Broken Distributions And Elections: This Hedge Fund Manager Specializes In Weekly Options Trading

Oraclum Capital's Vuk Vukovic tells Benzinga about his hedge fund's unique market approach, and how short-dated options enable flexibility.

Oraclum Capital (ORCA) CEO Vuk Vukovic recently met with Benzinga to discuss his hedge fund’s unique market approach, and how short-dated options enable flexibility and reduced risk exposure.

Here's an edited transcript of the conversation.

Benzinga: Explain how you became involved in markets.

Vukovic: I pursued my undergraduate studies in economics before transitioning to political economics for my master’s degree at the London School of Economics. Additionally, I attended summer programs at Harvard and Berkeley. Upon completing my studies, I returned to Zagreb, Croatia, where I married my wife and began a family.

In 2016, four years later, I enrolled at Oxford University to pursue my Ph.D. Three years later, I authored a book set to be published by the Oxford University Press. However, I decided to transition from academia, influenced by scientific approaches that accurately predicted Brexit and the Trump election victory. We seized the opportunity to monetize this approach, leading to the establishment of our hedge fund six years later.

Why political economics?

You can only understand the full scope of economics by broadly understanding politics. I was very much into political incentives shaping economic outcomes, with one of my topics of interest being corruption. I wrote a paper in 2014 that became public here in Croatia.

I was uncovering local corruption and tying that to the election chances of politicians. That pushed me even further. When I came to Oxford, my topic was the collusion between politics and the corporate sector and how that affects economic outcomes, focused explicitly on income distribution and inequality.

Why monetize this research you've done through investing?

The whole thing started as an academic paper. My two colleagues, Dejan Vinković, a physicist, and Mile Šikić, a computer scientist, were professors. We all came from academia and wanted to write a scientific paper about using network theory to improve election prediction models. We used it for elections. Initially, we tried to enhance polling because we noticed that representative samples were problematic. After all, they no longer followed the standard distributions. You have a bunch of problems with telephone polls, etcetera.

We combined the wisdom of the crowd’s concept with some network analysis to determine who will win based on responses. When you take those types of questions and figure out who the people are answering them, you can get much better precision. If you are in a sort of a bubble of groups or if all of your friends are, for example, left-wing or right-wing, you’re going to have a biased opinion about the world.

But if you were in a more heterogeneous group, then you have a much more balanced view. That doesn’t necessarily mean you will be a good predictor, but it gives you a higher probability. That’s what we use with our method. So, we assign a probability to every user based on their position in the network. We started doing this for the first time back in 2014. We asked students to predict test scores, and the predictions were incredibly accurate. Then we did it in a real-life setting with elections. The big prizes came with Brexit and Trump predictions within a single percentage point. We got it for all the critical swing states like Pennsylvania, Florida, and Ohio.

In the last election, we correctly predicted Biden. I was even more proud of that prediction because it was more accurate regarding which states would play a key role, saying that Pennsylvania, Michigan, and Wisconsin would be that. After that, we needed to do markets. So you have the Perma bears and the Perma bulls. And I want to find the people in between. We started testing the data in 2021. I traded my money for two years, turning $20,000 into $50,000. While doing so, I did this newsletter openly about my work.

Talk about the hedge fund and its structure.

It’s still the same three of us. My two colleagues are now on the quant team. Every week, we look at how the signal performed the week before, trying to adjust for different things, looking at year-to-year and three-month trends and how that works. And they're also looking at other things that can help the signal move. We’re also looking at what we traded.

Could we have improved the trading outcome of the previous week? So this is their job. My job is the chief investment officer. So, I’m handling the trading part, even though it’s simplified now. It’s primarily systematic. We also have a COO helping us with the sales part of the project, virtual assistants in the United States, a dev team, a couple of interns, and junior analysts.

How did you learn to trade?

Self-study. I had some experience in options trading before, but only a little. I had a couple of years. But it was that experience that propelled us into this whole idea of how we can test methods. When we got these signals, our first idea was to buy or sell the S&P 500 when the signal said up or down. We could do it even better with options. We tested several different structures and found it was best to buy spreads.

