Christopher Cole, CFA Artemis Capital Management LLC Artemis Vega Fund LP 520 Broadway, Suite 350

Santa Monica, CA 90401

(310) 496-4526 phone

(310) 496-4527 fax

info@artemiscm.com

BULL MARKET IN FEAR G R A N T ’ S F A L L C O N F E R E N C E / N E W Y O R K C I T Y - O C T O B E R 2 3 , 2 0 1 2

For Investment Professional Use. Not for Distribution

BU

LL MA

RK

ET IN F

EAR

1

“You cannot stop the waves, but you can learn to surf” Jon Kabat-Zinn

We live in uncertain times… a bull market in fear Volatility is the market price of uncertainty

Definition of fear from Merriam-Webster

BU

LL MA

RK

ET IN F

EAR

What is Volatility?

2

Volatility at World’s End Deflation Imagine the world economy as an armada of ships passing through a narrow and

dangerous strait between the waterfall of deflation and hellfire of inflation

Our resolution to avoid one fate may damn us to the other

Illustration by Brendan Wuiff based on concept by Christopher Cole

50

500

5,000

50,000

0

20

40

60

80

100

120

192819301932193419361938194019421944194619481950195219541956195819601962196419661968197019721974197619781980198219841986198819901992199419961998200020022004200620082010

DJI

A (l

oga

rith

mic

sca

le)

Rea

lize

d V

ola

tilit

y (%

)

Volatility at World's End DeflationDow Jones Industrial Index (RHS) vs. 1-month Realized Volatility of DJIA (LHS)

BU

LL MA

RK

ET IN F

EAR

Volatility in World’s End Deflation

3

Volatility shocks are rightfully associated with deflationary crashes

BU

LL MA

RK

ET IN F

EAR

Volatility in Hellfire of Inflation

4 Source: “Economics of Inflation; A Study of Currency Depreciation in Post-War Germany" by Constantino Bresciani-Turroni Out of Print / 1968 (1) Based upon monthly realized variance from available stock price data.

Extreme volatility can also occur in hyperinflation

0000001101001,00010,000100,0001,000,00010,000,000100,000,000

0

20

40

60

80

100

120

Feb

-18

May

-18

Au

g-18

No

v-18

Feb

-19

May

-19

Au

g-19

No

v-19

Feb

-20

May

-20

Au

g-20

No

v-20

Feb

-21

May

-21

Au

g-21

No

v-21

Feb

-22

May

-22

Au

g-22

No

v-22

Feb

-23

May

-23

Au

g-23

No

v-23

Pe

rfo

rman

ce in

pap

er

mar

ks (

mil

)

Pe

rfo

rman

ce a

dj.

fo

r fi

xed

exc

han

ge Performance of German Stock Market during Weimar Republic Hyperinflaton

Adj. according to USD exchange rate

Adj. according to wholesale index numbers

In paper marks, Weimar

0

500

1,000

1,500

2,000

Feb

-18

May

-18

Au

g-18

No

v-18

Feb

-19

May

-19

Au

g-19

No

v-19

Feb

-20

May

-20

Au

g-20

No

v-20

Feb

-21

May

-21

Au

g-21

No

v-21

Feb

-22

May

-22

Au

g-22

No

v-22

Feb

-23

May

-23

Au

g-23

No

v-23

Vo

lati

lity

(%)

Weimar VIX?(1)

Realized Volatility of German Stock Market during Weimar Republic Hyperinflation(monthly volatility data annualized)

Unknown Unknowns Known Unknowns

Volatility of Volatility Volatility

BU

LL MA

RK

ET IN F

EAR

Everything you need to know about trading volatility

5

US Fiscal Cliff

China hard landing

War with Iran

European Crisis

Global Recession

Fiscal Austerity

“There are known knowns; there are things we know that we know. There are known unknowns; that is to say there are things that, we now know we don't know. But there are also unknown unknowns – there are things we do not know, we don't know.”

Donald Rumsfeld, United States Secretary of Defense

?

Regimes of Volatility-of-Volatility (2007 to 2012)

Period Average

Volatility Regime Vol of VIX VIX indexSPX Return

(annual)

Total

(2007 to Sep 2012)87.5 24.8 +1%

Bull Market

(2006 to July 2007)81.7 13.8 +5%

Credit Crisis Onset

(Aug 2007 to Aug

2008)

82.7 23.0 -11%

Market Crash

(Sep 2008 to Feb

2009)

95.7 49.6 -71%

Recovery to Flash

Crash

(Mar 2009 to May

80.8 26.7 +35%

Post-Flash Crash

Steepening

(May 2010 to Oct

90.5 23.2 +10%

LTRO Steepening

(Nov 2011 to Sep

2012)

97.7 20.3 +16% Vanilla Options

VIX Index

Realized Volatility

Variance Swap

Forward Volatility

Convexity

Tail Risk Hedging

Vol Curve Trades

volatility) are associated with lower equity returns

Many people who trade volatility do not realize they

Risks that you know and can

quantity

Risks that you know but can’t

quantify

Risks that you don’t know but could quantify

Risks that you don’t know and can’t quantify

Unknown Unknowns Known Unknowns

BU

LL MA

RK

ET IN F

EAR

Everything you need to know about trading volatility

6

Two very different styles of crash depending…

?

