Dynahedge Capital Investments - Interview with Nicholas Pantazis

My guest today is Nicholas Pantazis of Dynahedge Capital Investments. Nicholas started Dynahedge Capital Inc. in December 2005. Since inception, the managed account program has posted a return of 9.29% compounded average annual rate of return through February of 2009. Past Performance Is Not Indicative of Future Results.

About The Trader
NICHOLAS PANTAZIS is the principal and trader for Dynahedge Capital Investments. Since 1991, upon graduation from university, he has worked in various capacities in the derivative industry. From 1993 until 1996 he worked as a proprietary currency trader for an international ship owning group. From 1996 until December of 2001 he was employed at PNB Management in the development and implementation of technical trading systems for use in commodities markets. In January of 2002 Mr. Pantazis did work for a number of companies, on a consultancy basis where he was responsible for trading strategies on options and futures up until April of 2003. In May 2003, Mr. Pantazis worked for the Triglobal Life Insurance Group where he developed and traded strategies focusing on options and futures on U.S. equity indices. In July of 2004, he decided to devote his attention and energies on becoming a CTA.

About The Strategy
The trading program primarily makes use of exchange traded future contracts and options on future contracts, specifically the SP 500 futures index.   Statistical models are employed to analyze the underlying price distribution and volatility parameters in order to aid in the initiation of the trades. The strategy attempts to generate returns in various ways, by either being long or short volatility and through the erosion of time premium.

The majority of the positions are put on as a spread basis and the manager also makes use of ratio spreads. These spreads can be either done in-the-money, at-the-money or out of-the-money, along with futures contracts which are used to hedge the majority of the time. The duration of the options positions initiated can range from 1 week up to 6 months with the majority of the duration being centered roughly in the 2 to 3 month cycle. The portfolio is constantly monitored on a real time basis so as to make the necessary adjustments when appropriate in order to adhere to the defined risk/reward scenarios applicable to the strategy and to avoid any surprises over the duration of the positions.

MFQ:  Option sellers have gone through being top ranked by many databases to experiencing record drawdowns. On the surface, you are an option seller. However, you have managed to escape the large drawdowns that many option sellers have experienced over the past few months. Why is this?

I believe that the true definition of a trader is being a risk manager and that is what I focus on the majority of the time I let the profits take care of themselves.

Firstly, I am an option seller when I believe this method will be successful. 

Secondly, the reason I have managed to escape the large drawdowns of option sellers is due to the fact that if I am short options it is only part of my position, I only sell options against other options that I am long I always initiate these type of strategies on a ratio basis.  The reason being is that I can negate a some of my gamma and vega risk initially and when the time comes to hedge with futures the number of contracts needed to hedge is more easily manageable then hedging an outright naked short option position.

Thirdly, position size relative to assets under management is very important.  In my case if I am net short options in my spreads I will use a combination of margin to equity ratio (which is capped at 25% at maximum with the norm being 10%) and standard deviation (probabilities) of prices within a predefined time frequency to define my risk.

Lastly, I try to keep negative months to no greater than -4% for it is easier to climb out of a shallow hole than a deep one.

If I am net long options it is easier to define my risk for I just ask myself what is the maximum percentage risk per month I want to take over the life of the options relative to the total assets and I structure my position size based on that criteria.

MFQ: Some would argue that the option selling strategy only works in a low-volatile environment. Prior to the last 5 years, the S&P had not had a greater than a 10% correction. During that time period many “option sellers” where able to generate excellent risk-adjusted returns. However, once the volatility went higher, they were unable to manage their risks…and subsequently encountered a drawdown. Do you agree or disagree with this assessment? And do you think this strategy can work well in any environment?

I believe to a certain extent that this is true, you can say that option selling as a strategy really took off in the late 80’ early 90’s up until 2000 we had a steadily rising equity market with no real corrections and this probably created an air of complacency amongst option sellers. I think option selling can add value to any portfolio but it has to be done in conjunction with additional offsetting legs or else the potential blow up risk is too high.

MFQ: How have you changed your strategy to adapt to the change in volatility and market conditions?

I look at option trading as a multi-dimensional matrix.  You may start out with one position/strategy but sometimes conditions may change and your position may have to be modified in order to reflect these market dynamics. 

In the last couple of months volatility has increased dramatically in the SP500 and the way that I have adapted is to modify the position sizes “by getting smaller” and I have been concentrating of late on long volatility, long option positions.  I believe it is a much more logical manner to proceed in under these challenging times for the risk parameter can be quantified precisely.

MFQ: What is a worst-case scenario for your strategy?

That is a hard question to answer for last year was the most challenging year in financial markets in quite some time and the worst-case scenario should have been realized then but it wasn’t. In 2007 my second year of business was my worst year the fund I was managing was down -10.71% and the managed accounts were up roughly 3%.   The reason for the difference in returns for the fund versus the managed accounts was simply due to the fact that the fund was traded with a higher risk tolerance.

I believe that 2007 taught me a lot of lessons and due to this the trading strategy evolved for the better and performed well in 2008 under very challenging conditions, but not to deviate from the question I believe the worst case scenario would probably be -20% on an annual basis and this is basically twice the amount of the worst year that the program ever experienced (in the Fund format).

MFQ: Looking back at your performance over the past 3 years, your yearly performance has ranged from a high of 20% to a low of 3%. To what would you attribute this range of returns?

Firstly I focus on one asset class that is the SP500 Index and in the last 3 years the index started off at 1250 (beginning of 2006) realized a high of 1576 in 2007 and then made a bottom in 2009 at roughly 666 that is quite a range in itself, basically what I am trying to portray here is in that short period of time the SP500 experienced some of the biggest swings in recent history if the market was behaving in a more “normal” fashion I guess the returns would have been more uniform, but you have to accept the cards you are dealt and make the best of it.

MFQ: What is your outlook for the market going forward?

I believe the market is going to be characterized by the same erratic and volatile dynamics that have been prevalent since the end of 2007, which will be defined by extreme levels of volatility and fast and viscous price action for the medium term.

Problematic economic issues still remain that have to be addressed, rectified and cleaned out in order to get the economy back on track until this happens it will be a challenging time but the opportunity to profit will still and always exist from a trading perspective.

The information presented in this letter is for general information purposes only. Although every attempt has been made to assure accuracy by ADMIS, it assumes no responsibility for errors or omissions contained herein. Trading futures presents a high degree of risk and is not for everyone. Trading options involves risk. Past performance is not indicative of future results. Only risk capital should be used when investing in the markets.