LTCM - A Case Study in Leverage

LTCM were known for their relative value bets but also for leverage: controlling $100bn in positions from $4.8bn in assets. (That's 20x leverage). However, leverage alone is meaningless without considering the volatility of the underlying assets. For example, many commonly available options products have 20x leverage built-in.

Straddle Calendar

One of their favorite trades was playing the long term volatility vs. short term volatility in the swaptions market via straddles.

With the Straddle Calendar, you are playing the term structure of volatility, not just instantaneous term structure of volatility, but how it evolves.

Worked Example of Straddle Calendar

Suppose the term structure of volatility is upward sloping.

Straddle Calendar Strategies

This did not work when short term vol surged due to the Russian crisis.

This trade requires a view on how the swaption volatility term structure will evolve.

The Basic of Option Leverage and Logarithmic Delta

Options leverage, also known as lambda, is the percentage change in the options price divided by the percentage change in the underlying spot price.

It can be shown that leverage of a call is (delta lnC / delta ln S). Alternatively, it is also delta multiplied by S over C, i.e. ratio of underlying price to call price. Lambda is also known as logarithmic delta.

It would be interesting to compare the leverage of different options, how it varies with moneyness and how it varies with asset class. Is there convexity in leverage?

Eric Benhamou's paper is a good introduction to option leverage.

As a trader, it is interesting to calculate leverage for each of your positions.