Regimes of Volatility-of-Volatility (2007 to 2012)

Period Average

Volatility Regime Vol of VIX VIX indexSPX Return

(annual)

Total

(2007 to Sep 2012)87.5 24.8 +1%

Bull Market

(2006 to July 2007)81.7 13.8 +5%

Credit Crisis Onset

(Aug 2007 to Aug

2008)

82.7 23.0 -11%

Market Crash

(Sep 2008 to Feb

2009)

95.7 49.6 -71%

Recovery to Flash

Crash

(Mar 2009 to May

80.8 26.7 +35%

Post-Flash Crash

Steepening

(May 2010 to Oct

90.5 23.2 +10%

LTRO Steepening

(Nov 2011 to Sep

2012)

97.7 20.3 +16%

Existential Flash Crash (Black Monday 1987, 2010 Crash)

Debt-Cycle Crash (2008 Crash, Great Depression)

Crash occurs over time (months)

Slow recovery

Natural end of leveraging cycle

High volatility for long period

Elevated volatility-of-volatility

Start of a recession or depression

Predictable

(in retrospect) Unpredictable

(even In retrospect)

Hyper-speed crash (days, seconds)

Fast recovery

Market fragmentation

Extreme volatility for shorter period

Extreme volatility-of-volatility

Omen of future recession (often)

BU

LL MA

RK

ET IN F

EAR

Bull Market in Fear

7

Bull Market in Fear is Defined by

1. Abnormally Steep Volatility Term-Structure

2. Distortions in Volatility from Monetary Policy

3. Expensive Portfolio Insurance

4. Violent Volatility Spikes and Hyper-Correlation

What is the “Bull Market in Fear”? New paradigm for pricing risk that emerged after the 2008 financial crisis as

related to our collective fear of the next deflationary crash

I. Emotional Post-traumatic Deflation Disorder

Desire for safety and security at any cost

II. Monetary Forced participation in risk assets drives desire for hedging

Unspoken feeling that gains in financial assets are “artificial”

III. Macro-Risks Debtor-developed economies face structural headwinds

Unrest in Middle East

IV. Regulatory Government regulation (Dodd-Frank, Volcker rule) has

constrained risk appetite for banks to supply volatility

Lower demand for structured products by investors

Structural imbalances in supply-demand dynamics of volatility markets

BU

LL MA

RK

ET IN F

EAR

Bull Market in Fear

8

Greater Demand for

Volatility

Less Supply of Volatility

BU

LL MA

RK

ET IN F

EAR Abnormally Steep Volatility Term Structure

9

"There is no terror in the bang, only in the anticipation of it." Alfred Hitchcock Volatility term-structure measures the anticipation of future volatility

VIX

M3

M6

0.50x

0.70x

0.90x

1.10x

1.30x

1.50x

1.70x

1.90x

Ma

r-0

4Ju

n-0

4S

ep

-04

No

v-0

4F

eb

-05

Ma

y-0

5A

ug

-05

Oct

-05

Jan

-06

Ap

r-0

6Ju

n-0

6S

ep

-06

De

c-0

6M

ar-

07

Ma

y-0

7A

ug

-07

No

v-0

7

Fe

b-0

8

Ap

r-0

8

Jul-

08

Oct

-08

De

c-0

8

Ma

r-0

9

Jun

-09

Se

p-0

9

No

v-0

9

Fe

b-1

0

Ma

y-1

0

Jul-

10

Oct

-10

Jan

-11

Ap

r-1

1

Jun

-11

Se

p-1

1

De

c-1

1

Fe

b-1

2

Jul-

12

Expiry

Vix

Fu

ture

s/S

po

t V

ix

Bull Market in Fear / VIX Futures Curve (normalized by spot VIX) 2004 to Present

1.2x

1.4x

1.6x

1.8x

2.0x

2.2x

2.4x

0.08 0.17 0.25 0.33 0.42 0.50 0.58 0.67 0.75 0.83 0.92 1.00 1.08 1.17 1.25 1.33 1.42 1.50

Exp

ect

ed

Vo

lati

lity

as a

Rat

io t

o S

po

t V

ola

tilit

y

Expiry (1=year)

Cumulative Average (1990-Mar 2012) 2012 YTD (avg.)

Bull Market of 1990s (avg.) 2000 to Feb 2009 (avg.)

2009 to 2012 Bull Market in Fear

BU

LL MA

RK

ET IN F

EAR Abnormally Steep Volatility Term Structure

10

The most extreme term-structure for S&P 500 index volatility in two decades reflects continued anticipation of a deflationary collapse

Ratio of Expected Future Volatility as Ratio to Spot Volatility S&P 500 options

VIX Index

10

15

20

25

30

35

Spot Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8

Forw

ard

VIX

ind

ex

(%)

Low Volatility? Really?VIX Futures Curve Comparison

August 2012 vs. September 2008

August 17, 2012 / Lowest VIX in 5 years

September 15, 2008 / Day after Lehman Bros. Bankruptcy

BU

LL MA

RK

ET IN F

EAR

Volatility is cheap and expensive at the same time

11

Low VIX index does not mean cheap volatility

!

15

20

25

30

35

40

45

50

60%

70%

80%

90%

100%

110%

120%

130%

Mar-0

9

May-0

9

Jul-0

9

Sep-0

9

No

v-09

Jan-1

0

Mar-1

0

May-1

0

Jul-1

0

Sep-1

0

No

v-10

Jan-1

1

Mar-1

1

May-1

1

Jul-1

1

Sep-1

1

No

v-11

Jan-1

2

Mar-1

2

May-1

2

Jul-1

2

Sep-1

2

VIX

Ind

ex

(%)

Fed

BS

% C

han

ge s

ince

Se

pte

mb

er

20

08

No Fed ActionQEIQEIIOp. Twist+LTRO(ECB)QEIIIVIX

BU

LL MA

RK

ET IN F

EAR

Volatility Regimes Defined by Central Banking

12

Since 2008 global central banks have expanded their balance sheets by $9 trillion - enough fiat money to buy every person on earth a 55'' wide-screen 3D television

Volatility spikes consistently occur after the end of central bank balance sheet expansion

Risk and Vol Returns in Fed BS Regimes

Crisis and Recovery (September 2008 to September 2012)

Period Average Weekly Change

SPX VIX 21d SV Fed BS

Fed Balance Sheet ↑ 0.6% -1.7% 0.0% 1.5%

Fed Balance Sheet > +1σ ↑ 3.2% -7.4% 0.0% 8.1%

Fed Balance Sheet ↓ 0.0% 1.3% -2.0% -0.9%

Fed Balance Sheet < -1σ ↓ 1.2% 2.7% -1.9% -4.7%

Post-Crisis Recovery Period (Mar 2009 to Sep 2012)

Period Average Weekly Change

SPX VIX 21d SV Fed BS

QEI con't (March09-Jun 09) 1.4% -2.6% -2.5% 0.6%

Post QEI (Jun09-Oct10) 0.2% -0.2% -0.8% 0.2%

QEII (Sep10-June11)(1) 0.5% -1.0% 0.0% 0.5%

Post-QEII (July11-Nov11) -0.2% 2.2% 2.3% -0.1%

LTRO (Dec11 to Sep 0.3% -1.5% -2.7% 0.0%

(1) period following announcement of QEII at Jackson Hole August 2010.

