Investing Billions - E189: Inside the Goldman Sachs Prop Desk: Lessons from a Top Trader w/Nancy Davis

Episode Date: July 21, 2025

Nancy Davis spent nearly a decade on Goldman Sachs’ legendary prop desk before founding Quadratic Capital, the firm behind the popular iVol ETF. In this episode, we dive deep into her options-based approach to investing, why she believes most investors manage risk backward, and how her firm is positioning for a potential return of stagflation. We also talk about her early days at Goldman, the psychological traps investors fall into, and why she thinks humility and coachability are underrated superpowers in finance. If you’ve ever wanted to understand volatility, inflation protection, or how to think like a derivatives trader—this episode is for you.

You started at the Goldman Sachs prop desk, which had a much sexier, less politically correct title at the time. I think it was called Risk Arbitrage. What was it like working on the Risk Arbitrage desk in Goldman Sachs in the 1990s? It was amazing. I loved every second of my time there and I felt so privileged to be part of that team. We did not touch anything to do with clients, so all we did was invest Goldman's capital. We were actually not allowed to trade with Goldman for the majority of my time there,

so we traded outside like a hedge fund essentially with other outside firms. But it was an amazing experience. I had some of the best mentors and high quality people around me and it was a joy and I feel very privileged to have been there. One of the most interesting things about what you did is you traded internal partner's money versus end client money. How did that change the nature of your investment strategies or risks you could take? How we invested was essentially using debit cards. So we used nonlinear derivatives, specifically options, and we

sized based on the most we could lose. When I started at Goldman, that was prior to the IPO of the firm. The firm IPO'd in 99. And it was just a really interesting way to think about managing risk, which is essentially sizing your risk the day that you invest and then profit-taking when that investment makes money versus kind of the rest of the world uses stop losses, which is sort of the opposite where you take risk and then you risk manage when the position doesn't go your way. Intuitively it feels like it makes sense to put in stop losses to manage the risk in your

portfolio. Why are you anti-stop losses and why do you believe in managing your portfolio the way that you do? You put in your stop loss the day that you implement your investment, because when you buy an option, very simply, you pay the premium upfront.

So that's my metaphor analogy to being a debit card. You fully pay for it and you can never lose more than that amount of stock loss at the beginning. And then your risk management is more about profit taking, whereas traditional stock losses, you set your risk with linear instruments, whether they're stocks, bonds, using derivatives, whatever it is, and then you risk manage after you lose money. Essentially, with our risk management style, we're always buying low and selling high because we're profit taking. If you think about a traditional, I don't know, let's just say

a traditional CTA, they try to replicate an option payoff by executing very quickly when that stop loss is breached, but that demands liquidity in the market and also the ability to trade. So if, you know, like March 2020 when oil went negative, that was the moment I was like, oh my goodness, this is going to really break a lot of people because there's no way to execute necessarily when you have these shocks. To use a simple analogy, it's instead of buying something at 100 and then having a stop loss at 90, you're paying the $10 upfront. And then if it doesn't execute, it goes down to zero, but it's essentially the same loss.

The difference there, when there's a stop loss, you're actually selling at the exact wrong time. You said that very well, David. And I think the other thing that's so interesting is we, we don't use leverage in the sense that we're not borrowing money, but we have the asymmetry from the option payoff. So when you, you know, size something, if you're buying an asset at a hundred, when it goes up to 110, instead of

making $10, we make an asymmetric amount on our premium at risk. So, having that nonlinear payout, a positive nonlinear payout is very attractive, I think, because when you're right, you have multiple times of what you had at risk. And when you're wrong, you know what your risk is. There's this psychological aspect and people get into these, I guess, death spirals where they might lose 20% of stock and they can't sell it because they can't take the loss. And yet sometimes options are seen as much more risky. And of course, they're a very sophisticated instrument. But it seems that the lack of self-awareness could actually be much more risky than actually, like you

said, using a debit card paying and knowing that that's what you're likely to lose. Something about that psychologically seems more predictable. Our philosophy is very unusual, right? We're probably the only firm that you've talked to that the options are the portfolio, right? Is that true, David? That is true. That is true.

Like, that's a strategy. But if you think about it, if you just close your eyes, most people have their core portfolio and then the options around the periphery, right? They're either selling options as a way of kind of overriding generating income or they're buying options for hedge hedges. But either way, those two, you know, type of strategies, both of them are trying to lose money in the options, right? That's their goal is to have the options, you know, expire worthless because it's not their their core portfolio. For us, we just turn that around. And the options are our core investment. And I think it's not their core portfolio. For us, we just turn that around and the options are our core investment.

