Short volatility strategy pays off in August

Currency managers going short volatility in August would have been top performers, benefiting from a spike in volatility towards the end of July from the dual effect of the US and European sovereign debt crisis, according to research from Royal Bank of Scotland.

The bank's naive simulation of the currency strategy generated a return of 4.9%, with all short straddles, with the exception of CAD, put on at the end of the month making a profit.

In August, the US dollar gained against most currencies in the midst of softening global economic data, as well as from market turbulence exacerbated by the S&P downgrade and ongoing European sovereign debt concerns. CAD and AUD suffered the most against the greenback, alongside SEK, GBP and CHF. However, EUR did manage to post a marginal gain, together with bigger ones from NOK and JPY.

The value strategy also offered a gain of 1.5% with only a long yen position against USD. The NOK position was short and was the biggest loser. All other currencies followed their spot movements and posted gains, with CAD and AUD being the stand-out winners.

Biggest losers were trend-followers, which made a loss of -5.9% as a result of the large amount of volatility last month. "However, the strengthening yen and the fact that its position was held throughout the month meant it came out as the biggest winner, whereas AUD was the biggest loser," says Theodore Chen, in the quant solutions group at RBS in London.

Chen says that in the yield strategy, it was a game of two halves for the two main drivers of its P&L. Both NOK and AUD posted losses in the first half of the month, but NOK more than erased its deficit to end up with a gain in the second half. AUD had a big fall largely due to the unwinding of its carry trade position from risk aversion.