Sources: Federal Reserve Bank, ECB, Bloomberg

Flash Crash

Aug 2011 Crash

QEII

LTRO (ECB), Op Twist (Fed) & QEIII (Fed)

Fed Balance Sheet Expansion and VIX index

0%

5%

10%

15%

20%

25%

-50

%

-45

%

-40

%

-35

%

-30

%

-25

%

-20

%

-15

%

-10

%

-5%

0%

5%

10

%

15

%

20

%

25

%

30

%

35

%

40

%

Cu

mu

lati

ve

Pro

ba

bil

ity

Implied 12m %G/L in S&P 500 Index

Actual from Sep 2008 to Sep 2012

Implied from Jan 1990 to Sep 2008

Implied from Sep 2008 to Sep 2012

September 2012 (average)

BU

LL MA

RK

ET IN F

EAR Post-Traumatic-Deflation-Disorder (PTDD)

13

Tail Events are now priced as if they are standard risks Highly unlikely events are either ignored or vastly over weighted based on our collective experiences

Implied Odds of % Returns for S&P 500 index SPX Options (1year)

A “black swan” is not dying because your parachute didn’t open while skydiving…. it is dying because the guy whose parachute didn’t open landed on you while you were golfing

Heart Disease 1 in 6

Stroke 1 in 28

Car Crash 1 in 88

Lifetime odds of Dying from these causes is 1 in 4.7(1)

Black Swan?

Note: Artemis calculates the implied probability distribution using interpolated weights from variance swap pricing. This methodology may occasionally give higher weightings to tails in down markets than other methods like taking the second derivative of call prices, fitting mixture of normal PDFs to recover prices, or fitting vol models (SVI,SABR).

(1) "Lifetime Odds of Death for Selected Causes, United States, 2007" / National Safety Council 2011 Edition

-50

.0%

-35

.0%

-20

.0%

-5.0

%

10

.0%

25

.0%

0%

10%

20%

30%

40%

50%

19

95

19

95

19

96

19

96

19

97

19

98

19

98

19

99

20

00

20

00

20

01

20

02

20

02

20

03

20

04

20

04

20

05

20

06

20

06

20

07

20

08

20

08

20

09

20

10

Cu

mu

lati

ve

Pro

ba

bil

ity

Implied 12m %G/Lin S&P 500 index

S&P 500 Index 12-month % Contribution to Model-Free Variance by Expected Returns

(1995 to March 2012)

40%-50%

30%-40%

20%-30%

10%-20%

0%-10%

BU

LL MA

RK

ET IN F

EAR

High Cost of Tail Risk Insurance

14

Fear of deflation is not MISPLACED but it is MISPRICED

You are not smart for hedging what everyone else already knows!

1995 to 2012

Note: Artemis calculates the implied probability distribution using interpolated weights from variance swap pricing. This methodology may occasionally give higher weightings to tails in down markets than other methods like taking the second derivative of call prices, fitting mixture of normal PDFs to recover prices, or fitting vol models (SVI,SABR).

0

0.2

0.4

0.6

0.8

1

20

00

20

01

20

02

20

03

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

Co

rre

lati

on

(0-1

)

HIGHER CORRELATIONS lead to...S&P 500 Sector Correlation (60 day)

2000 to 20120

0.2

0.4

0.6

0.8

1

20

00

20

01

20

02

20

03

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

Co

rre

lati

on

(0-1

)

HIGHER CORRELATIONS lead to...S&P 500 Sector Correlation (60 day)

2000 to 2012

45

65

85

105

125

145

165

185

205

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

Vo

lati

lity

(%)

More VIOLENT VOLATILITY SPIKESVolatility of VIX index (60 day)

2000 to 2012

(0.80)(0.60)(0.40)(0.20)

-0.20 0.40 0.60 0.80 1.00

Au

g-0

3

Feb

-04

Au

g-0

4

Feb

-05

Au

g-0

5

Feb

-06

Au

g-0

6

Feb

-07

Au

g-0

7

Feb

-08

Au

g-0

8

Feb

-09

Au

g-0

9

Feb

-10

Au

g-1

0

Feb

-11

Au

g-1

1

Feb

-12

Au

g-1

2

Hedge Fund Strategies 12m Correlation to ATM Short Straddle on SPX

(HFRX Absolute Return, Equity Nuetral, Hedge Index, Merger Arb, RV Arb, Convertible Arb / Monthly)

BU

LL MA

RK

ET IN F

EAR

15

Fire Risk is High Today in the Forest Higher correlations are kindling for violent volatility fires (spike)

Extreme Volatility-of-Volatility and Hyper-Correlations

-0.4

-0.2

0

0.2

0.4

0.6

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

Correlation of $USD Index to VIX Index(1986 to 2012)

BU

LL MA

RK

ET IN F

EAR

Note: Prior to 1990 there was not VIX index. We have substituted the CBOE VXO index, the precursor to the VIX, which was available starting in 1986.

