Fascinating presentation that I found on the web discussing volatility and risk. C

1. BULL MARKET IN FEAR
GRANT’S FALL CONFERENCE / NEW YORK CITY - OCTOBER 23, 2012
For Investment Professional Use. Not for Distribution
Christopher Cole, CFA
Artemis Capital Management LLC
Artemis Vega Fund LP
520 Broadway, Suite 350
Santa Monica, CA 90401
(310) 496-4526 phone
(310) 496-4527 fax
info@artemiscm.com

2. We live in uncertain times… a bull market in fear
BULL MARKET IN FEAR
Volatility is the market price of uncertainty
“You cannot stop the waves, but you can learn to surf”
Jon Kabat-Zinn
1
Definition of fear from Merriam-Webster

3. What is Volatility?
BULL MARKET IN FEAR
Volatility at World’s End Deflation
Imagine the world economy as an armada of ships passing through a narrow and
dangerous strait between the waterfall of deflation and hellfire of inflation
Our resolution to avoid one fate may damn us to the other
2
Illustration by Brendan Wuiff based on concept by Christopher Cole

4. Volatility in World’s End Deflation
BULL MARKET IN FEAR
Volatility shocks are rightfully associated with deflationary crashes
Volatility at World's End Deflation
120
Dow Jones Industrial Index (RHS) vs. 1-month Realized Volatility of DJIA (LHS)
50,000
100
80
DJIA (logarithmic scale)
Realized Volatility (%)
5,000
60
40
500
20
0 50
1928
1930
1932
1934
1936
1938
1940
1942
1944
1946
1948
1950
1952
1954
1956
1958
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
3

5. Volatility in Hellfire of Inflation
BULL MARKET IN FEAR
Extreme volatility can also occur in hyperinflation
120 100,000,000
Performance of German Stock Market
Performance adj. for fixed exchange
10,000,000
Performance in paper marks (mil)
100 during Weimar Republic Hyperinflaton 1,000,000
100,000
10,000
80 1,000
Adj. according to USD exchange rate 100
60 Adj. according to wholesale index numbers 10
1
40 In paper marks, Weimar 0
0
0
20 0
0
0 0
Feb-18
Feb-19
Feb-20
Feb-21
Feb-22
Feb-23
Nov-18
Nov-19
Nov-20
Nov-21
Nov-22
Nov-23
May-18
May-19
May-20
May-21
May-22
May-23
Aug-18
Aug-19
Aug-20
Aug-21
Aug-22
Aug-23
2,000
Weimar VIX?(1)
Realized Volatility of German Stock Market during Weimar Republic Hyperinflation
1,500
Volatility (%)
(monthly volatility data annualized)
1,000
500
0
Feb-18
Feb-19
Feb-20
Feb-21
Feb-22
Feb-23
Nov-18
Nov-19
Nov-20
Nov-21
Nov-22
Nov-23
May-18
May-19
May-20
May-21
May-22
May-23
Aug-18
Aug-19
Aug-20
Aug-21
Aug-22
Aug-23
Source: “Economics of Inflation; A Study of Currency Depreciation in Post-War Germany" by Constantino Bresciani-Turroni Out of Print / 1968 4
(1) Based upon monthly realized variance from available stock price data.

6. Everything you need to know about trading volatility
BULL MARKET IN FEAR
“There are known knowns; there are things we know that we know. There are known unknowns;
that is to say there are things that, we now know we don't know. But there are also unknown
unknowns – there are things we do not know, we don't know.”
Donald Rumsfeld, United States Secretary of Defense
Known Unknowns Unknown Unknowns
 US Fiscal Cliff  European Crisis
 China hard landing
 War with Iran
 Global Recession
 Fiscal Austerity ?
Volatility Volatility of Volatility
 Vanilla Options  Realized Volatility  Forward Volatility  Tail Risk Hedging
 VIX Index  Variance Swap  Convexity  Vol Curve Trades
Risks that you Risks that you Risks that you Risks that you
know and can know but can’t don’t know but don’t know and
quantity quantify could quantify can’t quantify
5