And I think it's a really good source of alpha because most people are not trying to make money in the options themselves, whereas we are. So it's just a variant perception. Reason I have this psychology framework is actually my own previous experiences. I got caught in this deft trap. It's very vicious. The opposite is actually true as well, which is once you have a gain, there's this kind of knee-jerk reaction to sell.

The most common example of this is in Bitcoin. A lot of people bought at 100 and sold at 135 and thought they were geniuses. Sometimes you're also selling too soon and sometimes you're not selling soon enough. There's a lot of psychology around that. When I was preparing about this interview and I asked about you, somebody at JP Morgan said that you had some of the biggest trades on Wall Street at the time in the world, in the entire market. And then when I clarified, it wasn't actually Goldman Sachs, it was you, Nancy Davis. So what are some of those trades? On behalf of Goldman Sachs.

On behalf of Goldman Sachs, yes, disclaimer. But what were some of those markets and how did you end up being the largest player in some of these markets? It was definitely an amazing time and sizing positions with options. We were doing things that people were not doing in the market. What I found very early on is that if you have also the delta exposure, so you're not trying to just capture that implied volatility difference, you're actually expressing your directional view with options. It's a really great way to make money because you can have the exposure to the underlying asset

class directionally, but also have all the Greek risks with, you know, as that position works, we tend to roll our strikes. So, you know, say in your example, if you, you know, whatever, we don't trade Bitcoin, but, you know, just, just for example, you buy something for 100 and it goes to 135 instead of just saying, okay, we're going to sell it and be done like a Delta one portfolio would do. We would just roll our option strikes and reset the convexity. And it's a way of actually locking in our profits, which we did with Silicon Valley Bank. We definitely had a huge move very quickly in the rates market. And in hindsight, I wish I sold more and rolled more aggressively. We didn't do enough because with the BTSP, the market kind of normalized very quickly.

But I think having that rigor and rules-based way of investing where you're just constantly profit-taking as the strategy works. When we last chatted, you mentioned that the market is no longer concerned with inflation, which really shocked me, maybe naively. How do you know that the market is no longer concerned about inflation? You can see where it's pricing. When I started my career in Goldman in the late 90s was right when the treasury started the inflation protected bond market.

So tips are pretty new product. They only started in the late 90s. So a lot of people, when they want to add inflation to their portfolio, they're looking at things that were around in the 70s or 80s. And I like to grab people and say, look, the inflation markets are new. They, you know, a lot of people don't look at inflation because it didn't exist back then. And then the interest rate derivative markets, that's even newer than tips. Let's just take tips for a second. Tips reset with one index, which is the consumer price index. For the next 10 years, the market is pricing CPI inflation to be around 2.3%, 2.4%. So I think there's not a lot of inflation premium priced into that market. For instance, just in the COVID

shock, the 12-month realized CPI hit 9.1%. So it's really kind of hugging that long term target of 2 percent where the Fed's expecting it. So to me that's pretty asymmetric. The 10 year right now is 2.4. The five year is 2.45. So the inflation curve is downward sloping, meaning the market is pricing in that CPI is going to fall in the future. The Fed sets a policy rate, but the market sets a term premium interest rates. And it's a really crazy, crazy time because the yield curve inverted in 2022. And it stayed inverted for three years. It's never happened before that the yield curve went as negative as it did and for as long as it did in the history of financial markets. So now in 25, the 2s 10s spot curve, for instance, and I'm looking at the swaps market just went

positive in 25. And so it's a really, really exciting time to capture that. So backing up to your time at Goldman, you spent a decade at Goldman Sachs working on the risk ARB deck, which is the proprietary fund. And York was some of the smartest people on the face of the planet at that time, at least. What were some lessons that you learned while at your time at Goldman? As we talked about in the opening of your podcast, really having that different way of managing risk and getting exposure, that was probably number one. But I think it was also just an incredible place to work because I had so much intellectual

firepower and culture around me, especially as a young trader. You know, I worked at Goldman in my 20s, right? It was a really wild time. I was very young, but the prop desk was a very, very flat environment, and being in a real meritocracy, especially being, you know, I would say somewhat bubbly,

you know, long bond hair. I've always had that. I've always been, you know, a smile and giggle when I get nervous. You know, I don't know if I would have made it if I was on the South side, because I wasn't, you know, a very kind of normal trader. But being on the prop desk was just an incredible place

to be and I spent, not my entire 10 years at Goldman. I was there for almost 10 years. It was like not quite a decade, but about 10 years, a little shy of it. And the majority of my time was with this, what used to be called, when I joined it was Risk Arbitrage, but we had a couple of different name changes over the years. But it was a super cool place to be. And I'm very grateful for those people that I worked with and the knowledge and kind of differentiated way of managing risks that I took away after I left. Several institutional investors that know you have said that you're very good at being mentored.

