Odd Lots - Why the Short Volatility Trade Is Back and Bigger Than Ever

Episode Date: January 29, 2024

There are plenty of one-off risks at the moment, but it seems like betting on pretty much nothing happening is more popular than ever. Investors are increasingly reaching for a wide variety of derivatives to bet against volatility. Those derivatives include one- and zero-day options which expire in 24 hours or less, and have become a hot button topic on Wall Street. So what's the impact of this explosion in options trading? Why is it happening at a time when the possibility of major disruptions seems more likely than ever (even if realized volatility remains low)? And what impact could it have on the wider market? In this episode, we speak with Kris Sidial, Co-CIO of Ambrus Group, about the return of the short vol trade.See omnystudio.com/listener for privacy information.

Thanks for listening to Odd Lots. Follow the show on Amazon Music for more future episodes or just ask. Alexa, play the Odd Lots podcast on Amazon Music. Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway. And I'm Joe Wisenthall. Joe, do you know what's coming up? The Odd Lots Pub Quiz. That's true. Also Valentine's Day, I guess. Oh, yeah, that's a little bit later on. What else you have in mind, Sheldon?

Do you celebrate the anniversary of Volmageddon? Do I celebrate it? Yeah. I mean, gee, who doesn't? No, I don't celebrate it. But that was such a formative moment. So that was February, when was the day? 2018.

So it's the six-year anniversary. That was one of, like, our first, like, really good episodes where we sort of had a good, we talked about what blew up the short VAL, ETF, XIV. I feel like if we go back through our history, that was, like, an important episode. Wait, don't say that was one of the first good ones because we were doing this for years before 2018. You're right. We've had many good ones. I think that was like a, that was a good one. It was a highlight. It was a highlight. Okay. Yes, okay. Um, well, I do in fact celebrate the anniversary of

Volmageddon because I always enjoy going back to tweets around that time because there are a lot of volatility traders on social media who have very strong and often erroneous opinions. And one of the opinions they were holding around January 2018 was that everything was fine. Yeah. Shortfall was this perpetual moneymaker, no issues with the two volatility exchange traded notes that eventually ended up blowing up, one of which was XIV, as you pointed out. And I remember tweeting things in January of 2018 stuff like if the VIX curve inverts, which was about to happen, this would be an absolute disaster for XIV. And I had a bunch of people pushing back complaining about the access on my chart. And lo and behold, about a week later, XIV, not only blew up, but was dead within a couple of days and actually roiled the market as well.

I remember it was very popular XIV, this vehicle. And there was a sound intuition about it, I think, which is that, you know, is this basically betting against the VIX. And you start with the assumption that, okay, people systematically and perpetually overpay for downside protection, understandable. people pay for insurance. And so you can harvest that premium basically by taking the other side. And that by and large, shorting vol is a sort of like a good way to a way that people supercharge the returns. And look, like a core thing is that when we talk about vol, I think like we are mostly in life short vaul, anyone who owns stocks for a long period or any period is short vol or sort of like VAL is bad for portfolios, et cetera. So like when we talk about specifically short, VAL, though, then that's where it gets interesting.

Yeah. So this is one of the things that I find very remarkable about our current moment, which is that, you know, shorting VAL post the 2008 financial crisis became a very popular strategy because you had low interest rates. So people wanted to pick up yield wherever they could. Yeah. You also had central banks out there in the market literally crushing volatility. So you knew that there was the put that sort of existed over the over the over.

overall market, so why not trying to monetize it? There wasn't a lot going on up until 2018, so it made sense to bet on nothing, basically, on things not happening. But what I find really fascinating about the current moment is we seem to be seeing a return of that short volatility trade. So you and I have discussed on this podcast, these shorter dated options, one or zero Diodated options becoming incredibly popular, absolutely exploding in terms of volume. There's other types of derivatives that are also becoming more popular. And yet, when I look around at the market, it seems like there is so much potential for one-off events.