16

Volatility is a Shadow Currency in the Bull Market for Fear $USD currency index strength = Higher Volatility

Extreme Volatility-of-Volatility and Hyper-Correlations

BU

LL MA

RK

ET IN F

EAR

Volatility of an Impossible Object

17

How to beat a “Bull Market in Fear”

When Risk-Free is Risky… buy Volatility on Safety Itself! when a “bull market in fear” meets a “bubble in safety” bet on interest rate volatility

Fear is a better reason to buy than fundamentals Volatility (fear) is an effective leading indicator to inform asset allocation

The more we fear the left tail the more you should buy the right Tail risk pricing (both left and right) has been consistently late to the game

Hedge unknown unknowns and sell known unknowns When the market identifies a risk it is usually overpriced in volatility markets

40

60

80

100

120

140

160

180

200

220

240

11-Oct-12 6-Nov-12 3-Dec-12 28-Dec-12 25-Jan-13 21-Feb-13 19-Mar-13 15-Apr-13 9-May-13

Vo

lati

lity

of

VIX

(%

)

Forward Period

Fiscal Cliff or Volatility of Volatility Cliff?Predicted Volatility of VIX vs. Realized Vol of VIX

October 2012

Market Expected Volatility of VIX (local)

5yr Average Realized Vol-of-VIX

1yr Average Realized Vol-of-VIX

6mo Average Realized Vol-of-VIX

BU

LL MA

RK

ET IN F

EAR

Bet on unknown unknowns… don’t hedge known unknowns

18

Cheap Fear

Very Expensive Fear

US Fiscal Cliff

Volatility markets are surprisingly bad at predicting future risk

When markets identify a ‘known unknown’ that risk traditionally is overblown or at the very minimum over-hedged

Volatility of VIX was 200% on Oct 13, 2008 Maximum was 265% on Aug 29, 2011

1.0x

1.1x

1.2x

1.3x

1.4x

1.5x

1.6x

Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8

Forw

ard

Vo

lati

lity

Te

rm S

tru

ctu

re

Forward Volatility (October 2012) Historical Average Forward Volatility (since 2004)

BU

LL MA

RK

ET IN F

EAR

Bet on unknown unknowns… don’t hedge known unknowns

19

Sell “known unknowns” and Buy “unknown unknowns”… …monetize the bull market in fear by playing the term structure

Fear Arbitrage (Volatility futures & Options, SPX Vol Term Structure)

Known-Unknown Crash Unknown Unknown Crash

US EquityIntl. Equity (Dev)Intl. Equity (Emerg)UST 30yrUST 10yrHY BondsOilGold

0%

10%

20%

30%

40%

50%

60%

-3.0σ

-2.5σ

-2.0σ

-1.5σ

-1.0σ

-0.5σ

+0.0σ

+0.5σ

+1.0σ

+1.5σ

+2.0σ

+2.5σ

Pro

bab

ility

Of

Ret

urn

Expected 1yr Asset Return Distributionby Standard Deviation (Historical)

US EquityIntl. Equity (Dev)Intl. Equity (Emerg)UST 30yrUST 10yrHY BondsOilGold

0%

10%

20%

30%

40%

50%

60%

-3.0

σ

-2.5

σ

-2.0

σ

-1.5

σ

-1.0

σ

-0.5

σ

+0.0

σ

+0.5

σ

+1.0

σ

+1.5

σ

+2.0

σ

+2.5

σ

Pro

bab

ilit

y O

f R

etu

rn

Expected 1yr Asset Class Return Distribution by Standard Deviation (Historical)

BU

LL MA

RK

ET IN F

EAR

The more people fear the LEFT TAIL the more you should buy the RIGHT… and vice versa

20

Role of the trader is not so much to predict the future but to identify mispriced risk The options market is consistently late to the game in pricing both the right and left tails

financial crash options market is marked by the transfer of risk premium from the right of the return distribution to the left tail

2012 Pre-Crisis 2008

Right Tail Bias

Left tail bias

Cross Asset Implied Probability Distribution Comparison (2008 pre-crisis to 2012) Variance Swap Weighting { SPY, EFA, EEM, TLT, IEF, HYG, USO, GLD }

US EquityIntl. Equity (Dev)Intl. Equity (Emerg)UST 30yrUST 10yrHY BondsOilGold

0%

10%

20%

30%

40%

50%

60%

-3.0σ

-2.5σ

-2.0σ

-1.5σ

-1.0σ

-0.5σ

+0.0σ

+0.5σ

+1.0σ

+1.5σ

+2.0σ

+2.5σ

Pro

bab

ility

Of

Ret

urn

Expected 1yr Asset Return Distributionby Standard Deviation (Historical)

Note: Artemis calculates the implied probability distribution using interpolated weights from variance swap pricing. This methodology may give higher weightings to tails in down markets than more traditional methods like taking the second derivative of call prices, fitting mixture of normal PDFs to recover prices, or fitting vol models (SVI,SABR).

0%

5%

10%

15%

20%

-50% -43% -35% -28% -20% -13% -5% +3% +10% +18% +25% +33% +40% +48%

Cu

mu

lati

ve P

rob

abili

ty W

eig

hti

ng

One Year Gain/Loss % in S&P 500 index

Mirror Reflection: Deflation vs. HyperinflationS&P 500 Probability Distributions in different Regimes of Risk

1-year Gain-Loss%

Implied from March 2012 SPX options

Simulated from in 2013-2022 Hyperinflationary Model (1 scenario of 10k)

BU

LL MA

RK

ET IN F

EAR

The more people fear the LEFT TAIL the more you should buy the RIGHT…

21

Maybe it is correct to buy tail risk insurance ... but is everyone just hedging the wrong tail?