How complex are these spreads?

Simple verticals. We found that overcomplicating things can cost us a lot of money. As soon as we started the fund, we had a significant drawdown of 15%. The reason for that was different from the primary options strategy. Now, we allocate up to 10% to the options trades, leaving the remainder as cash, not something greedy that will eventually hurt us.

In addition to taking a position on direction, do you take a position on implied volatility?

Direction, though we're always looking at volatility. It could be helpful for us in terms of auxiliary signals.

Do you take the remaining 90% cash and invest that into T-bills?

As you said, it’s 10% in the weekly spreads, where we limit the maximum drawdown we can take. 90% is in one-year duration T-bills. 

What's a big lesson you learned doing this business?

Risk management. It’s different when you have other people’s money at stake. I can be much more volatile with my portfolio than with others. And that hit us immediately. When that 15% drawdown happened, we lowered our risk exposure to 1% per week. And it took us about five months to get back to break even. It would have been even faster had we used greater risk. But, the point was to move up sustainably.

What do you say to die-hard systematic investors, based on the lessons you've learned?

I have a lot of folks trying to sell us strategies that deliver 2000% returns over 20 years. By the way, every backtest is perfect. I have yet to see a backtest that doesn’t work. Then, I ask what the biggest drawdown is. If the most significant drawdown is 40%, I invite them to imagine themselves in this situation. "So you’re down 40%. Do you continue with the strategy?" No way. But, in theory, you have to do so to get that return. As a fund, we have investors to answer for.

How much time do you spend evolving your strategies?

We’re focused on improving the signal. We’re also looking at how we can use the power of the options market to help us. So, I am engaged with many people who know more than I do and have much more experience, including market makers. I am trying to learn as much as possible from them, including how the market's positioning can impact movement. We haven’t yet implemented this in the strategy itself. This is just for me to observe for now, but I want to have a systematic way to use that and, for example, if there’s a gamma switch or something we can react to.

How long does your typical trade last?

Our surveys run at the beginning of the week. We position ourselves on Wednesday, after the open, buying options with two days to expiration. We open the positions on Wednesday and close them on Friday. That’s it.

Would you adjust this position before expiry?

We have a whole systematic approach to doing this. For example, there are rules if there’s a jump in our direction and we make a lot of money. We raise the stops, helping us if things start going down. If we look at a significant uptick in our performance by the end of Thursday, we add to the positions. So, we have all these scenarios to guide us. In other words, "If this happens, then we do that." We can be algorithmic, but we still do it ourselves because we want to gather enough data. We follow the rules to exclude our emotions from it.

Who do you trade with? 

Interactive Brokers. We don't do any separately managed accounts.

How does that 10% allocation vary?

The allocation is up to 10% but varies based on our current performance at a given time of year, scaling if our returns are high. It's a progressional risk exposure. We’re cautious about the long-term risks related to the model improving and whether the signal is improving or not. We must see if the trend is moving against us or in our direction to ensure we can amplify the gains.

What are some of the significant risks in markets you see, and how do you take advantage of them?

Take FOMC weeks. We have a high potential for growth during them. We only place the positions after Powell speaks because we want to avoid that initial volatility, which can distort the price of the options. When there are earnings weeks, we tend to be more careful. We want to maximize during those five or six weeks we tend to get the prediction right and perform well.

If you started over today, what would you do differently?

I keep saying that I wish our March episode last year hadn’t happened, but if it hadn’t happened, we would not have had the great performance afterward. Psychology is essential, and I have hired a coach accordingly. Everything that happened was necessary.

Moving to New York soon?

My wife and three kids want to go to New York. I want to give them that experience. But it’s also for building the fund. At this point, I’m running it remotely. I have an office and everything here, but I need to be there to make and push it. $8.6 million assets under management. It will be about $10 million by the end of next month, and by the start of the third quarter, it will be $20 million. If I want to push this to $100 or more million, I need to be in New York. That’s the reason why we’re going.

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