You know, the Fed is hiking rates. We have geopolitical risk, as we always talk about, joke about on the show. Supply chain disruptions. The chance of one-off events actually happening seems greater than ever. yet shorting vol is popular and measures of vol itself remain pretty low. The VIX is pretty low. The volatility of the VIX index. The VVIX is really low. So I think we need to ask why is short fall back and why is it particularly popular at this moment in time? And what does it mean for the wider market? Let's do it. I am very happy to say that we do in fact have the perfect guest.

We're going to be speaking to Chris Sidial. We've had him on the podcast before. He is the co-CIO of Ambrose Group, and he is now officially one of my favorite guests ever because he brought us donuts. And if I sound more energetic than normal, it's because I'm currently on a sugar rush. And also I'm talking about volatility. And you took a Zinn this morning. I did not. Although you tried to get me one. Can you imagine if I had a donut and Zinn at the same time? That would be bad. Okay. Chris, thank you so much for coming back on Odd Lots. Thank you so much for having me. So when we talk about short volatility, you know, Joe and I discussed it a little bit in the intro, but what is the expression of going short volatility?

Yeah, the expression of going short volatility is taking a bet that the normality will continue, right? So effectively, if you are betting on long volatility, you are pretty much betting on the abnormality taking place. So, I mean, I said it in the beginning, but I sort of think that most like that. in investing is implicitly short. Well, if you have SPY in your retirement account, then, you know, you think it's just generally going to go up very time. That is normal. That is, so as you, but per your definition, that is an implicit short volatility. How does it get expressed in the options market? And, or maybe a question is, why do people make that bet in the options market,

rather than just going the implicit route of being long risk assets? Yeah, because I think It's something that generally pays off the majority of the time within the spread as to how you can trade it. It's this embedded risk premium that, I mean, sure, people could argue that there's an equity risk premium as well. But the expression towards how you apply this, whether it's short S&P puts, short fix calls, short variant swaps, it has a tendency to win the majority of the time. And this expression lulls market participants into very poor habits of expressing the trade. Imagine you have taken a trade and you're going to win 90% of the time. And when the trade is working against you, you're adding more size and you're adding more conviction over the course of years. When the trade is beginning to work against you, you have a tendency to believe that this is just another one of those cases.

Right. It's like being rewarded for buying the dip. If you do it over and over again, you're going to feel this conviction towards it. But in short volatility terms, eventually it catches up and it all goes wrong at once. Yeah. The journalistic euphemism that was usually deployed is picking up pennies in front of a steamroller, right? So why don't you talk to us about the numbers that you're seeing in the market? We say short vol seems to be back and bigger. than ever. What are the actual figures around that? Yeah. So I think it's important for listeners to have a little bit of an understanding of my background and why it is we track these numbers. So I was a prop trader on two different desks, chimera securities and Xanthus Capital. And then I went to a large Canadian investment bank. I spent three and a half years there. And also my time was spent trading exotic derivatives. Then myself and a couple of my partners who are XCTC, ex-Citadel guys, we got together and we said, hey, we could run this carry neutral tail risk strategy, which effectively,

when volatility is exploding, it's going to have this massive return. But when markets are dormant, we use a lot of short-term proprietary trading to be flat. So you'll have foundations, high-networked individuals, family offices that will use something like this as a hedge in their portfolio. Because of that, we need to understand the derivative market micro-structure. And Also the ecosystem, understanding how certain agents in that ecosystem are participating with one another. So over the last year, what started to come up in the data was that the short volatility trade was coming back in huge size. So when you think about the S&P complex and the VIX complex, the net short vaguenotional today is two times higher than where it was during January of 2020. 2018, which was the month right before Volmageddon.

This is when we're going to have to define Vega. Vega notional. Tell us what we're going to do it. We should just do all the Greek letters and just cut them out of the way right now. But Vega. Yeah. So in in Vol terms, right, think one point of a vol move and how much you'll make or lose. Okay.

