Warrington: Ready for the return of volatility
Dallas-based Warrington Asset Management has operated its Strategic trading program for more than 20 years, however, it has only recently, since April 2015, offered it directly to customers outside of the wirehouse network. Warrington founder Scott Kimple created his unique options strategy while working with Shearson-Lehman Hutton, which would ultimately be acquired by Morgan Stanley.
“I was part of a unique approach to the industry,” Kimple says. “I had a mentor in Dallas named Stan Finney who was a very successful S&P 500 option trader. When I joined him in 1990, he had a unique relationship with Morgan Stanley and predecessor firms. They would take financial advisors [and] if they had talent they would allow them to build a track record, and if they were successful, the firm would build a fund program around them that was exclusively offered under the Morgan Stanley predecessor’s distribution network.”
Kimple had been preparing for this opportunity since childhood. “I like to consider myself a student of markets,” Kimple says. “We had a family company traded on the Amex. At eight years old my dad would bring home The Wall Street Journal, not coloring books. By 16 he gave me real money to trade; I got hooked on the stock market and focused [my] studies on U.S. equity markets.”
In 1990 he earned an MBA from Southern Methodist. He already had a strong theoretical background in trading when he met Finney.
“Stan was a more traditional option seller in that his risk return program resembled what people have [unfortunately] attributed to the risk reward program of an option program,” he says.
That risk profile includes a series of significantly profitable months followed by a month with a substantial drawdown that erases several months of previous profitability.
Kimple worked with Finney from 1990-93 and then he was tapped to work on his own program. “From 1993-96, I [worked on an] idea on what I wanted to accomplish in options trading. I came up with what I consider to be a different way to trade options from your standard option-type programs,” he says.
He learned to trade options from Finney but with his own twist. He asked himself, “Is there a way to create a new style of options trading to avoid this [picking up nickels in front of a steamroller mentality], to strip off some of the risk that is traditionally associated with options trading but preserve a really solid return profile? To turn the typical risk/return model on its head and to create an option program that could produce consistent returns in any stock market environment.”
Warrington was always independently owned by Kimple, but for their first 18 years it had a dual registration. “We were registered CTAs through Warrington but all of my staff were also registered reps of Morgan Stanley and predecessor firms,” Kimple says. “We still run the fund for Morgan Stanley but we are developing new partnerships.”
In addition to the new partnerships, Kimple has made the Strategic program fully UCITs (undertakings for the collective investment of transferable securities) compliant to offer it in Europe and is working on creating a 40-Act structure to offer its five-year-old Tactical program, which has more of a traditional option writing strategy.
“We are almost like an emerging manager because our old exclusive would not allow us to do business with a lot of partners, but we are also a very experienced seasoned manager with a 20+ year track record,” Kimple says.
Strategic initiates trades that are delta neutral and where no position exceeds three to four weeks. “Strategic is designed to be an all-weather type product,” he says. “It is using options spreads to try and capture ranges in the historical high probability zone of trading in the S&P 500. We use put and call spreads to optimize the option Greeks to try to produce consistent returns no matter where the market goes. We made money in low volatility [and] high volatility; we lost money in up markets, we lost money in down markets; but the idea was that we were truly non-correlated to the S&P, to bonds [and] to other alts.”
Warrington generally employs ratio spreads. “We buy the near-money longs, we look to balance the debit cost of our longs by selling the wings, preferably outside of our high probability range. We try and keep our debit cost close to neutral, so if we are wrong, we rarely have a loss in the middle of the bands of more than 1%; generally we can salvage a small profit on trades that are unsuccessful,” Kimple says. “We may be long one near-money call [and] short two deep out-of-the-money calls to try and balance the debits, to try and balance the deltas. We often have a short gamma bias initiating the trade, but the way we follow up trades we can go to a neutral or long gamma bias by either adding options on the wings or allowing theta decay to flip us to a long gamma bias. As we approach expiration we love to see a big directional move to move the market into a high probability range.”
Kimple says they like to front load the risk management of a trade and let the market move, knowing what their next trade is going to be in advance. “Say we buy a near-money long put for $10 and sell three deep out-of-the-money puts for $3 that would initially be delta neutral. We have a net debit of $1.
The idea is that if those $3 short puts go down to 50¢ and the long goes from $10 to $15, that $1 net debit is now a net $12.50 profit. That is the way we try and monetize our trades in Strategic.”
While Warrington often sells options they don’t rely on premium collection. “We can employ short volatility, we can be long volatility, but what we do well is knowing when to be short volatility and when to be long volatility,” Kimple says. “We made over 2% in the Brexit decline. We were one of the few managers out there enjoying that night session and when the market was bouncing back we monetized our longs; we took our shorts off and captured a 2%+ profit by being long volatility coming into Brexit.”
Warrington’s Tactical program has outperformed its Strategic program because the environment has been better for more traditional option writing programs. The Tactical program has averaged 8.78% since launching in mid-2012. The Strategic program has earned low single-digit during the last five years, but has only produced two negative years in 20 and has an average annual return of 10.10% since 1997. They are both about around 5% in 2017 through June.
Kimple says that the recent environment is dangerous and that Strategic is well-positioned for the eventual end of the current central bank dominated markets.