Tail protection for long investors: Trend convexity at work

TL;DR

This paper explores how trend following strategies derive their positive convexity from the difference in realized variances, revealing stronger effects than previously thought and connecting to risk parity and options-based long-term variance exposure.

Contribution

It demonstrates the robustness of trend convexity across various definitions and introduces a new options portfolio to access long-term variance exposure.

Findings

Trend strategies' performance linked to variance differences.

Aggregate CTA performance shows stronger convexity than expected.

Proposes a strangle options portfolio for long-term variance exposure.

Abstract

The performance of trend following strategies can be ascribed to the difference between long-term 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 (CTAs) 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.