Right. So if you're net long a million bucks of Vega and volatility moves up one ball point, you'll make a million bucks. Okay. Vice versa, right? So what that's saying today, that number, the netting short exposure, is two times higher than where it was during January of 2018, which is right before Ballam again. Additionally, and I sent you guys this chart from Morning Star, which is such a crucial

chart in my opinion, these derivative income generating funds, the AUM in these have increased by over 10x since January 2018, right? That's another sort of fact that's pretty insane to think about. What's the definition of a derivative income fund? Yeah, so it's the same thing as to what we were talking about at the beginning of the pod, where we said different expressions towards harvesting these volatility risk premium traits. Join Bloomberg in New York or via live stream on May 19th for building an AI future ready business. This event will examine how organizations are moving beyond experimentation to scale agentic AI across the enterprise.

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Listen to leading by example, executives making an impact on the IHeart radio app, Apple podcast, or wherever you get your podcast. It's intuitive to me why there was so much interest in these income generating derivative strategies during the ZERP years when you couldn't just generate income by going out and buying a government bond. But now you can get 5% or whatever. So why do people go to the exotic route for income generation when they're a very plain vanilla things that actually pay yield these days? I think 2021 is a year that will go down in the derivative history books because what happened

during that year was you had a slew of new mandate additions between, large foundations, pensions, RIAs, endowments, mainly because of what transpired in 2020. You had a really big vol move in 2020, and then also in Q1 of 2021, you had the whole meme stock sort of debacle. So if you were a large institution that did not have exposure to derivatives and that type of mandate, you almost looked at as archaic in a way, right? So at that time, a lot of these institutions said, we want to start trading options. Simultaneously, what was going on was the exchanges started listing more and more tenors, right? So you started having seven days till expiration options, five days till expiration,

zero days till expiration. And a lot of the consultants at these larger institutions started realizing, well, back in the day, if we wanted to sell a 20% out-the-money S&P put, we have to wait one quarter to collect five bucks in premium terms, right? Today, we could sell a zero DT option for 50 cents and do that 20 times over and over and over. And what this does on paper is that it changes the path dependency, right? So you really won't get hurt for one little thing happening at the end of the month or the end of the quarter. The problem with that is that on paper, it looks like that. you run certain correlations, you realize that you're still taking the same exact trait. Because if

you wake up tomorrow and you say balls are up, five ball points across the ball surface and the term structure, you're going to realize that seven days till expiration option and the one month till expiration option are both going to be negatively impacted. Maybe this is a good chance to talk about the ecosystem of the options world. So setting aside the derivative funds, which are buying these things, someone is also selling them the options, usually the market makers or the dealers. So what is the role of market makers in this process? And then also, I'm curious how cheap it is to go short volatility in general now, because this was also a hallmark of the 2010s, which was it was pretty cheap to do these trades, right? And so that was also another part of the appeal.

Like, why not just pick up a little extra yield for not that much money? Right. So in the ecosystem, the market makers play a very unique role because if you look at some of the data that some cell side research desk put out, it's not really entirely correct because a lot of these desks like to take a certain narrative. But that positioning, changes day by day with these market makers. So it's not to say that every single day, their long gamma or short gamma. It's at certain moments where that positioning becomes unbalanced and can really create that more cascading effect. In cheapness and richness and volatility terms, we're seeing one of the lowest levels of tail exposure that we've ever seen. Huh. And this is something

that is really surprising because everybody understands you shouldn't sell tilts. That was something that people learned in 2008, 2018, 2020, yet that exposure keeps making its way back into the market. And right now, forward-skew that like 30 days out skew, and I'm not trying to get super esoteric with the Vol terminology, but just that type of wingy exposure. has been oversupplied over the last, let's call it, six to nine months. So, wait, sorry, just to be clear, there is not currently a lot of people buying de facto tail insurance right now.

Correct. Not at all. It's weird. I mean, I guess on some level, I'm surprised because, right, like things seem crazy and there's wars going on and people are concerned about what the Fed is going to do and the economic environment is uncertain and the political environment is uncertain. On one level, it feels like it would be an environment that would be, oh, I want to grab tails. I want to buy insurance. On the other hand, the stock market is at all time highs, volatility is low, clearly just looking at financial markets. This is not a market environment in which many people seem particularly concerned about very much. Well, why would you buy tails?

