Daniel Och’s hedge-fund group bought options on almost $12 billion of U.S. stocks during the first quarter, a move that may generate profits if markets turn more volatile this year.
The strategy, disclosed in a May regulatory filing by New York-based Och-Ziff Capital Management Group LLC, included an $8.8 billion option bet on companies in the Standard & Poor’s 100 Index. The firm bought both bearish put options and bullish calls on most of the members, including Exxon Mobil Corp., American Express Co. and General Electric Co.
Och, a former risk arbitrager at Goldman Sachs Group Inc., hasn’t previously disclosed the widespread use of options since his firm began reporting holdings electronically in 1999. With the S&P 500 little changed this year, options have become an inexpensive way for managers wagering that markets will become more turbulent, said Christopher Rich, head options strategist at JonesTrading Institutional Services LLC in Chicago.
“The only reason you would want to do this is if you were massively concerned about the markets on the whole and expected volatility to rise,” Rich said in an interview. “Going from zero to this is very, very significant.”
Jonathan Gasthalter, an outside spokesman for Och-Ziff, declined to comment.
Six weeks of stock-market losses failed to spur investors to pay higher-than-average prices for options that protect against declines. The CBOE Volatility Index, known as the VIX, rose 3.06 points, or 17 percent, yesterday to 21.32, closing above its historical average of about 20 for the first time since March.
The VIX, also known as the market’s “fear gauge” because it almost always rises when stocks fall, measures the cost of using options as insurance against declines in the S&P 500 and expresses expectations for stock swings in the next 30 days.
The Chicago Board Options Exchange VXO Index, a gauge of S&P 100 options prices, rose 16 percent to a three-month high of 20.51 yesterday as reports spurred concern the economy is slowing. The VXO has averaged 16.86 this year.
Och, 50, who once served as Goldman Sachs’ co-head of U.S. equity trading, oversees about $30 billion in assets as chairman and chief executive officer at Och-Ziff, a publicly traded hedge-fund manager. Since starting the firm in 1994 with $100 million in capital from Ziff Brothers Investments LLC, he has sought to deliver positive returns with less volatility than the S&P 500 Index, according to the company’s website.
14% Annual Gains
The firm’s flagship OZ Master Fund has generated net annual gains of about 14 percent from inception through 2010 with one-third of the volatility of the S&P 500, according to a March investor presentation. Och’s strategies include investing in structured credit, stocks, closely held companies and arbitrage involving mergers, derivatives and convertible bonds.
Och-Ziff bought options on $11.8 billion of U.S. stocks in the first quarter, swelling the face value of its domestic-equity holdings to about $19 billion from $6.9 billion as of Dec. 31, according to a Form 13F filed May 16 with the U.S. Securities and Exchange Commission. As of March 31, Och-Ziff held call and put options on U.S. stocks with face values of $4.65 billion and $7.14 billion, respectively, according to the filing.
Calls give the right to buy a security for a certain amount, the strike price, by a set date. Puts convey the right to sell. Investors use options to guard against fluctuations in the price of securities they own, speculate on share-price moves or bet that volatility, or stock swings, will rise or fall.
Och-Ziff has disclosed owning options six times since the firm began filing Form 13Fs through the SEC’s electronic document system in 1999, and only once before did the holdings equal more than 1 percent of reported equities. In March 2006, Och-Ziff held puts on $197.8 million of Engelhard Corp. shares and calls on $67.6 million of Dade Behring Holdings Inc., equaling 3.8 percent of the $6.9 billion of assets listed.
Without knowing what other investments Och-Ziff has made, along with the maturities and strike prices of the options, it’s difficult to tell what sort of strategy the firm is pursuing, said Bob Gordon, president of Twenty-First Securities Corp., a New York-based broker that creates investing strategies for high net-worth individuals.
“It could be a bet on implied volatility,” Gordon said in an interview.
Och-Ziff might be following an options strategy known as a “dispersion trade” that has become increasingly popular this year, said Jared Woodard, principal at Condor Options, a New York-based trading and research firm that focuses on market-neutral strategies.
Dispersion trades are a way of betting on an end to the historically high market correlation that began during 2008, when shares of companies in various industries all rose and fell together, frustrating money managers who earned their keep by researching and picking individual companies.
In a dispersion trade, managers sell put and call options on an index such as the S&P 100 during market declines, when demand is heavy among investors who want to protect themselves from losses. They use the rich premiums received for the index options to buy put and call options on some or all of the stocks comprising the index.
Och-Ziff’s Form 13F filing doesn’t disclose whether the firm sold any options on the index. Money managers with more than $100 million of U.S.-listed stocks must file a Form 13F at the end of each quarter that lists their equity-related holdings, including options and convertible bonds.
The first-quarter purchases included contracts on 93 of the stocks within the S&P 100, a benchmark comprising the largest U.S. companies. The money manager held contracts on $8.84 billion of S&P 100 stocks as of March 31, and the market value of its direct shareholdings in the companies totaled about $565 million.
For all but three of the companies, Och-Ziff bought both put and call options, positioning the firm to profit regardless of whether the shares subsequently rose or fell. The holdings included $3.4 billion of calls and $5.4 billion of puts, as Och-Ziff held more bearish than bullish options on March 31, particularly on financial, cyclical and energy stocks.
If the stocks within an index go in different directions, a dispersion trade can yield a profit. Ideally, half of the stocks surge, driving up the value of related call options, while half plunge, increasing the value of the put options. The index itself would remain flat because half of its members are rising and half are falling, canceling each other out.
The level of correlation in the market remains elevated, according to Bouhari Arouna, vice president of equity derivatives strategy at the New York office of BNP Paribas SA. He pointed to a CBOE index that compares the cost of options on the S&P 500 to the cost of options on 50 of the largest stocks within the benchmark.
The CBOE S&P 500 Implied Correlation Index tied to January 2013 option maturities rose 1.6 percent to 63.79 yesterday, above the low of 42.76 recorded in October 2008 and higher than its 62.01 average this year.
“Usually when you trade dispersion, you are betting that correlation will drop,” said Stephane Mattatia, head of global equity-flow engineering at Societe Generale SA in Paris. “If we switch to a stock-picker’s market, what will happen is low correlation and you will make money.”