7. Everything you need to know about trading volatility
BULL MARKET IN FEAR
Two very different styles of crash depending…
Known Unknowns Unknown Unknowns
Debt-Cycle Crash Existential Flash Crash

(2008 Crash, Great Depression)
Crash occurs over time (months) 
?
(Black Monday 1987, 2010 Crash)
Hyper-speed crash (days, seconds)
 Slow recovery  Fast recovery
 Natural end of leveraging cycle  Market fragmentation
 High volatility for long period  Extreme volatility for shorter period
 Elevated volatility-of-volatility  Extreme volatility-of-volatility
 Start of a recession or depression  Omen of future recession (often)
Predictable Unpredictable
(in retrospect) (even In retrospect)
6

8. Bull Market in Fear
BULL MARKET IN FEAR
What is the “Bull Market in Fear”?
New paradigm for pricing risk that emerged after the 2008 financial crisis as
related to our collective fear of the next deflationary crash
Bull Market in Fear is Defined by
1. Abnormally Steep Volatility Term-Structure
2. Distortions in Volatility from Monetary Policy
3. Expensive Portfolio Insurance
4. Violent Volatility Spikes and Hyper-Correlation
7

9. Bull Market in Fear
BULL MARKET IN FEAR
Structural imbalances in supply-demand dynamics of volatility markets
I. Emotional
 Post-traumatic Deflation Disorder
 Desire for safety and security at any cost
II. Monetary Greater
 Forced participation in risk assets drives desire for hedging Demand for
 Unspoken feeling that gains in financial assets are “artificial” Volatility
III. Macro-Risks
 Debtor-developed economies face structural headwinds
 Unrest in Middle East
IV. Regulatory
 Government regulation (Dodd-Frank, Volcker rule) has Less Supply
constrained risk appetite for banks to supply volatility of Volatility
 Lower demand for structured products by investors
8

10. Abnormally Steep Volatility Term Structure
BULL MARKET IN FEAR
"There is no terror in the bang, only in the anticipation of it." Alfred Hitchcock
Volatility term-structure measures the anticipation of future volatility
Bull Market in Fear / VIX Futures Curve (normalized by spot VIX)
1.90x
2004 to Present
1.70x
Vix Futures/Spot Vix
1.50x
1.30x
1.10x
0.90x
0.70x
0.50x
Mar-04
Jun-04
Sep-04
Nov-04
Feb-05
May-05
Aug-05
Oct-05
Jan-06
Apr-06
Jun-06
Sep-06
Dec-06
Mar-07
May-07
Aug-07
Nov-07
Feb-08
Apr-08
Jul-08
Oct-08
Dec-08
Mar-09
Jun-09
Sep-09
Nov-09
Feb-10
May-10
Jul-10
Oct-10
Jan-11
Apr-11
Jun-11
Sep-11
Dec-11
M6
Feb-12
M3
Jul-12
VIX
Expiry
9

11. Abnormally Steep Volatility Term Structure
BULL MARKET IN FEAR
The most extreme term-structure for S&P 500 index volatility in two decades
reflects continued anticipation of a deflationary collapse
Ratio of Expected Future Volatility as Ratio to Spot Volatility
2.4x
S&P 500 options
Expected Volatility as a Ratio to Spot Volatility
2.2x
2.0x
VIX Index
1.8x
1.6x
1.4x
1.2x
0.08 0.17 0.25 0.33 0.42 0.50 0.58 0.67 0.75 0.83 0.92 1.00 1.08 1.17 1.25 1.33 1.42 1.50
Expiry (1=year)
Cumulative Average (1990-Mar 2012) 2012 YTD (avg.)
Bull Market of 1990s (avg.) 2000 to Feb 2009 (avg.)
2009 to 2012 Bull Market in Fear
10

