While many investors shudder whenever there is a market-shaking event, for Rob Celej volatility is something to embrace and generate profits.
"We try to take the volatility out of markets by using volatility. We do that by using options," says Celej, manager of the $27-million Spartan Multi Strategy and chief investment officer at Toronto-based Spartan Fund Management Inc. "We put on positions where we can profit in both up and down markets. The direction is not an issue for us."
Celej's bias is to have long options and to set up positions that cost little, but could have significant upside. Backed by a nine-person team, which includes an independent risk officer, Celej uses Black-Scholes option-pricing models that are driven by quantitative data in order to identify cheap options. "But the Black-Scholes model is only one part of it."
From a qualitative perspective, other tools include analysis of current events surrounding companies, such as earnings surprises and potential merger and acquisition activity or divestitures. "We look to play these events using options," says Celej, adding that he uses 90-day options. "But we're cheap, and looking for those where the cost is minimal."
The fund holds 50% in cash, given the margin requirements for options positions. It may have 50 to 200 positions, with single positions limited to 2% of fund assets. There is also a 5% limit every 90 days that restricts how much can be spent on premiums. Turnover is high, at 400%, as befits a hedge fund with options expiring every three months.
One of the events that Celej benefitted from was the fallout following the Japanese earthquake and tsunami. "We had no idea that Japan was going to have a nuclear crisis. But if you can have positions that move when volatility moves up, then you're able to profit," he says.
Such was the case with the uranium producer Cameco Corp. CCO , a position that Celej established last January. "The options were cheaper than where the stock was trading. We believed we could capture that difference."
Employing a strategy known as "long volatility," Celej bought calls, and also shorted half the Cameco stock for half of the option position. When the earthquake struck, Cameco tumbled and Celej made a healthy profit on the short position.
The calls were later sold at a profit, mainly because they had become expensive as Cameco's stock began to recover. "We had bought them when volatility was low and calls were cheap," says Celej. "Our focus is getting stuff cheap, through options."
Established in May 2006, the fund has a minimum investment of $5,000 and is sold to accredited investors. One of the better performers among multi-strategy hedge funds, and a Canadian Investment Awards nominee last year, the fund returned 10.4% for the 12 months ended March 31. Over the three-year period, it returned an annualized 11.8%.
A 24-year industry veteran, Celej graduated from the University of Toronto with a BA in political science in 1987 and joined Nesbitt Thomson, as it was then known, as a floor trader on the Toronto Futures Exchange. In 1994, he moved to Midland Walwyn (which was later acquired by Merrill Lynch Canada) and became manager of the equity-options department.
In 2000, Celej went to Dundee Securities, where he managed the equity-option proprietary trading book. Between 2003 and 2006, he worked at Refco Futures (Canada) Ltd., where he focused on creating managed accounts and used the skills he developed at previous firms.
In 2006, Celej established Spartan. Three years later, he joined forces with hedge-fund executives Gary Ostoich and Brent Channell. The firm's objective is to bring the expertise of floor traders within a fund structure. Overall, the firm manages more than $60 million.
Importantly, Spartan Multi Strategy has never had a losing year. In the severe bear-market year of 2008, for example, it returned 2.9%. "We tend to outperform in the down markets," says Celej. "But when the market is on a tear, volatility tends to fall and there are fewer opportunities to capture movements in volatility." In spite of the decline in volatility, in 2009 the fund still gained 26.5%.
While low or falling volatility presents challenges, Celej and his team can employ other strategies, such as relative-value options. Last winter, they took a position in Research In Motion Ltd. RIM , in advance of earnings surprises that could go either way.
"We can give up some of the upside, but also limit our losses," says Celej, noting that the options were cheap. In the end, the RIM position returned 200%. However, it was a relatively small holding.
"Statistically, if you put enough positions on, you will capture some of the differences," says Celej. "We're not trying to predict where a stock or the market is going. We're trying to take advantage of the pricing inefficiencies to get that same exposure."