What exactly does that mean? And break down that skill set for me. that know you have said that you're very good at being mentored. What exactly does that mean? And break down that skill set for me. I think I'm coachable. And I think kind of keeping humility and not thinking, you know, when people give you feedback, A, being grateful for that feedback and B, trying to change. You know, I'm always, and B, trying to change. I consider myself a lifelong learner.

For instance, I've been running my own firm as an entrepreneur for 12 and a half years. It's longer than my time working at Goldman. There are not a lot of women out there who go and create their own asset management firm and run a company. There are a lot of things that I've had to learn that I never had any experience with. I'm always grateful for feedback from everyone about how to continue to improve. I think having that mindset that when someone gives you critical feedback, it's to help you. And I think that's always how I took it.

And that's probably how it helped me kind of rise up quickly during my time at Goldman is I am coachable. Like I'm not perfect. I make mistakes all the time. My goal though is to know when I make a mistake and not do it again, right? And always be learning. You know, I'd a mistake and not do it again, right? And always be learning. I'd never been a CEO before,

I'd never run a business before. There are a lot of new things that I had to learn and a lot of mistakes that I made, but I tried to correct as I made them and figured out I was doing things wrong to fix those issues. If you asked 100 people on whether they like feedback or they like to be coached, I'd say probably 95 to 99 would say yes, but the reality would speak

differently. And the way that I think about it is that people like to get feedback in the abstract, but not always in the specific case. And that is because there's almost this spiritual fight in everybody in terms of getting better and preserving their ego. And at the time when that feedback is delivered, most people, as a default, unless you train your mind, your default is to go into ego preservation mode, which is kind of an evolutionary predisposition, which leads to two things. One obvious thing, one is you don't get the feedback, so you don't learn. But two is also something to keep in mind is that if somebody comes to you, delivers feedback, and you do anything but smile and say thank

you and constantly positively condition that person for giving that feedback, they're unlikely to do it again. So you also have to think about it from the perspective of the feedback giver, which is they have a strong insight of not to give feedback for that same very reason that most people go into this ego preservation mode. You almost can't overthink somebody for feedback because there's such a reluctance to provide feedback. We'll get right back to interview, but first we're looking for the next great guest.

If you or someone you know is a Capital Allocator and would make for a great guest, please reach out to me directly at David at WyspiritCapital.com. What's your most contrarian take for the market for the rest of 2025? My most contrarian? I mean, people are pretty euphoric right now on equities are near all-time highs. I'd say the most contrarian take that I would have would probably be the stagflation word, which I know is a really dirty, awful word, but I think there's, you know, there's really no guarantee that, you know, things are going to continue as they

are. And I do think stagflation is one of the risks that Eibol can help potentially mitigate. But I do think it's kind of the disaster node for most people, right? That's where, you know, specifically a 60-40 portfolio really has problems. So I think I don't know that that's going to happen, but I do know that it's not priced into markets. And implied volatility in particular has fallen tremendously from where it was around Silicon Valley Bank. So to me, having that long optionality payoff is a really contrarian view because most people are not worried about volatility or kind of anything surprising the market. And that to me is a buying opportunity.

And stock inflation being high inflation, slow economic growth, and high unemployment, kind of a triple death spiral. Yeah, and that's especially bad for credit. I think that's the worst performing asset class historically is things with credit risk. And so I know some of our really smart clientsVol as a spread product, but without adding credit spread, it adds rate spread and as a potential diversifier, just in case that does happen. Nancy, this has been a masterclass on options, on derivatives. What would you like our listeners to know about you,

about Quadratic, or anything else you'd like to share? That's so open-ended, David. We're an open book. I'm happy to talk to people. I'm very accessible. Our products are ETFs, so they're fully transparent. It's kind of like a managed account where you can see all the holdings, all the positions. So we have our ETF websites. If you want to contact us, learn more about it. Do you want me to

give the website? Sure. So the iVol website is just iVol, not iVol, it's i-V-O-L, ETF.com. And on that you can see all the, you know, the prospectus, the SAI, all of our materials, even our white paper is there for financial professionals to read up about, you know, these macro environments like risk off, risk on and stack inflation and how eyeball could potentially help. Well, I'm due for a trip to Greenwich, Connecticut. I look forward to continuing this conversation live.

That would be awesome. I look forward to meeting you in person. Thank you, Nancy. Thank you. Thanks for listening to my conversation. If you enjoyed this episode, please share with a friend. This helps us grow,

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