and swift decline.”

“If you thought August was bad, history says September can be worse because not only is it the month with the largest average decline but is the only month to fall more frequently than it rises,” said Stovall.

Investors in yield enhancement strategies are likely to feel the pain.

In fact, UBS brokers sold up to $6 billion of their Yield Enhancement Strategy, or YES to wealthy clients with conservative portfolios.

During times of low market volatility, the YES Strategy generated positive returns. But it racked up huge losses at the end of last year when market gyrations – volatility – picked up.

And because the program used borrowed money, investors had to either add additional money when trades went south or sell their positions at a loss, according to a recent Wall Street Journal article.

Collateral Yield Enhancement Strategies Sold By Harvest Volatility Management Called Into Question

Other banks, including Merrill Lynch, sold its high net worth clients a similar management strategy, dubbed the Collateral Yield Enhancement Strategy or CYES, which is run as an overlay with no capital commitment or opportunity cost.  Potentially billions of client assets are at risk.

In the CYES strategy, an outside manager, Harvest Volatility manages a $9 billion portfolio of an options structure via separately managed accounts using listed index options.

A stock option gives an investor the right, but not the obligation, to buy or sell a stock at an agreed upon price and date, according to investor website Investopedia. There are two types of options: puts, which is a bet that a stock will fall, or calls, which is a bet that a stock will rise.

The CYES strategy is supposed to generate a premium on the options by selling overpriced volatility with the promise of limited risk.

But with a storm brewing in the markets, conservative investors with options overlays on their portfolios could be in for out-sized losses this fall.

In hurricane parlance, it’s time to batten down the hatches.

Update (9/17/19): As BusinessWire reports, Zamansky LLC is now launching an investigation on behalf of Harvest CYES Investors. If you believe you have a claim, contact our firm today.