Tuesday, 14 June 2016

Obligatory Brexit post

I've had a few questions along the lines of "what are you going to be doing to prepare your trading system for Brexit?" (and I'll admit there is a strong element of bandwagon jumping here). The short answer is nothing. The slightly longer answer forms the rest of this post.

(This is not a post about whether we should be in or out. If you're interested, I'm voting to remain. Rather than retread all the arguments about this I can't do any better than recommend you read chapters 8 and 9 of this excellent book.  If you're too lazy to do that then I will point out that nearly every respected economist or grouping thereof has suggested that leaving will have significant negative economic costs. I could also point out that you probably shouldn't be voting unless you've done some proper research first.

Any blog comments attempting to engage me on the political side of this debate will be deleted. That's what twitter is for guys.)

Nigel Farage used to be a commodities broker. Draw your own conclusions. Source: mirror.co.uk (photo shopped of course, but too good not to use)

Change of direction

Firstly should I change the direction of any of my trades? For example, put on a short GBPUSD position in anticipation?

Lest you've forgotten I run a systematic trading system, trading nearly 40 futures markets across the world. A couple of important points there. The first is the "across the world" bit. Quite a lot of the portfolio will be mostly unaffected by Brexit. 

The second, more important, point is the word systematic. I didn't put "systematic mostly, except when I feel like putting on a different position".  If you want to trade in a discretionary way, be my guest (though you'd still benefit from using a systematic position management framework like the one described in my book). But if you're going to trade systematically, then do it properly. We can't backtest these kinds of interventions, yet we made money in our backtests.

Actually I'd seriously question why anyone would bet on Brexit. It's a very close run almost binary event and there is no insider knowledge available (though this might work and even then the exit polls on a very close vote might come out wrong). But it's your money.

Change in risk

This is a more interesting point. I scale my positions according to expected risk. But for expected risk I actually use historic volatility. What I do not use is option prices, i.e. implied volatility. Now if you have a terrifying binary event approaching then historic volatility may well not reflect the true uncertainty in the market. 

It's not the same time scale but going into payroll numbers the market often becomes eerily quiet but if you wanted to sell one week vol you'd get a much bigger premium (this is something the author did whilst still trading options at an investment bank. Never again).

It does seem reasonable then that we should increase our expectation of volatility, and thus cut our positions, to reflect the upcoming Brexit event.

(If this is a subject you're interested in it would be remiss of me not to plug this excellent paper)

In practice however I am not going to reduce my positions. This is for a few reasons.

Firstly I don't have a GBPUSD position, or indeed EURUSD, although I suppose I could stop myself taking any on before polling day. My positions in other markets are less obviously exposed to Brexit.

Secondly historic cable vol is actually pretty high already, reflecting the swings in the polling numbers. Using realised instead wouldn't make that much difference. 

Thirdly, and most importantly, this isn't something I've done systematically before or properly backtested. I don't have the technology or the time to implement this properly, and frankly the benefits would be very small compared to other projects I want to work on so I probably never will. It's not worth doing in a half assed way. 

Note that large hedge funds like my former employers AHL do use implied vol as an input into position scaling, but then they have the time and the resources to do it properly.

Just out of curiosity...

Out of curiosity I thought I'd see if my portfolio looks to have a strong sensitivity to an in or out.

I don't trade FTSE, but even if I did it would only be a few percent of my portfolio. I trade both GBP and EUR against the dollar, but as it happens I'm flat in both right now. I trade European equities, which I guess could suffer a bit, and also short European equity vol. I'm long german bonds, which I guess might go up, and French bonds which might do anything (probably go on strike). 

My biggest positions right now are: long soybeans, Eurodollar, French bonds, short VIX, long US 20 year bonds, bunds, short copper, long Korean bonds and long the S&P 500. Apart from the French bonds and Bunds there is nothing there that is exposed to Brexit, and even these will be second order effects. It doesn't even look like a strong "risk on" or "risk off" theme, though I look to be a little bit more "risk off". Overall my risk is around 3/4 of the long run average, reflecting relatively weak signals.

I trade pretty slowly, so it's unlikely this will change before polling day. As always diversification is the best weapon against instrument specific risk.

Equities, currencies and hedging

In fact my biggest sensitivity to Brexit is in the non-futures part of my portfolio. I have some UK equities that I trade purely systematically (though not automatically), and a buy and hold diversified portfolio of ETF's covering various asset classes and countries. Again it's "buy and hold" not "buy and then sell if I get a bit scared with some tactical trading when I feel like it". There will be no trading here.

The ETF's are not currency hedged, so a GBP devaluation following brexit would benefit them (I measure everything in GBP value), ceritus paribus. The effect on stocks is a little tricker to predict, but I would imagine my UK stocks would hurt - perhaps 5% at worse? A huge one day drop which will probably be partly reversed, but not the end of the world.

As I've said before my futures trading account is funded by a long stock position, which is in a mixture of UK stocks and a European ETF IDVY; hedged by a Eurostoxx futures short. This is a more interesting little portfolio; ignoring the effects on stocks if the pound gets hammered then in GBP terms this portfolio will go up in value - there will be a gain in the value of the ETF but the futures hedge won't move since it's unaffected by currency movements.

I try and keep my currency balances spread fairly evenly, so I do have some Euros for margin purposes and a bit extra which again could gain in value.


It's my policy (read this) to rarely intervene in my portfolio (this was the last time when 2 year german interest rates went below zero - 10 year rates have now done the same but I'm still trading bobl and bunds since their volatility has remained high enough). So it shouldn't be a huge surprise that I'm not intervening now. 

Handily it doesn't look as if Brexit will affect my portfolio too much, since otherwise it would be more difficult than ever to sit on my hands - something that is usually the best course of action.


  1. Nice post and surprising result. I see several systematic funds did well out of this. You mentioned "I have some UK equities that I trade purely systematically (though not automatically)". Can you do a post on how you trade equities?

  2. http://boards.fool.co.uk/time-to-join-the-party-13313278.aspx