Note: Artemis created a model to simulate the behavior of the S&P 500 index and volatility during an inflationary shock. The model is not intended to be a prediction of the future but is merely a rudimentary stochastic-based method to understand what modern markets may look like in rampant inflation. The simulation runs 10,000 price scenarios for the S&P 500 index over 10 years modeling daily stock price behavior using a generalized Wiener process (Wiener.. not Weimar) and a drift rate that assumes linkages between annual CPI and equity performance. We assume inflation rises sharply from current levels of 2.87% in 2012 to 26% by 2015 and stays elevated at that level until 2017 (20% a year overall). The average volatility shifts are based upon assumptions regarding equity return to variance parameters observed in prior inflationary episodes (1970s US & 1920s Germany). The simulation shows annualized SPX returns for the decade at +9.94% but adjusted for inflation this drops to -9.8%.

…but it is a valuable exercise to theorize! … Volatility markets turn

0%

5%

10%

20.0%30.0%40.0%

0

500

1,000

1,500

2,000

2,500

15%20%

25%30%

35%40%

45%

50%

5yr UST Yield

Val

ue

of C

all O

pti

on

5yr implied vol

Double Convexity in Inflation Boom SPX 10yr OTM Call - 10K Strike

5 yrs to expiry/ SPX @ 3,000 (16% annual gain)

Future?

100

150

200

250

300

350

400

450

500

550

600

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Gro

wth

of

$1

00

Period of Steep Vol Slope (1yr VarK / VIX > 1.10)

S&P 500 Index

Tactical Allocation to S&P 500 during periods with Steep Vol Slope

75

175

275

375

475

575

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Gro

wth

of

$1

00

Period of Steep Vol Slope (1yr VarK / VIX > 1.10)

S&P 500 Index

Tactical Allocation to S&P 500 during periods with Steep Vol Slope

05

101520253035404550

1-1

88

15

-18

84

9-1

88

71

-18

91

5-1

89

49

-18

97

1-1

90

15

-19

04

9-1

90

71

-19

11

5-1

91

49

-19

17

1-1

92

15

-19

24

9-1

92

71

-19

31

5-1

93

49

-19

37

1-1

94

15

-19

44

9-1

94

71

-19

51

5-1

95

49

-19

57

1-1

96

15

-19

64

9-1

96

71

-19

71

5-1

97

49

-19

77

1-1

98

15

-19

84

9-1

98

71

-19

91

5-1

99

49

-19

97

1-2

00

15

-20

04

9-2

00

71

-20

11

Cyclically Adjusted PE Ratio

(Price to Average Inflation Adjusted Earning from past 10-years)1881 to 2012

BU

LL MA

RK

ET IN F

EAR

Fear over Fundamentals

22

It is hard to have a bear market in a bull-market for fear Volatility term-structure is an effective indicator to inform equity exposure

It pays to have exposure to stocks when markets are hedged! S&P 500 index portfolio exposure based on Vol Slope

1996 to 2012

0.5

1

1.5

2

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Ra

tio

Volatility Term Structure1-year Volatility / 1-month Volatility

BU

LL MA

RK

ET IN F

EAR

Risk Free Assets are Risky

23

When the “Bull Market in Fear” meets a “Bubble in Safety” a short equity option position and “risk-free’ UST bond have similar risk-to-reward payoffs!

0.00x

0.20x

0.40x

0.60x

0.80x

May-03 May-04 May-05 May-06 May-07 May-08 May-09 May-10 May-11 May-12

TLT 20+ US Treasury Bond ETF - 5% OTM Vol Skew

Yield to Risk / UST Bond vs. "Volatility Bond" (Collateralized Short Put on S&P 500 index)Investment Stress Test #1 Stress Test #2 Stress Test #3 Stress Test #4

Volatility Bond / Short SPX Put + Collateral SPX ↓ -9% SPX ↓ -14% SPX ↓ -25% SPX ↓ -50%

Yield MaturityEst. MTM

Loss

Historic Prob.

%

Risk to

Reward

Est. MTM

Loss

Historic Prob.

%

Risk to

Reward

Est. MTM

Loss

Historic Prob.

%

Risk to

Reward

Est. MTM

Loss

Historic Prob.

%

Risk to

Reward

SPX Put (Strike @-25%) 2.69% 1 year -2% 68% 1.373x -4% 39% 0.616x -11% 13% 0.242x -33% 2% 0.081x

SPX Put (Strike @2009 lows) 0.51% 1 year -0.4% 68% 1.319x -0.9% 39% 0.588x -3% 13% 0.176x -15% 2% 0.034x

US Treasury Bond UST Rates ↑ 100bps UST Rate ↑ 200bps UST Rate ↑ 325bps UST Rate ↑ 600bps

Yield MaturityEst. MTM

Loss

Historic Prob.

%

Risk to

Reward

Est. MTM

Loss

Historic Prob.

%

Risk to

Reward

Est. MTM

Loss

Historic Prob.

%

Risk to

Reward

Est. MTM

Loss

Historic Prob.

%

Risk to

Reward

US Treasury Bond / 10-year 1.87% 10 years -9% 68% 0.214x -17% 39% 0.113x -25% 13% 0.074x -41% 2% 0.045x

US Treasury Bond /30-year 3.09% 30 years -18% 68% 0.176x -31% 39% 0.099x -44% 13% 0.070x -62% 2% 0.050x

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

-65%-55%-45%-35%-25%-15%-5%

1yr Volatility Bond (short OTM SPX Put Option Collateralized)

Lond Dated UST Bonds

Risk / Unrealized Loss in Stress Test Scenario

SPX ↓ -9% to -14% 68% to 33% probability

SPX ↓ -50% 2% probability

10yr UST Bond

30yr UST Bond

SPX Short Put (Strike @-25% OTM)

Rates ↑ 320bps to 600bps 13% to 2% probability

Rates ↑ 100bps to 200bps 68% to 33% probability

Note: All data as of September 14, 2012. Estimated unrealized loss on position given stress test scenario. Historic probability data based on period of 1960 - 2012 for the UST bonds and 1950 to 2012 for the S&P 500 index. Option pricing based on estimated local volatility shifts, however actual shifts may differ from estimates during a real crash depending. All stress tests are assumed to occur close to the purchase period of the instrument. Unrealized losses may differ closer to maturity.

