Hello!I'm trying to find out how the hedgefund-strategy called "Split Strike Conversion" works in detail. Here is a link withof such a fund. MarketMaster (.pdf) 139KbThe core trading technique works as follows:- Purchasing a basket of 30-35 large capitalization S&P 100 stocks, which togetheraccount for the greatest weight of the Index and therefore, when combined, present a high degree of correlation with the general market.- Selling out-of-the-money S&P 100 Index Call options representing a dollar amount ofthe underlying Index equivalent to the dollar amount of the basket of shares purchased.- Purchasing at-the-money or slightly out-of-the-money S&P 100 Index Put options in thesame dollar amount.The investment manager aquires a basket of 30-35 stocks that mimics the S&P 100 Index(OEX);selection is based on the stocks volatiltiy and correlation to the market. The Manager uses asophisticated, proprietary automated trading system that optimizes the basket of stocks to replicatethe performance of the overall market. Once the basket is identified , the investment manager hedgesthe equity fund by establishing option positions. The manager sells out-of-the-money calls and buysat-the-money or slightly out-of-the money puts on the index. This strategy allows the stocks toappreciate to the call with the downside protection at the strike price of the put, creating across hedge collar. The (long) Put/ (short) Call position represents a "synthetic" position, short of themarket, which provides a hedge against the long stock position. The strategy has defined risk profit parameters.Here is also a short description of a typical portfolio of such a fund. I foundit in the prospectus.(June 30, 2002)Nr. of shares.....................Company 4.350...... MMM........ 3M13.050.... AXP......... AmericanExpress26.100.... AIG.......... AmericanInternationalGroup11.310.... AMGN...... Amgen8.700...... BUD......... AnheuserBusch 46.980.... AOL......... AOLTimeWarner 39.150.... T............. AT&T 12.180.... ONE......... BancOneCorp 15.660.... BAC......... BankofAmerica 20.010.... BMY......... BristolMyersSquibb 76.560.... CSCO...... CiscoSystems 52.200.... C............. Citigroup 25.230.... KO........... CocaCola 10.440.... DD........... DuPont 69.600.... XOM........ ExxonMobil 103.530...GE........... GeneralElectric 31.320.... HPQ......... HewlettPackard 25.230.... HD........... HomeDepot 18.270.... IBM.......... IBM 71.340.... INTC........ Intel 30.450.... JNJ........... Johnson&Johnson 20.880.... JPM.......... JPMorganChase 12.180.... MDT......... Medtronic 22.620.... MRK......... Merck&Co 56.550.....MSFT........Microsoft11.310.... MWD....... MorganStanleyDeanWitter 60.030.....ORCL....... Oracle 18.270.... PEP......... Pepsico 64.380.... PFE.......... Pfizer 13.050.... PHA......... Pharmacia 20.880.... MO.......... PhilipMorris 13.050.... PG........... Procter&Gamble 33.930.... SBC......... SBCCommunications 18.270.... TXU......... TexasInstruments 20.010.... USB......... USBancorp 27.840.... VZ........... VerizonCommunications 18.270.... VIA.......... Viacom 45.240.... WMT........ Wal-MartStores 20.880.... DIS.......... WaltDisney 17.400.... WFC........ WellsFargo Options (870)......Short.........S&P 100 Index July 495 Call 870.........Long.........S&P 100 Index July 490 Put Here are some interesting comments from the monthly reports of the MarketMaster Fund Current Report (.pdf) 46Kb" The collar strategy placed on the equity basket should benefit when there isan accelerated downside movement. Typically in times of uncertainty, a fast droppingmarket creates a favorable decreasing correlation between the equity basket and the putsowned. The puts increase in value more than the total drop in value of the basket.""For example, a split strike conversion portfolio could be carrying a basket of stockswith an overall value of $10m when the S&P 100 Index was standing at 491 andhedged by the simultaneous purchase of an appropriate number of three-month puts(strike 490) and the sale of three month calls (strike 505). Without working through themathematics, the three-month risk/reward profile of the strategy appears to be quite attractive;the downside risk is -0.06%, while the upside potential is +2.99% (+12% annualised).""MarketMaster enjoyed a very strong month, capitalizing in particular on moderate volatility within trending market conditionsfor a portion of the month. Position were taken in two stagesduring a dip in the market and allowed to mature over a period of several days. Upon expiry of the underlying options on the third Friday of the month, the trade was closed, yielding particularlyattractive returns." (June 2002)"MarketMaster gained 0.70%, benefiting from strong equity market upside trends. However, volatilityas measured by the the VIX index remained subdued by recent standards, declining from 23.8 to 21.4 by month end." (June 2003)"From January to April the manager achieved solid returns, gaining 4.9% over the period. In May theVIX Index dropped from 35 to 24, and lower volatility reduced trading opportunities and performances.The trend continued during June and July, and after seven months the manager had gained 5.9%. Volatility returned again in August and year-to-date returns totalled 7.0%. October volatility started strong,but in latter weeks trended down, with the VIX dropping from 35 at the start of the October to 23 bythe end of December."The fund generates steady small profits with almost no loosing month.I have done some research on the web, but didn’t find any useful resources - may be the strategy is known by another name. The strategy consists of a long + a synthetic short position, but what I don’t understand is how it generates its profits and when you enter or exit such a position. I tried to calculate the basket (based on weights in S&P100) on an intraday basis.I then looked at the appropriate S&P 100 options to calculate the risk/reward profile,but the option are very efficient priced, so I never saw a risk/reward of 0.29%/2.99%as described by the manager above. May be the secret is in the calculation of the basket...So, the main points of the strategy are still unclear:1. When to initiate and de-activate the strategy.2. How to calculate the basket of stocks (e.g. S&P 100)3. Which stocks and weights to use for the basket.4. Which options, strikes, months are used?5. How does volatility influence the profitability? It would help me a lot if you can point me to some useful resources.Many thanks in advance!Erich