12. Volatility is cheap and expensive at the same time
BULL MARKET IN FEAR
Low VIX index does not mean cheap volatility
35 Low Volatility? Really?
VIX Futures Curve Comparison
August 2012 vs. September 2008
30 !
Forward VIX index (%)
25
20
August 17, 2012 / Lowest VIX in 5 years
15
September 15, 2008 / Day after Lehman Bros. Bankruptcy
10
Spot Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8
11

13. Volatility Regimes Defined by Central Banking
BULL MARKET IN FEAR
Volatility spikes consistently occur after the end of central bank balance sheet expansion
130% Fed Balance Sheet Expansion and VIX index 50
No Fed Action LTRO (ECB),
120% QEI Aug 2011 Crash Op Twist (Fed) & QEIII (Fed) 45
Fed BS % Change since September 2008
QEII
Op. Twist+LTRO(ECB)
QEIII
110% VIX QEII 40
Flash Crash
VIX Index (%)
100% 35
90% 30
80% 25
70% 20
60% 15
May-09
May-10
May-11
May-12
Mar-09
Mar-10
Mar-11
Mar-12
Sep-09
Sep-10
Sep-11
Sep-12
Nov-09
Nov-10
Nov-11
Jul-09
Jul-10
Jul-11
Jul-12
Jan-10
Jan-11
Jan-12
Since 2008 global central banks have expanded their balance sheets by $9 trillion - enough fiat
money to buy every person on earth a 55'' wide-screen 3D television
12

14. Post-Traumatic-Deflation-Disorder (PTDD)
BULL MARKET IN FEAR
Tail Events are now priced as if they are standard risks
Highly unlikely events are either ignored or vastly over weighted based on our collective experiences
Lifetime odds of Dying 25% Implied Odds of % Returns for S&P 500 index
from these causes is 1 in 4.7(1) SPX Options (1year)
Black Swan?
20%
Heart Disease Actual from Sep 2008 to Sep 2012
1 in 6 Implied from Jan 1990 to Sep 2008
Implied from Sep 2008 to Sep 2012
Cumulative Probability
15% September 2012 (average)
Stroke
1 in 28
10%
Car Crash
1 in 88
5%
0%
-45%
-40%
-30%
-25%
-15%
-10%
-50%
-35%
-20%
10%
15%
20%
25%
30%
35%
40%
-5%
0%
5%
Implied 12m %G/L in S&P 500 Index
A “black swan” is not dying because your parachute didn’t open while skydiving…. it is dying
because the guy whose parachute didn’t open landed on you while you were golfing
Note: Artemis calculates the implied probability distribution using interpolated weights from variance swap pricing. This methodology may occasionally give higher weightings to tails in down markets than other
methods like taking the second derivative of call prices, fitting mixture of normal PDFs to recover prices, or fitting vol models (SVI,SABR).
13
(1) "Lifetime Odds of Death for Selected Causes, United States, 2007" / National Safety Council 2011 Edition

15. High Cost of Tail Risk Insurance
BULL MARKET IN FEAR
Fear of deflation is not MISPLACED but it is MISPRICED
You are not smart for hedging what everyone else already knows!
S&P 500 Index 12-month % Contribution to Model-Free Variance by Expected Returns
(19951995 to 2012
to March 2012)
50%
40%
Cumulative Probability
30%
40%-50%
20%
30%-40%
10% 20%-30%
0% 10%-20%
1995
0%-10%
1995
1996
1996
1997
1998
1998
1999
2000
2000
2001
2002
2002
2003
2004
2004
2005
2006
2006
2007
2008
25.0%
2008
10.0%
2009
-5.0%
-20.0%
2010
-35.0%
-50.0%
Implied 12m %G/L
in S&P 500 index
Note: Artemis calculates the implied probability distribution using interpolated weights from variance swap pricing. This methodology may occasionally give higher weightings to tails in down markets than other
14
methods like taking the second derivative of call prices, fitting mixture of normal PDFs to recover prices, or fitting vol models (SVI,SABR).