SPX ↓ -25% 13% chance

SPX Put Stress Test

UST Bond Stress Test

Risk / Unrealized Loss in Stress Test Scenario

Efficient Frontier / Risk to Reward Comparison Long Dated UST Bond vs. 1yr OTM Short Puts (collateralized)

Ret

urn

/ Y

ield

50

100

150

200

250

Oct-0

8

Dec-0

8

Feb-0

9

Ap

r-09

Jun

-09

Au

g-09

Oct-0

9

Dec-0

9

Feb-1

0

Ap

r-10

Jun

-10

Au

g-10

Oct-1

0

Dec-1

0

Feb-1

1

Ap

r-11

Jun

-11

Au

g-11

Oct-1

1

Dec-1

1

Feb-1

2

Ap

r-12

Jun

-12

Au

g-12

Oct-1

2

Interest Rate Volatility is Low... and a better bargain on a forward basis than equity vol

Merrill Lynch MOVE Index = VIX for UST BondsWeighted Volatility of 2yr,5yr,10yr & 20yr UST

BU

LL MA

RK

ET IN F

EAR

Risk Free Assets are Risky

24

Yield to Risk / UST Bond vs. "Volatility Bond" (Collateralized Short Put on S&P 500 index)Investment Stress Test #1 Stress Test #2 Stress Test #3 Stress Test #4

Volatility Bond / Short SPX Put + Collateral SPX ↓ -9% SPX ↓ -14% SPX ↓ -25% SPX ↓ -50%

Yield MaturityEst. MTM

Loss

Historic Prob.

%

Risk to

Reward

Est. MTM

Loss

Historic Prob.

%

Risk to

Reward

Est. MTM

Loss

Historic Prob.

%

Risk to

Reward

Est. MTM

Loss

Historic Prob.

%

Risk to

Reward

SPX Put (Strike @-25%) 2.69% 1 year -2% 68% 1.373x -4% 39% 0.616x -11% 13% 0.242x -33% 2% 0.081x

SPX Put (Strike @2009 lows) 0.51% 1 year -0.4% 68% 1.319x -0.9% 39% 0.588x -3% 13% 0.176x -15% 2% 0.034x

US Treasury Bond UST Rates ↑ 100bps UST Rate ↑ 200bps UST Rate ↑ 325bps UST Rate ↑ 600bps

Yield MaturityEst. MTM

Loss

Historic Prob.

%

Risk to

Reward

Est. MTM

Loss

Historic Prob.

%

Risk to

Reward

Est. MTM

Loss

Historic Prob.

%

Risk to

Reward

Est. MTM

Loss

Historic Prob.

%

Risk to

Reward

US Treasury Bond / 10-year 1.87% 10 years -9% 68% 0.214x -17% 39% 0.113x -25% 13% 0.074x -41% 2% 0.045x

US Treasury Bond /30-year 3.09% 30 years -18% 68% 0.176x -31% 39% 0.099x -44% 13% 0.070x -62% 2% 0.050x

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

-65%-55%-45%-35%-25%-15%-5%

1yr Volatility Bond (short OTM SPX Put Option Collateralized)

Lond Dated UST Bonds

Source: Bloomberg

When risk-free is risky … it is time to buy volatility on safety itself

Higher interest rate volatility can be realized in deflation and inflation

BU

LL MA

RK

ET IN F

EAR

Volatility of an Impossible Object

25 Illustration by Brendan Wiuff based on concept by Christopher Cole

Modern financial markets are an impossible object

Volatility of an impossible object is our changing perception of risk

BU

LL MA

RK

ET IN F

EAR

Volatility of an Impossible Object

26

the next “Unknown Unknown” Crash… What is not priced into markets that will seem as obvious in 10 years as it is

laughable today?

Today everyone is afraid of the next 2008

I am afraid of the next 1987…. possibly for stocks…

but more likely bonds

Fracture between the fundamental

and the abstract is a source of great risk

Bull Market in Fear is prepared for yesterday’s crash… you want to be hedged for what happens tomorrow

BU

LL MA

RK

ET IN F

EAR

Post-Modern Economy

27

Post-Modern Economy & “Simulacra and Simulation” Baudrillard recalls Borges fable about cartographers of a great empire who drew a detailed map

When the empire collapses the map is accepted as truth and the empire forgotten In the postmodern economy market expectations are more important to fundamental growth

than the reality of supply and demand the market was designed to mimic

What Baudrillard calls “the desert of the real” is what Bernanke identifies as the “wealth effect” The real economy is not slave to the shadow banking system… our economy IS the

shadow banking system… the empire is gone and we live in the abstraction

BU

LL MA

RK

ET IN F

EAR

Volatility can be more than just FEAR

28

Volatility is the perfect post-modern asset class for our existential economic future…

Volatility

Fiat Currency

Volatility Markets

BU

LL MA

RK

ET IN F

EAR

Truth and Volatility

29

Volatility as a concept is widely misunderstood. Volatility is not fear. Volatility is not the

VIX index. Volatility is not a statistic or a standard deviation, Black-Scholes input, or any

other number derived by abstract formula.

Volatility is no different in markets than it is to life.