They are simply collaring their portfolio and try to make it sound very sophisticated (by calling it "split strike conversion"... sounds much better than just "collar" doesn't it ... maybe I should start calling my call positions "asymmetric potential generators"...whaddya think? )The volatility doesn't have so much of an impact on the strategy, but rather the skew (particularly the difference between upside and downside skew).Calculating the basket in the stocks is a simple tracking error minimization problem. By including the 30 to 40 heavyweights, you are already pretty close.They probably try to include high-alpha stocks to try to get some kick to the upside. These are very basic optimization problems.. and they probably use excel Solver to do it They would most likely used near month options (first 2, maybe 3 months).Strikes are most likely selected on a cost basis, i.e. I need to buy some puts, how much do I have to go down the strike ladder on my calls to get a good portion of the premium back (think zero-cost collars).Basically it comes down to picking the right stocks in the basket, which they probably do by hand anyway, rather than any of their "sophisticated, proprietary automated trading system".Hope this helps.

this could become a very interesting thread.one manager has the "monopoly" on this strategy. All split-strike funds which are out there (largest being Kingsway, Fairfield Sentry) are all feeders to Bernie Madoff. Now, Madoff Securities is to my knowledge the largest Specialist Firm on the NYSE, with a market share of around 15% of daily volume (don't nail me on the exact numbers).Madoff runs arguably the largest hedgefund out there. Estimates are out there close to 20bn aum.If they state that the managers edge is:- an exquisite sense of timing, as to when to initiate and de-activate the strategy- access to real time order flows- a low cost baseyou should put that into the right context.there are many rumors in the ai industry about the madoff funds which i account to the fact that all funds are totally untransparent. you will never meet anybody close to those who are making the calls on your money.ai industry itself is divided in the judgement of those funds. some favor them very strongly because of the nearly unbeaten risk/return profile, others would simply shy away from the fact that there are too many open questions, and it simply sounds too good to be true.

Madoff Securities are not a specialist on the NYSE - there are only 7 specialist firms on the NYSE , LaBranche, Goldman (through SLK), Fleet, Van Der Moolen, Bear Wagner, Performance, and Susquehanna.

skewed, you are right. misconception on my side.

Surely these are just ultra-vanilla collars. Assets managers do them in bulk (short the call and long the put; counterparty = merchant bank). The skew is the most important thing in pricing, and interest rates if they are volatile. More interesting is cliquets of these things - forward skew and so on. Great fun.

graeme, fdax: what about corellation risk in this kind of trade?

From the point of view of the merchant bank: they are writing the product on the index as quoted. To them , this is routine activity. Typically it might have some quasi-asian feature e.g. the terminal spot is the average of the index closes over the last week of the product (which lasts a year, say).From the point of view of the asset manager: they have the index protection, now rather than purely track the index, they wish to have positive tracking error, by going heavy stocks they like (for whatever reason) and light stocks they don't like. To them, this is routine activity.From memory (its a pain you can't see the thread when you are writing the message) the example given they had only 35 stocks on an index of 100. Well, that quite brave, but it is still an example of trying to get positive tracking error, and the product with the merchant bank will still be on the entire index, not on the basket, which is (again, from memory) in no way static.

Hi,Just browsing through stuff here and I came across this thread. It touched on a recent conversation about pricing which left me slightly puzzled. I am fairly certain that more experienced people can set me straight. In practice, are zero cost collars for real? I have seen a number of funds advertise this strategy under different names but every time I take a look at pricing -- at the retail level -- I see no way to implement it. The calls one strike above are inevitably selling for less than the puts at the ATM strike. In line with that notion, I spoke with one fund manager today who admitted to day trading his "positions" to add a 100 bp/month to his returns -- since he was only up 4% ytd I was, shall we say, confused . After checking, many of these funds seem to be doing 1%-2%/month. It has the sound of "almost" free money. So, from a practicioner's perspective what am I missing? How do these guys get it done at zero cost? Where did the risk go...Many thanks to anyone who can set me straight.Sam

I guess I am replying to a very old thread... just got interested in it after hearing the term "Split Strike Conversion" strategy ... I actually found the term on the description of FAISENI VI Equity on Bloomberg, although there is another academic who wrote a paper on this long time ago without giving it any fancy term ... Seems like a lot of people on this thread have debunked the idea --- just to add my caveat -- the key trick lies in picking the appropriate strikes in various volatility environments ... i don't want to write much on this, neither mention the academic paper, but the returns are definitely not from skew ... grow up kids - all this skew-explanation bullshit is for books ...

i simulated this strategy on excel using realtime data but couldn't get it to turn a profit. could you name the paper? i don't know what i'm missing...

QuoteOriginally posted by: gtyi simulated this strategy on excel using realtime data but couldn't get it to turn a profit. could you name the paper? i don't know what i'm missing...1) Simulating stuff is an art form. If you think about it for long enough, you can tell yourself whatever you want to hear.2) You can't get this thing to be "profitable" because it's f4rking moronic.