From Harley Bassman. The Convexity Maven, at Simplify Asseet Management, February 1:
As much as it is an aspirational goal to sell at the top, or buy at the bottom, it is in fact highly unlikely. Similarly, it is a blessing that it is equally hard to sell the lows or buy the highs, although it does seem to be a much easier task.
I can brag that as a senior trader at Merrill Lynch I once bought the low print; but I must confess that this only occurred because I was trying to sell and pressed the wrong button by accident.
In this vein, today I will detail the stupendously unfortunate timing of introducing the Simplify Interest Rate Hedge Strategy at $50 last May 2021, and how it promptly declined to its present $40 value.
Previewing the conclusion: If you liked it at $50, you will love it at $40.
The conundrum that perplexes many investment managers is how to reconcile the -kaffir line- Spot 20yr rate that closed at 1.992% on May 11, 2021, and its subsequently close within a basis point of that level on January 25, 2022, yet the Simplify Interest Rate Hedge Strategy is hovering near $40; down ~20%. ....*****
....The answer is a tad complex, but the colorful charts will make the story a bit easier to digest. Nonetheless, if you have little interest in financial math, please skip ahead. But before you do, let me assure you all is well; the Strategy is working as originally designed and described.
The Strategy took 75 days to design, and we introduced it on day 76, which happened to coincide with the May CPI release that topped interest rates.
As a brief reminder, the Strategy consists of $25 of the (originally five-year) USTreasury that matures in April 2026, and an interest rate “put option” struck at 4.25% on $800 of the 20yr rate that expires in May 2028, seven years from its introduction. The Strategy is static and proportional; thus, it is easy to model.
When the Strategy was introduced, the cost of this option was about $25, which when combined with the $25 UST created the $50 total Net Asset Value (NAV).
Presently, the UST is worth about $24.20 reflecting the increase in shorter-dated interest rates, and the option is worth about $15.80, which creates a total NAV of about $40.00.
So, the curiosity is how the option declined by 37%, from $25 to $15.80, over not quite nine months when the Spot 20yr rate is effectively unchanged....
....MUCH MORE (9 page PDF)