Think about this. It's been four years since the last real fall move. So in the face of rising inflation, in the face of a declining S&P in 2022, in the face of a mini banking crisis, in the face of all those things, you've been able to sell VAL and make money. This is why, so some of the data that we track is like U.S. equity shortball hedge funds. That AUM has grown six times since 2018. Why would that AUM grow? Because those funds are doing insanely well. Because you've been able to sell volatility left and right and really just get away with it.

A generic straddle selling program, like without having any sort of true quantitative input, you just wake up every day and sell straddles, has made money hand over fist over the last four years. Could it be the case? You mentioned the shorter tenors that are now available, and this has been a much discussed point among market commentators. The impact of zero and one-day options, ODTE and one-D-TE. Could it be the case that people are buying less tail-risk exposure or extreme downside protection in favor of maybe hedging themselves on a day-to-day basis with the shorter dated options? So what we're seeing is that during certain events, that's the case. However, that doesn't take away for the reach that you have in that 30-day exposure,

because when you look at the volume across the VIX complex and you look at the volume traded in that 30-day exposure, it's still heavy. It's still there. So people that are saying, well, nobody's going to hedge with 30-day options anymore because they're hedging with zero DT so the VIX so the VIX won't go up. That's really a bad view. And there's one real point that I'll bring up that will push back on that in a pretty large way. If you are an institution, a multi-billion dollar institution, and tomorrow, God forbid, there's a geopolitical event, are you going to hedge a multi-billion dollar book with zero DT options? There's no way. Any sophisticated fund is going to realize, well, I probably need to extend my duration on that hedge.

So that reach for one to, let's call it three-month-fall will always be there. It's just that in the recent environment, again, over the last four years, that has not been the case because we really have not been met with a catalyst that has tested the broad market. Just real quickly going back. So a short straddle trade, which are very popular, or it has been a big moneymaker, as you said, that's just betting that markets won't move much. But selling a call and selling a put at the same time. Implicitly, it's just like, you're just betting.

that things basically stay in a narrow range. Correct. You're selling, yeah. How did short vol make money in 2022 when the stock market was going down? That was the main point of 2022, if you were a vol trader. And you don't need to take my word for it. You could look at how well shortfall funds did in 2022, really because there was not a pickup in equity fall. And a lot of people misunderstand this because rates vol moved, FX fall moved.

It was almost like every VAL in every aspect move except for US Equity Vault. So when you look at, and you can look at just the VIX to begin with, right? Yeah, yeah. Mix is a great representation of something like that because it's variance, right? So it's really VAL squared. S&P VAL squared is going to give you VIX. So SMP 30A implied VAL always stayed in that range from like 20 to I believe the high end was like 30 something. it's really difficult to get vol to move up when you have a lack of realized move and panic that's coming in

so a slow grind down every day going down 1% half a percent two percent that's not really going going to get people panicking to bid for that insurance protection let's go back to the sort of worst case scenario that you were touching on earlier but just before Christmas, I think it was like a Wednesday or a Tuesday. There was a sharp drop in the S&P 500, and this kicked off a wave of speculation about the degree to which shorter dated options had exacerbated that fall into the close. And the thinking here is that, well, when stocks start to move down like that, all the market makers have to go out and hedge their exposure. And so you can get this sort of doom feedback loop in the market where stocks keep going.

down because dealers have to hedge the fact that stocks are going down. Walk us through that dynamic and then how much are you actually seeing an impact in the wider market from these shorter dated options on a day-to-day basis? Yeah. So we wrote a paper earlier on in 2023 that got a lot of attention. Surprisingly, it got attention from regulators and central banks. And I think when some of the regulators reached out to us, it was because they understood as well just how severe a certain situation can end up being. And they want to collect data on that as well. So when you talk about zero DT, it usually falls into two camps. You have Camp A that says, oh, no, nothing's going to happen. The positioning offsets one another. This is not a risk. And then you have Camp B that says,

This is going to create a massive catastrophe. Black shoals kind of stuff. Right. This is, you know, a black swan event. And I don't think either or are true, right? This becomes a problem when dealers are hedging their exposure in a high-vall environment. So what ends up happening is during normal conditions, when you have most of the flow that's lean to sell these shorter dated options, that is stabilizing to the broad market.