16. Extreme Volatility-of-Volatility and Hyper-Correlations
BULL MARKET IN FEAR
Fire Risk is High Today in the Forest
Higher correlations are kindling for violent volatility fires (spike)
HIGHER CORRELATIONS lead to...
1 S&P 500 Sector Correlation (60 day)
2000 to 2012
0.8
Correlation (0-1)
0.6
0.4
0.2
0
2000
2001
2002
2003
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
205 More VIOLENT VOLATILITY SPIKES
185 Volatility of VIX index (60 day)
165 2000 to 2012
Volatility (%)
145
125
105
85
65
45
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
15

17. Extreme Volatility-of-Volatility and Hyper-Correlations
BULL MARKET IN FEAR
Volatility is a Shadow Currency in the Bull Market for Fear
$USD currency index strength = Higher Volatility
Correlation of $USD Index to VIX Index
0.6
(1986 to 2012)
0.4
0.2
0
-0.2
-0.4
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Note: Prior to 1990 there was not VIX index. We have substituted the CBOE VXO index, the precursor to the VIX, which was available starting in 1986.
16

18. Volatility of an Impossible Object
BULL MARKET IN FEAR
How to beat a “Bull Market in Fear”
Hedge unknown unknowns and sell known unknowns
When the market identifies a risk it is usually overpriced in volatility markets
The more we fear the left tail the more you should buy the right
Tail risk pricing (both left and right) has been consistently late to the game
Fear is a better reason to buy than fundamentals
Volatility (fear) is an effective leading indicator to inform asset allocation
When Risk-Free is Risky… buy Volatility on Safety Itself!
when a “bull market in fear” meets a “bubble in safety” bet on interest rate volatility
17

19. Bet on unknown unknowns… don’t hedge known unknowns
BULL MARKET IN FEAR
Volatility markets are surprisingly bad at predicting future risk
When markets identify a ‘known unknown’ that risk traditionally is overblown or at
the very minimum over-hedged
Fiscal Cliff or Volatility of Volatility Cliff?
240 Predicted Volatility of VIX vs. Realized Vol of VIX
October 2012
220 Volatility of VIX was 200% on Oct 13, 2008
Maximum was 265% on Aug 29, 2011
200
180
Volatility of VIX (%)
160
Very
140 Cheap Expensive Fear
Fear
120
100 Market Expected Volatility of VIX (local)
US Fiscal Cliff 5yr Average Realized Vol-of-VIX
80
1yr Average Realized Vol-of-VIX
60 6mo Average Realized Vol-of-VIX
40
11-Oct-12 6-Nov-12 3-Dec-12 28-Dec-12 25-Jan-13 21-Feb-13 19-Mar-13 15-Apr-13 9-May-13
Forward Period
18

20. Bet on unknown unknowns… don’t hedge known unknowns
BULL MARKET IN FEAR
Sell “known unknowns” and Buy “unknown unknowns”…
…monetize the bull market in fear by playing the term structure
1.6x Fear Arbitrage
(Volatility futures & Options, SPX Vol Term Structure)
Forward Volatility Term Structure
1.5x
1.4x
1.3x
1.2x
1.1x
Unknown
Known-Unknown Crash
Unknown Crash
1.0x
Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8
Forward Volatility (October 2012) Historical Average Forward Volatility (since 2004)
19

