Alphacution: Parplus demise attributed to equity collateral, variance swaps and Ronin relationship

Parplus Impersonates LTCM, Drags Ronin Down

The overlay – the “plus” in Parplus – is believed to have been variance swaps comprised of strips of short VIX options (at the CBOE) against long SPX futures (at the CME). Now, under normal market conditions – and even anticipating volatility spikes up to, say, 40 or so – this spread strategy can work quite well. Clearly, something was going right to grow AUM from $118 million to north of $500 million in a single year.

However, when we consider the convergence of factors, and the “six sigma”-type move in this spread that occurred, Parplus ends up as a bag of broken sticks:

  1. (Too) fast growth in AUM relative to strategy capacity, when under market stress;
  2. An incentive fee-only compensation mechanism – as detailed in a March 27 Institutional Investor piece, “A Hedge Fund CEO Bragged About Not Taking Management Fees” – that may have warped risk incentives;
  3. Unprecedented volatility of volatility, as detailed in our Feed post, “Marketquake: The Volatility of Volatility” (including the chart below, as refresher); and,
  4. Both CBOE and CME floors being closed on the dates that the margin call sirens were going off, thereby limiting a human being from putting any tourniquet on the bleeding…

All of these factors – and likely others – converged to widen a spread beyond anyone’s expectations, causing Parplus’ futures, options and collateral value to evaporate. Furthermore, given’s Ronin’s stake in Parplus, the CME and ABN AMRO Clearing came after them, too… And, if ABN’s loss is $200 million net, that likely means that the total loss is ~$700 million (given Parplus’ most recent AUM).

The full article is available at http://alphacution.com/parplus-impersonates-ltcm-drags-ronin-down

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