“It’s not a disappearance of momentum—it was overnight momentum,” said Bolesta.
His program—which bears a few differences from the bank products and trades a variety of stock indexes—has returned an annualized 7% since its 2017 launch. After a strong first half, it dropped every month for the remainder of 2020.
Another theory: Option traders seemingly turned against momentum followers.
The likes of market makers and specialized funds typically hedge their option books as stock prices move, a practice known as gamma hedging. For example when the S&P 500 is plunging, these derivatives traders can intensify the selling by offloading shares to balance their exposures—and vice versa.
But nowadays these dealers are buying and selling counter to the overall direction of the market, the theory goes. In options parlance, they’ve gone from negative gamma to positive. The market makers switched around April just as the S&P was beginning to recover from its historic rout, according to SocGen derivatives strategist Jitesh Kumar.
One explanation is that rising shares spurred dealers to hedge their exposures to bullish call options by shorting the market. Another holds that the decline of short-volatility strategies thanks to the pandemic rout may also be having an impact on hedging activity—making traders less likely to fuel stock trends.
Keep The Faith
Even though it’s unclear what exactly is causing things to go awry, many quants are betting the strategy will pay off in the next downturn. It’s pattern that’s played out in the past. In the first quarter of 2020, the Deutsche Bank index jumped 20% before falling for the rest of the year. In 2008, it made 46%.
“The more realized volatility you have in prices, the less liquidity market makers will be willing to offer, and the more trends will be created during the day,” said Sandrine Ungari, head of cross-asset quant research at SocGen, which offers a version of the strategy.
Demand on Wall Street appears to be strong, with Deutsche introducing a variation of the trade that ends just before the U.S. close. Meanwhile Bolesta at Deep Field has retooled his to rider shorter trends, helping it fare better of late.
At Seven Investment Management in London, Matthew Yeates just recently invested in a bank-issued momentum strategy. Like many in the systematic world, he’s keeping the faith.
“When the market really moves on one big piece of news, that will likely propagate into the sort of distortions that help these strategies do well,” the head of alternatives and quantitative strategy said.
This article was provided by Bloomberg News.