21. The more people fear the LEFT TAIL the more you should buy the RIGHT… and vice versa
BULL MARKET IN FEAR
Role of the trader is not so much to predict the future but to identify mispriced risk
The options market is consistently late to the game in pricing both the right and left tails
Cross Asset Implied Probability Distribution Comparison (2008 pre-crisis to 2012)
Variance Swap Weighting { SPY, EFA, EEM, TLT, IEF, HYG, USO, GLD }
Pre-Crisis 2008 2012
60%
60% 60%
Right Left
50%
50% Tail 50% tail
Bias bias
Probability OfOf Return
40%
Probability Of Return
Probability Return
40% 40%
30%
30% 30%
20%
20% 20%
Gold Gold
Oil Oil
Gold
HY Bonds 10% Oil Bonds
HY
10% UST 10yr 10% UST 10yr
HY Bonds
UST 30yr UST 30yr
UST 10yr
Intl. Equity (Emerg) UST 30yr (Emerg)
Intl. Equity
Intl. Equity (Dev)
Intl. Equity (Dev)
Intl. Equity (Emerg)
US Equity 0% Intl.Equity (Dev)
US Equity
0% 0% US Equity
-3.0σ
-2.5σ
-2.0σ
-1.5σ
-1.0σ
-0.5σ
+0.0σ
+0.5σ
+1.0σ
+1.5σ
+2.0σ
+2.5σ
-3.0σ
-2.5σ
-2.0σ
-1.5σ
-1.0σ
-0.5σ
+0.0σ
+0.5σ
+1.0σ
+1.5σ
+2.0σ
+2.5σ
-3.0σ
-2.5σ
-2.0σ
-1.5σ
-1.0σ
-0.5σ
+0.0σ
+0.5σ
+1.0σ
+1.5σ
+2.0σ
+2.5σ
Expected 1yr Asset Return Distribution
Expected 1yr Asset Class Return Distribution Expected 1yr Asset Return Distribution
by Standard Deviation (Historical) by Standard Deviation (Historical)
by Standard Deviation (Historical)
Note: Artemis calculates the implied probability distribution using interpolated weights from variance swap pricing. This methodology may give higher weightings to tails in down markets than more traditional methods
like taking the second derivative of call prices, fitting mixture of normal PDFs to recover prices, or fitting vol models (SVI,SABR).
20

22. The more people fear the LEFT TAIL the more you should buy the RIGHT…
BULL MARKET IN FEAR
Maybe it is correct to buy tail risk insurance ... but is everyone just hedging the
wrong tail?
Mirror Reflection: Deflation vs. Hyperinflation
20% S&P 500 Probability Distributions in different Regimes of Risk
1-year Gain-Loss%
Cumulative Probability Weighting
15% Implied from March 2012 SPX options
Simulated from in 2013-2022 Hyperinflationary Model (1 scenario of 10k)
10% Future?
5%
0%
-50% -43% -35% -28% -20% -13% -5% +3% +10% +18% +25% +33% +40% +48%
One Year Gain/Loss % in S&P 500 index
Note: Artemis created a model to simulate the behavior of the S&P 500 index and volatility during an inflationary shock. The model is not intended to be a prediction of the future but is merely a rudimentary stochastic-
based method to understand what modern markets may look like in rampant inflation. The simulation runs 10,000 price scenarios for the S&P 500 index over 10 years modeling daily stock price behavior using a
generalized Wiener process (Wiener.. not Weimar) and a drift rate that assumes linkages between annual CPI and equity performance. We assume inflation rises sharply from current levels of 2.87% in 2012 to 26% by
2015 and stays elevated at that level until 2017 (20% a year overall). The average volatility shifts are based upon assumptions regarding equity return to variance parameters observed in prior inflationary episodes
21
(1970s US & 1920s Germany). The simulation shows annualized SPX returns for the decade at +9.94% but adjusted for inflation this drops to -9.8%.

23. Fear over Fundamentals
BULL MARKET IN FEAR
It is hard to have a bear market in a bull-market for fear
Volatility term-structure is an effective indicator to inform equity exposure
It pays to have exposure to stocks when markets are hedged!
S&P 500 index portfolio exposure based on Vol Slope
600 1996 to 2012
550
Period of Steep Vol Slope (1yr VarK / VIX > 1.10)
500 S&P 500 Index
Tactical Allocation to S&P 500 during periods with Steep Vol Slope
450
400
Growth of $100
350
300
250
200
150
100
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
22

