The idea behind the RP Gamma fund

From an economic point of view, fund investors are in fact shareholders of an insurance company known as the RP Gamma fund, which is managed by RP Crest GmbH.

The RP Gamma fund captures broadly diversified volatility risk premiums across all global regions and in all asset classes where liquid, exchange-traded options exist.

In the RP Gamma fund, the capital paid in by investors serves as equity for the insurance business. Insurance coverage is provided by writing options on shares, bonds, currencies or other assets. It is in the nature of options that directional market risks, such as share price risk, arise every day as a result of market movements. The intention of the RP Gamma fund is precisely not to take on these risks. All directional market risks resulting from a short options position are therefore hedged on a continuous basis. 

In the hedge portfolio, which incorporates all hedging transactions, the fund managers continuously replicate the performance path of the short options portfolio, but on the basis of the actual realised volatility. Thus, on balance the fund shorts implied volatility (via selling options) and goes long realised volatility. As a result, the fund earns money whenever implied volatility is higher than realised volatility. You can see how this works in the film ‘An alternative asset class – the volatility risk premium’.

In essence, our business model is very similar to a traditional insurance business. Insurance companies earn money when the actual claim (or realised volatility in the case of the RP Gamma fund) is less than the loss ratio calculated in the respective policy (i.e. the implied volatility). However, insurance companies do not know this until the policy expires. The situation is similar for the RP Gamma fund, where portfolio managers also have to wait for options to expire before they can determine whether the options sold in previous periods have generated a profit or a loss after deducting hedging costs.

From an economic perspective, the RP Gamma fund is an insurance company wrapped up as a regulated investment fund (UCITS IV), specialised in underwriting capital market event risk. It pursues no exotic trading strategies, arbitrage models, trend-following systems or the like, but simply offers third parties insurance against capital market risks. Operating this business on a profitable basis requires no forecasting of volatility trends.

The volatility risk premium is comparable to the equity or interest rate risk premium. In the equity world, investors are remunerated for providing liquidity and taking on business risk, while the interest rate risk premium is remuneration for the risk of lending money. The volatility risk premium is compensation for the provision of risk insurance in the capital markets. As such, the RP Gamma fund underwrites risks on capital markets just like an insurance company does in the insurance business. History shows that volatility risk premiums are much more attractive – on a risk-adjusted basis – than traditional risk premiums. 

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