However, when volatility is going up and these end users are not only closing their position, but opening new ones, that puts dealers under pressure where they now need to hedge their exposure and reflexively that could drive the asset price lower or in some cases higher as well. So in this situation, it's not really a case of the S&P going from 0% on the day to down 5%. It's what does this look like if the S&P is down 5% and then could escalate to down 10%. The second point to that that I'll bring up, and this is a very valid point, if you are a hedge fund or an asset manager, you understand that the larger primes are concerned with trading with their clients trading this stuff because of the lack of visibility around certain intraday margin requirements. So if you're a hedge fund, you have a certain EMS that may be outsourced somewhere else. What's EMS stand for? It's just like an execution management system. Okay.

Right. So you might be trading somewhere else and those positions are settling at the end of the day. The P.B is not really able to see that. So if those positions go against you, you may be on the hook for certain exposure that is not accurately assessed for. That's really the second, yeah, that's the second problem there. I have so many questions already, but I do think this is actually an important point, which is that in a lot of the commentary on shorter dated options in zero TTE, there's an implication that it's all these stupid retail traders who are using these things.

And, you know, people talk a lot about Wall Street bets, and it is true that you can find some out there stories about people on Wall Street bets, losing and also making money on shorter dated options. but a big portion of this is huge institutional, ostensibly sophisticated investors. I'm glad you brought that up because actually this brought me back to something that I wanted to return to. The sophisticated investor, talk more about what happened in 2021 with the introduction of these mandates because I do think that's, that feels like a very important element that like we can always talk about market environment and we are in a high-val environment or a high-rate

environment or low rates environment. But if the allocation is going to change and new products exist, we see how that affects the market. What specifically were these decisions that were made where these big institutions felt that they had to like, tell us a little bit more about some of these decisions. Yeah. So think of 2020. 2020 was a year that option trading did very well on both sides. Hedging programs did very well. And then also when the market rebounded, certain stock replacement programs did extremely well. When 2021 came Q1 and the meme stock craze hit, that was almost like the nail in the coffin where you had certain investors and boards that started pounding on the door and saying, why are we not exposed to options? Because look,

everybody's making money. Not in the sense that they want exposure to meme stocks, but they're saying, hey, we should have long-call tech exposure, you know, or we should have volatility risk premium harvesting programs. And ultimately, that put a lot of pressure on certain consultants. It put a lot of pressure on certain teams. But as I said, simultaneously, when the exchanges began listing more and more tenors, people started realizing that, well, ideally, we probably want to engage in these volatility risks premium harvesting programs because look if this is what the S&P is doing, look how much more we can make by selling VAL. And now the path dependency has completely changed. So ideally this becomes an easier trade for everybody. Tracy, now I am reminded, it's so funny,

all these things I forgot from that time, but there was like that big thing with like soft bank because, you know, a massive buyer of just like long call options on tech as if it already exposed enough to tech beta, they also bought a bunch of call options on tech style. Got to double down. No, I do find it remarkable that everyone thinks Wall Street bets and that retail craziness was sort of people trying to imitate Wall Street. But now we basically have Wall Street trying to imitate the retail crowd and the sort of Yolo mindset of let's just try to make as much money as possible in a short an amount of time as possible. I want to go back to the impact on markets. And I take the point about the Doom Loop scenario, although as you say, you don't think

it's as bad as, you know, getting a sort of Black Shoals-esque kind of crash. But one thing, I guess I don't quite understand in this argument is people are not going to keep doing the same stuff if the market is falling significantly. So if someone has a put that went up 500 percent, they're probably going to sell some of it, right? So if you have people selling puts, then wouldn't that bring in buying from the market makers, which could actually stabilize the market in that scenario? No, no.