Regardless of how it is measured volatility reflects the difference between the world

as we imagine it to be and the world that actually exists

We will only prosper if we relentlessly search for nothing but the truth, otherwise

the truth will find us through volatility

Volatility is an instrument of truth

the Truth is that Capitalism can save us… but First We Must Find a Way to Save Capitalism

BU

LL MA

RK

ET IN F

EAR

Christopher Cole, CFA – General Partner and Founder Contact Information Reference Material & Acknowledgements

30

Artemis Research:

Volatility of an Impossible Object: Risk, Fear, and Safety in Games of Perception

Volatility at World’s End: Deflation, Hyperinflation and the Alchemy of Risk, March 30, 2012

Fighting Greek Fire with Fire: Volatility Correlation, and Truth, September 30, 2011

Is Volatility Broken? Normalcy Bias and Abnormal Variance, March 30, 2011

The Great Vega Short- volatility, tail risk, and sleeping elephants, January 4, 2011

Unified Risk Theory - Correlation, Vol, M3 and Pineapples, September 30, 2010

Artwork:

"Volatility at World's End" by Brendan Wiuff 2012 / copyright owned by Artemis Capital Management LLC

"Volatility of an Impossible Object" by Brendan Wiuff / Concept by Christopher Cole 2012 / copyright owned by Artemis Capital Management LLC

“Jack-o-Lantern” Istock photo / used based on purchase of rights

“Ocean Waves” Istock photo / used based on purchase of rights

"Odysseus facing the choice between Scylla and Chrybdis" by Henry Fuseli 1794 / public domain

"Penrose Triangle, Devil’s Turning Fork & Necker’s Cube” Derrick Coetzee / Public Domain

"Liberty Leading the People" by Eugène Delacroix 1830 / public domain

Ocean wave pictures provided by istockphoto.com

Reference Material:

“Simulacra and Simulation” by Jean Baudrillard / University of Michigan / 1994

"A Tale of Two Indices" by Peter Carr & Liuren Wu December 22, 2005

“VIX Derivatives: A Poor Practitioner’s Model” Maneesh Deshpande / May 19 2011

“Understanding VIX Futures and Options” Dennis Dzekounoff; Futures Magazine/ August 2010

“The Volatility Surface: A Practitioner’s Guide.” Jim Gatheral / John Wiley and Sons, Hoboken, NJ, 2006

"Think Fast and Slow" by Daniel Kahneman / Farrar, Staus and Giroux 2012

“Options, Futures, and Other Derivatives” John C. Hull, Fifth Edition; Prentice Hall 2003

"Lifetime Odds of Death for Selected Causes, United States, 2007" / National Safety Council 2011 Edition

“Volatility Trading” Evan Sinclair, Wiley Trading 2008

"Dying of Money: Lessons of the Great German and American Inflations" by Jens O. Parsson / Wellspring Press 1974

"Economics of Inflation; A Study of Currency Depreciation in Post-War Germany" by Constantino Bresciani-Turroni Out of Print / 1968

“Variance Swaps” Peter Allen, Stephen Einchcomb, Nicolas Granger; JP Morgan Securities / November 2006

"Laughter in the Dark - The Problem of the Volatility Smile" by Emanuel Derman May 26, 2003

“Robust Hedging of Volatility Derivatives” Roger Lee & Peter Carr; Columbia Financial Engineering Seminar / September 2004

“More than you Ever Wanted to Know About Volatility Swaps” Kresimir Demeterfi, Emanual Derman, Michael Kamal & Joseph Zou; Goldman Sachs / March 1999

“The Performance of VIX Option Pricing Models: Empirical Evidence Beyond Simulation” Zhiguang Wang; Florida International University / April 2009

“Recent Developments in VIX Exchange Traded Products” Maneesh Deshpande/ April 3, 2012

"Deflation: making sure 'it' doesn't happen here" by Ben S. Bernanke (speech) / US Federal Reserve November 2002

"US Options Strategy TVIX Explosion Drives Vol-of-Vol Higher" Deutsche Bank February 23, 2012

"Unknown Unknowns: Vol-of-Vol and the Cross Section of Stock Returns" Guido Baltussen, Sjoerd Van Bekkum and Bart Van Der Grient / Erasmus School of Economics & Robeco Quantitative Strategies/ July 30, 2012

Definition of "Impossible Object" / Wikipedia / http://en.wikipedia.org/wiki/Impossible_object

BU

LL MA

RK

ET IN F

EAR

Christopher Cole, CFA – General Partner and Founder

Artemis Vega Fund L.P. Artemis Capital Management, L.L.C.

520 Broadway, Suite 350 Santa Monica, CA 90401

info@artemiscm.com www.artemiscm.com

Christopher Cole, CFA

Managing Partner & Portfolio Manager (310) 496-4526 phone

(310) 496-4527 fax c.cole@artemiscm.com

Contact Information Artemis Capital Management – Contact Information

31

Christopher Cole, CFA

Managing Partner & Portfolio Manager / Artemis Capital Management LLC

Christopher R. Cole, CFA is the founder of Artemis Capital Management LLC and the portfolio manager of the Artemis Vega Fund LP. Mr. Cole’s core focus is systematic, quantitative, and behavioral based trading of exchange-traded volatility futures and options. His decision to form a fund came after achieving significant proprietary returns during the 2008 financial crash trading volatility futures. His research letters and volatility commentaries have been widely quoted including by publications such as the Financial Times, Bloomberg, International Financing Review, CFA Magazine, and Forbes. He previously worked in capital markets and investment banking at Merrill Lynch. During his career in investment banking and pension consulting he structured over $10 billion in derivatives and debt transactions for many high profile issuers. Mr. Cole holds the Chartered Financial Analyst designation, is an associate member of the NFA, and graduated Magna Cum Laude from the University of Southern California.

Key Information/ Biography

LEG

AL D

ISCLA

IMER

Legal Disclaimer

THIS IS NOT AN OFFERING OR THE SOLICITATION OF AN OFFER TO PURCHASE AN INTEREST IN ARTEMIS VEGA FUND, L.P. (THE “FUND”). ANY SUCH OFFER OR SOLICITATION WILL ONLY BE MADE TO QUALIFIED INVESTORS BY MEANS OF A CONFIDENTIAL PRIVATE PLACEMENT MEMORANDUM (THE “MEMORANDUM”) AND ONLY IN THOSE JURISDICTIONS WHERE PERMITTED BY LAW. AN INVESTMENT SHOULD ONLY BE MADE AFTER CAREFUL REVIEW OF THE FUND’S MEMORANDUM. THE INFORMATION HEREIN IS QUALIFIED IN ITS ENTIRETY BY THE INFORMATION IN THE MEMORANDUM.