24. Risk Free Assets are Risky
BULL MARKET IN FEAR
When the “Bull Market in Fear” meets a “Bubble in Safety” a short equity option
position and “risk-free’ UST bond have similar risk-to-reward payoffs!
Efficient Frontier / Risk to Reward Comparison
Long Dated UST Bond vs. 1yr OTM Short Puts (collateralized)
30yr UST
Bond
Return / Yield
SPX Short Put
(Strike @-25% OTM)
10yr UST
Bond
Risk / Unrealized Loss inin Stress Test Scenario
Risk / Unrealized Loss Stress Test Scenario
SPX Put SPX ↓ -9% to -14% SPX ↓ -25% SPX ↓ -50%
Stress Test 68% to 33% probability 13% chance 2% probability
UST Bond Rates ↑ 100bps to 200bps Rates ↑ 320bps to 600bps
Stress Test 68% to 33% probability 13% to 2% probability
Note: All data as of September 14, 2012. Estimated unrealized loss on position given stress test scenario. Historic probability data based on period of 1960 - 2012 for the UST bonds and 1950 to 2012 for the S&P 500
index. Option pricing based on estimated local volatility shifts, however actual shifts may differ from estimates during a real crash depending. All stress tests are assumed to occur close to the purchase period of the
23
instrument. Unrealized losses may differ closer to maturity.

25. Risk Free Assets are Risky
BULL MARKET IN FEAR
When risk-free is risky … it is time to buy volatility on safety itself
Higher interest rate volatility can be realized in deflation and inflation
250 Interest Rate Volatility is Low
... and a better bargain on a forward basis than equity vol
Merrill Lynch MOVE Index = VIX for UST Bonds
Weighted Volatility of 2yr,5yr,10yr & 20yr UST
200
150
100
50
Oct-08
Oct-09
Oct-10
Oct-11
Oct-12
Dec-08
Dec-09
Dec-10
Dec-11
Apr-09
Apr-10
Apr-11
Apr-12
Feb-09
Aug-09
Feb-10
Aug-10
Feb-11
Aug-11
Feb-12
Aug-12
Jun-09
Jun-10
Jun-11
Jun-12
Source: Bloomberg 24

26. Volatility of an Impossible Object
BULL MARKET IN FEAR
Modern financial markets are an impossible object
Volatility of an impossible object is our changing perception of risk
25
Illustration by Brendan Wiuff based on concept by Christopher Cole

27. Volatility of an Impossible Object
BULL MARKET IN FEAR
the next “Unknown Unknown” Crash…
What is not priced into markets that will seem as obvious in 10 years as it is
laughable today?
Bull Market in Fear is prepared for yesterday’s crash…
you want to be hedged for what happens tomorrow
Fracture between the fundamental
and the abstract is a source of great risk
Today everyone is afraid of the next 2008
I am afraid of the next 1987…. possibly for stocks…
but more likely bonds
26

28. Post-Modern Economy
BULL MARKET IN FEAR
Post-Modern Economy & “Simulacra and Simulation”
Baudrillard recalls Borges fable about cartographers of a great empire who drew a detailed map
When the empire collapses the map is accepted as truth and the empire forgotten
In the postmodern economy market expectations are more important to fundamental growth
than the reality of supply and demand the market was designed to mimic
What Baudrillard calls “the desert of the real” is what Bernanke identifies as the “wealth effect”
The real economy is not slave to the shadow banking system… our economy IS the
shadow banking system… the empire is gone and we live in the abstraction
27

29. Volatility can be more than just FEAR
BULL MARKET IN FEAR
Volatility is the perfect post-modern asset class for our existential
economic future…
Volatility
Markets
Volatility
Fiat
Currency
28

30. Truth and Volatility
BULL MARKET IN FEAR
Volatility as a concept is widely misunderstood. Volatility is not fear. Volatility is not the
VIX index. Volatility is not a statistic or a standard deviation, Black-Scholes input, or any
other number derived by abstract formula.
Volatility is no different in markets than it is to life.
Volatility is an instrument of truth
Regardless of how it is measured volatility reflects the difference between the world
as we imagine it to be and the world that actually exists
We will only prosper if we relentlessly search for nothing but the truth, otherwise
the truth will find us through volatility
the Truth is that Capitalism can save us…
but First We Must Find a Way to Save Capitalism
29