So when an end user is short the put, the market maker is effectively long the put, right? So at that time, if they're long to put, they're going to be long the underlying one the other side. long stock. It changes when the end user is now long the put. That puts the dealer short the put. If they're short the put, that's bullish, which means that they now need to sell the underlying on the other side. So, and this is where this comes into like a second order effect. Naturally, if the end user is selling this, the market maker is stabilizing this. When that

position starts to move against them, what is the end user going to do? They're either going to close off that position. Right. Or they're going to close it off and then take more of the other side. So they're going to say, okay, we're closing this off and maybe we're going to bet on long volatility. Oh, I see. Okay.

That is when the market maker begins to get put under pressure. And just to be clear, this has existed since derivatives started trading. I think people think that gamma hedging is something that came about six years ago. That's not the case. If you were a market maker in the early 2000s and the 90s, you realized that, hey, this is how we hedge a derivatives book. So that second order effect only becomes more relevant because the sheer size of what you're trading is so much larger. So now you have, back in the day, you had 20 market makers. Today you have four, right, four main market maker, or let's go

it five that really control the flow in the U.S. equity market. These are really big bank trading desks. Are these? Not just banks. Not just banks. I probably, I'm not going to name them, but like, well, just like, what are the nature of these, like, the four or five? I'll whisper to them to you after the show. But I don't, wait, we could, I mean, we have no limitations on saying. You guys can lay. You guys could.

Yeah. Tracy, who are we talking about? Okay, so people like J.P. Morgan, Citadel, that kind of thing. So just big trading shop. Yeah. Okay. So some bank, but not necessarily bank. Yes.

Okay. Yeah. So going back to the numbers, right? index option trading has grown two times since 2018 and equity option trading has grown almost two and a half times in totality so when you think about the concentration risk here you have less market makers and more options being traded so of course it's natural to think that those market makers will get caught off sides on positioning especially when the end user is so dogmatic in their application of this shortfall trade.

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It's important to understand where you spike, but also really acknowledge where you don't and find people who can fill. those gaps. Listen to leading by example executives making an impact on the IHeart radio app, Apple podcast, or wherever you get your podcasts. You know, you mentioned what was it, EMS earlier. What is the underlying like risk management architecture for managing these positions? Because it has to be, there must be so many numbers involved with this. And like the values are constantly changing. So things like gamma and delta are changing along with the market. And if you are one of the market makers, I can only imagine all the different exposures you have at any one point in time that you are trying to calculate in real time as well. How do people actually do it?

So if you are a sophisticated vol arbitrageeure, you will have certain in-house systems that monitor certain second order Greek exposure like vol of all, right? spot moves in gamma exposure, Vana exposure. Very few people in the world who need to care about that. For the most part, if you are an RIA or even like a macro hedge fund that's trading options, you're probably going to be on like a certain bank platform and that's going to be okay. Because you really don't need to care about second order Greek exposure. But if you are more so a dynamic fall shot, those things become more important.

I think when you're thinking about the problems of an EMS and how that translates to something like this and then also the applications of shortfall, really you have to understand that the majority of the world and how they trade is not like a sophisticated ball shop. It's like an RIA that's going to wake up and say, hey, we need to make 50 basis points every month. So sell these options. And if the position begins to move against them, them, they're going to say, oh, well, great, sell some more. And then it moves against them, sell some more. And then it moves against them, and then maybe they'll capitulate the position. So it's not really, the bulk of the world is not really dynamically trading these things.

They're more so dogmatically taking a one-sided view on this. And that's why you get those ball blowups. Yeah. Who is Longval these days? Because, you know, again, in my mind, just think, you know, very, my very rudimentary. The theoretically, they should net, right? The amount of people shorting vol should be offset by the amount of people going to long vol. And also, I just think, like, if I had a lot of money, I would want to take out some insurance against some sort of blow.