AN INVESTMENT IN THE FUND IS SPECULATIVE AND INVOLVES A HIGH DEGREE OF RISK. OPPORTUNITIES FOR WITHDRAWAL, REDEMPTION AND TRANSFERABILITY OF INTERESTS ARE RESTRICTED, SO INVESTORS MAY NOT HAVE ACCESS TO CAPITAL WHEN IT IS NEEDED. THERE IS NO SECONDARY MARKET FOR THE INTERESTS AND NONE IS EXPECTED TO DEVELOP. NO ASSURANCE CAN BE GIVEN THAT THE INVESTMENT OBJECTIVE WILL BE ACHIEVED OR THAT AN INVESTOR WILL RECEIVE A RETURN OF ALL OR ANY PORTION OF HIS OR HER INVESTMENT IN THE FUND. INVESTMENT RESULTS MAY VARY SUBSTANTIALLY OVER ANY GIVEN TIME PERIOD.

CERTAIN DATA CONTAINED HEREIN IS BASED ON INFORMATION OBTAINED FROM SOURCES BELIEVED TO BE ACCURATE, BUT WE CANNOT GUARANTEE THE ACCURACY OF SUCH INFORMATION.

32

DISC

LOSU

RE

General Disclosure Statement

An investment in the Partnership and strategies discussed in this document involve a number of significant risks. For a full list of potential risk factors please review the

Offering Memorandum. Prospective Limited Partners should read the entire Memorandum and the Partnership Agreement and consult with their own advisers before

deciding whether to invest in the Partnership. In addition, as the Partnership’s investment program develops and changes over time, an investment in the Partnership may

be subject to additional and different risk factors. Prospective investors should also consult with their own financial, tax and legal advisors regarding the suitability of this

investment. Artemis Capital Management, L.L.C. does not guarantee returns and investors bear the risk of losing a substantial portion of or potentially their entire

investment.

All 2009 performance numbers quoted within this document are derived from financial statements that were audited by Spicer Jeffries. Proprietary trading results for

White Fox, LLC (the “Proprietary Account”) are presented within this document that were verified by Spicer Jeffries. The Principal of the General Partner, Christopher R.

Cole, used the Proprietary Account as a vehicle to incubate the investment strategy of the Partnership with personal funds as well as those of close family members. Note

that no management or performance fees were charged to the Proprietary Account profiled. Accordingly, the Pro Forma Performance presented in this document includes

imposition of a 2% Management Fee and 20% Performance Allocation (in line with those charged against the Partnership).Past performance is not indicative of future

returns.

Commodity Pool Operator Disclosure Statement

YOU SHOULD CAREFULLY CONSIDER WHETHER YOUR FINANCIAL CONDITION PERMITS YOU TO PARTICIPATE IN A COMMODITY POOL. IN SO DOING, YOU SHOULD BE

AWARE THAT FUTURES AND OPTIONS TRADING CAN QUICKLY LEAD TO LARGE LOSSES AS WELL AS GAINS. SUCH TRADING LOSSES CAN SHARPLY REDUCE THE NET

ASSET VALUE OF THE POOL AND CONSEQUENTLY THE VALUE OF YOUR INTEREST IN THE POOL. IN ADDITION, RESTRICTIONS ON REDEMPTIONS MAY AFFECT YOUR

ABILITY TO WITHDRAW YOUR PARTICIPATION IN THE POOL.

FURTHER, COMMODITY POOLS MAY BE SUBJECT TO SUBSTANTIAL CHARGES FOR MANAGEMENT, ADVISORY AND BROKERAGE FEES. IT MAY BE NECESSARY FOR

THOSE POOLS THAT ARE SUBJECT TO THESE CHARGES TO MAKE SUBSTANTIAL TRADING PROFITS TO AVOID DEPLETIONS OR EXHAUSTION OF THEIR ASSETS. THE

OFFERING MEMORANDUM CONTAINS A COMPLETE DESCRIPTION OF EACH EXPENSE TO BE CHARGED THIS POOL AND A STATEMENT OF THE PERCENTAGE RETURN

NECESSARY TO BREAK EVEN, THAT IS, TO RECOVER THE AMOUNT OF YOUR INITIAL INVESTMENT .

THIS BRIEF STATEMENT CANNOT DISCLOSE ALL THE RISKS AND OTHER FACTORS NECESSARY TO EVALUATE YOUR PARTICIPATION IN THIS COMMODITY POOL.

THEREFORE, BEFORE YOU DECIDE TO PARTICIPATE IN THIS COMMODITY POOL, YOU SHOULD CAREFULLY STUDY THE OFFERINGMEMORANDUM, INCLUDING A

DESCRIPTION OF THE PRINCIPAL RISK FACTORS OF THIS INVESTMENT.

YOU SHOULD ALSO BE AWARE THAT THIS COMMODITY POOL MAY TRADE FOREIGN FUTURES OR OPTIONS CONTRACTS. TRANSACTIONS ON MARKETS LOCATED

OUTSIDE THE UNITED STATES, INCLUDING MARKETS FORMALLY LINKED TO A UNITED STATES MARKET, MAY BE SUBJECT TO REGULATIONS WHICH OFFER DIFFERENT

OR DIMINISHED PROTECTIONS TO THE POOL AND ITS PARTICIPANTS. FURTHER, UNITED STATES REGULATORY AUTHORITIES MAY BE UNABLE TO COMPEL THE

ENFORCEMENT OF THE RULES OR REGULATORY AUTHORITIES OR MARKETS IN NON-UNITED STATES JURISDICTIONS WHERE TRANSACTIONS FOR THE POOL MAY BE

EFFECTED.

33