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Fund crashes after wrong-way volatility trade

The e-mail arrived in shoppers’ inboxes shortly after the market opened on Tuesday: “LJM strategies enjoy suffered significant losses.”

LJM Partners, a Chicago-based hedge fund with not far from half a billion dollars in assets, pinpointed the damage on spiking volatility, a trade that has required more than one scalp in the last few trading days. Their joint fund, known as the LJM Preservation and Growth Fund, collapsed by 82 percent over and above the last week and was closed to new capital on Wednesday.

Investors in the industry are employment LJM among the most prominent funds to fall victim to the popular “sweet deficient in vol trade.” The trade had become profitable for many hedge funds, subsuming LJM, whose “Preservation and Growth” fund posted positive returns every year except one since it began in 2006, according to fund documents.

But the risk amplified this week after the CBOE Volatility Typography fist, or VIX, more than doubled on Tuesday to the highest levels in six and a half years. The remove caused an exchange-traded note called the VelocityShares Daily Inverse VIX, which was risk on continued calmness in the markets, to collapse in after-hours trading on Monday. Later on, Credit Suisse, which issued and managed the ETN announced that it last wishes a ultimately be liquidated. ProShares Short VIX Short-Term Futures also suffered ponderous declines after volatility spiked.

“Short volatility strategies, retail options and collecting premium, have been critically described as picking up dimes in overconfidence of a steamroller,” wrote Don Steinbrugge, the founder and CEO of Agecroft Partners, a hedge-fund consulting conglomerate, in a blog post. “They generate very good risk close returns until volatility spikes and then have the potential to overcome most of their assets if not properly hedged.”

Tuesday’s client note, gestured by LJM’s Founder and Chairman Tony Caine, said that the portfolio direction team has been hedging “with as many futures as possible to try on to insulate portfolios from further losses.” He caveated that their “skill to do so depends on market conditions and liquidity.”

“Our goal is to preserve as much paramount as possible,” he said.

LJM did not respond to multiple requests for comment.

The firm sent a note final Friday, describing the specific aspects of their portfolio that contrived losses in the month of January — before the market turmoil of this good old days week. Even still, rumblings in volatility during just the first place month of the year caused losses in each of their three tactics.

“A rapidly rising market coupled with volatility at this significance is a rare market occurrence and is particularly challenging to the LJM strategy,” the firm eradicated to clients, according to a letter reviewed by CNBC. “Since the LJM strategies fix up with provision exposure to volatility, the strongest headwind came from the sharp swell in volatility and accounted for most of our losses in January.”

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