But if the people with the money, even them are sort of like, sort of changing their strategies, is there anyone who's structurally long vol in their, in parts of their portfolio for like the sort of the hedging aspect? Yeah. So for what we do, it's called carry neutral tail risk hedging. And this is more so a tactical approach. However, the majority of what you call strategic or solutions-based long ball or tail risk hedging has done insanely poor over the last three to four years. It's been, right?

It's been obliteration. And we're pretty outspoken that those type of applications don't work because what you'll see at an asset management for, they'll say okay great you have if you're a family office you have 500 million dollars in equities let's take 1% a year and allocate it to some longfall yeah and then over the course of years you realize that well that's really destroying my portfolio I can't just lose a percent a year right that's why you're seeing more sophisticated institutions go or lean towards tactical defensive hedging as opposed to the solutions based defensive hedging because those just

really do not work over the long run. So you just can't wake up and say, yeah, I'm going to buy a put and just keep rolling it and rolling it. Right. That eventually costs a lot of money. Exactly. Who are the big winners from the explosion in shortfall and derivatives in general? I have to imagine the CBOE would be in there, given that they're the ones selling the shorter dated options,

maybe some of the market makers. Who's making tons of money from this? Yeah, so definitely. the exchanges are doing quite well. Marketmakers generally do quite well when you have big vol environments for the most part. It's important to note, and I think that this goes over a lot of, it goes over a lot of people's head when they're going through the research. Sebo is incentivized to make sure that the data that they're showing you is pretty. Right. So Sebo's never really going to come out and say, hey, all these options traded is a hazard because it just goes against what

they're trying to do as a business. And for what it's worth, I like the guys at CBO, respect them, clearly doing extremely well from a business standpoint. But yeah, the exchanges are doing quite well. Market makers are doing quite well. But whenever you're reading research or data about these options or zero DTE, it's important to take it with a grain of salt when you're getting the research from people who have been doing well. I just have one. I just have one. more question. It kind of goes back to what I was saying, like, how, you know, I understood the value of income generating strategies through derivatives, particularly in the ZERP era when there was not many sources of just sort of like income. You know, the market complexion has obviously

changed quite a bit because now, you know, there's yield, but also like traditional, like, sort of natural hedges in the market don't work anymore. So if you had, you know, this, the old 6040 portfolio, at least for a while, it was like terrible. So like this idea like, oh, a hedge by having a little bit along here, along here, and they do differently like that doesn't work. How has that changed the VAL trading business, these sort of reversals of some longstanding just sort of correlations of bread and butter assets? Yeah, I think it's for the good of the ecosystem because I think it is cycled out the bad managers. managers who have not been able to navigate this environment have been really taken to the woodshed. And I think that's important.

You need a healthy cycle out of those bad products and those bad managers because, look, everybody's a hedge fund these days. Everybody manages some sort of assets these days. And the reality is that that alpha doesn't exist everywhere. So when you have poor products, after a while, people start. realizing just how poor they are. And then those participants get cycled out. So I think it's healthy that this sort of stuff has come to light because, yeah, you shouldn't just be able to put somebody in some generic put buying program and charge 25 basis points and, you know, a 5% incentive fee on that. That doesn't just jive well. I have one more question, which is how do you

prove that the explosion in options is having an impact in the market. Because so far, the observable pattern that I have seen is that something like a December 21st happens where the market falls. J.P. Morgan publishes a note saying part of this was because of shorted dated options. And then the CBOE comes out and says, no, no, no, we didn't see any evidence of that. And you have all this polarized commentary. It feels like in something as mathematical, is options trading and finance, we should be able to point to concrete evidence, but we are still having this debate about the overall impact. So what do you look at to prove that this is happening? So the way how we trade is literally a second by second basis. And I think unless you're trading

like that, you won't be able to have a good picture as to what's going on. So we have certain agency desks and market makers that cover our flow. And you talk to these guys, you go out to eat with them, you build relationships with them. And there's an ongoing joke that we have with one of them. And they say, listen, every time volatility spikes, we have five clients that will come in and fight with each other to sell it. They are jumping over one another to sell volatility. Now, it's hard when you don't have that color or you're only seeing a price on screens. But when you you understand the ecosystem and what's transpiring under the hood, it paints a cleaner mosaic to understand that we've only seen one side of the equation, which is, yeah, volatility

