Journal of Investment Strategies

Risk.net

Tail protection for long investors: trend convexity at work

Tung-Lam Dao, Trung-Tu Nguyen, Cyril Deremble, Yves Lemperiere, Jean-Philippe Bouchaud and Marc Potters

  • Trend following strategy is an arbitrage between long-term variance and short-term variance.
  • The convexity of trend must be observed in association with the time scale of trend filter.
  • Both diversified trend and global trend following are interesting hedges for the long "Risk Parity" portfolio.
  • The link between trend-following and long-volatility strategies is proven by a simple trend model. This trend following strategy has exactly the same exposure to the long-term variance as a portfolio of naked strangles. Hence, it provides a trivial "Delta hedge" for the naked strangle portfolio without any hypothesis.

The performance of trend-following strategies can be ascribed to the difference between long- and short-term realized variance. We revisit this general result and show that it holds for various definitions of trend strategies. This explains the positive convexity of the aggregate performance of commodity trading advisors, which, when adequately measured, turns out to be much stronger than anticipated. We also highlight interesting connections with so-called risk parity portfolios. Finally, we propose a new portfolio of strangle options that provides a pure exposure to the long-term variance of the underlying, offering yet another viewpoint on the link between trend and volatility.

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