[yyyyip]

ok while we're playing "ask a hedge fund guy"

Say I set up a fund holding a low cost s&p500 index ETF, but at the end of each year sold naked puts with a ~1/25 risk of ruin to earn ~4% return. Therefore my fund consistently makes 4% over the market index, except for 1/25 years when it explodes and loses everything. Because the volatility is low, my sharpe ratio is good (until it explodes), correct?

Assuming it can stay in business >10-15 years won't I be a billionaire hedge fund manager by then and then change to a low risk strategy that only makes 1-2% more than market index with very low risk of ruin and just let my investors lose interest and quit the fund over the next decade while I continue to earn fees from them?

[lordnacho]

Investors will ask you what you're up to, and if you're just doing that they won't invest. They also keep an eye on whether you're doing what you say.

Anything that's both simple and mechanical is gonna have problems attracting investment. The guys you're talking to are gonna have problems justifying giving you 2/20 for buying a fund and selling options.

Or should. I've met a lot of investors who didn't ask the right questions.

Regarding the Sharpe, if they know what they're doing they're not just using the textbook version either. There's a paper by Andrew Lo about it, well worth a read, not terribly complex math.

[DennisP]

Would that be this paper?

https://www.researchgate.net/publication/228139699_The_Stati...

[lordnacho]

Yes

[yyyyip]

But it would be pretty easy to obfuscate the whole thing behind a few layers of "We've got 50 PhDs working here, we run black box algorithms" etc etc, the strategy could be artificially made a couple of orders of magnitude more complex while still producing the exact same outcome.

Do hedge fund investors keep an eye on whether you do what you say? How did Bernie Madoff go for so long if that's the case?

Of course the mechanism is simple and mechanical, but that isn't how you'd market it to investors.

I'll go read the Lo paper...

[lordnacho]

The 50 phds thing is exactly what certain large firms are doing. The emperor's new hedge fund. I know people who've worked at major firms, and they've told me what they do. But you are going to have a hard time doing a startup with 50 phds.

Madoff was the cause of all the due diligence, though I'd say Europe was a bit different from the US at the time.

[radiusvector]

Strategy discussion aside, a 4% risk of ruin is not “low” by any means. A sophisticated investor would never accept.