being stabilizing and just not really performing in dormant markets. But there will come a day when there's a catalyst that pushes this thing through. And it's very similar to like fall megetten where everybody who was trading vault during that time understood the exposures were baked into the ETPs and then after it occurs they'll say oh yeah it was so obvious didn't you know that everybody was short volatility in the ETPs I swear to god it was not obvious to everyone chris did you'll thank you so much again for coming back on all thoughts that was a fantastic explanation of you know a pretty technical change in the markets but an important one so thank you Thank you guys for everything.

Yeah, that was great. Thank you so much. Joe, that was so good. That was really interesting. I have a joke. Uh-oh. It's not as good as Chris's joke, though. Maybe I shouldn't tell it.

Tell it. Tell it. Tell it. What does a risk manager with a science degree at a large market maker say when he wants a salary increase? Tell me. He asks for a gamma raise. Oh, that's good. Yeah, that's good.

Gamma raise. Oh, that's good. Gamma raise. Gamma raise. That's good. He asked for gamma rays. Okay, it's good. I'll work on it.

I'll workshop. No, I thought that was really interesting. He's sort of chrystallized, oh, Chris crystallized something in my head, which was about the exact mechanism of the feedback loop. Because I had assumed that as the market moves around, like, people are lessening their exposure. But as he put it, like the thing they're doing to lessen the exposure can also lead to market maker behavior that is not ideal in a stock. going down and everyone's scrambling altogether scenario. Yeah, I thought that was very interesting. I also just thought like this sort of big picture, if you have a lot of money,

you just cannot buy insurance trivially. It's not like he's like, oh, I'm just getting like, as he pointed out, like, you know, you take 1% of your assets a year and roll it into some fund that supposedly is going to deliver major returns every time there's a pandemic or some major thing. Like you're just going to lose too much money that. way. And so then the idea of like, okay, well, like these institutions take the other side and see opportunities in Shorting Vall. And so you sort of see how this trade can just get so large on one side. I also like the point that, okay, this is not nothing. It's not a trivial evolution of the

market. But at the same time, it's not a Black Monday, Black Shoals redux where this is going to lead to like a massive crash. Because at the end of the day, one day options expire. At the end of the day, The options are ended. The end day options end. Okay, I need to work to shop that one too. Thank you. But there's something there. But, no, I like that point.

I thought it was a very clear description of the ecosystem. Yeah. And it is amazing to me, given everything that's sort of gone on how much the vol trading environment has changed. Because you would have thought after 2018, after the wildness of the post-pandemic period, that things would have gone in the other direction, but nope. No, and also we knew because of, you know, in 2021, we talked a lot about retail, obviously, but it really is telling, and then that fell off. And then, you know, you could see, you know, Sebo as a stock kind of peaked at the end of 2021 for a while and then fell and everything. But obviously, there's just so much more than retail.

And so when we're talking, you know, I think if people hear zero-day options or any of these options, you know, they just sort of think about people like on their apps, But the idea that it's not necessarily gambling, but the sort of like very dynamic, intentional hedging participation in these markets from big money is pretty astounding. Sometimes it is gambling, though. And there's gambling. All right. Well, at the end of the day, one day options expire. That's what it is. But the conversation and the controversy over them certainly does not. It goes on forever. Sounds good. Shall we leave it there?

Let's leave it there. This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me at Tracy Alley. away. And I'm Jill Wisenthall. You could have followed me at the stalwart. Follow our guest, Chris Sidial. He's at KSIDIIII. I, I follow our producers, Carmen Rodriguez, at Carmen Armin, Dashel Bennett at Dashbot, and Kel Brooks at Kel Brooks. Thank you to our producer, Moses Ondom. For more OddLod's content, go to Bloomberg.com slash oddlots, where we have transcripts, a blog, and a newsletter. And you can chat about all these topics 24-7 in the

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