The Derivative - 50 Charts showing the Current State of Volatility, with Jeremie Holdom and Colin Suvak of LongTail Alpha

Episode Date: April 25, 2024

This episode of The Derivative discusses the current state of Volatility – and how to use those measurements in diversifying investment strategies with Jeremie Holdom and Colin Suvak of LongTail Alpha, an investment firm focused on tail risk hedging. The guests share insights into their work, analyzing volatility across asset classes and constructing customized hedging solutions for institutional investors.  Jeff, Jeremie, and Colin do something a little bit different in this pod – walking through several graphics and charts to discuss notable stats and trends in implied and realized volatility pricing in not just equities, but across various asset classes including energies, Gold, interest rates, and more. Check the episode out on YouTube if you're wanting to see their beautiful charts. They also explore topics like the influx of options selling and its implications. They dive into topics like interest rate movements, inflation effects, fixed income-equity correlation shifts, and how these influence positioning across strategies like tail hedging and trend following.  Learn about Longtail's customized approach to constructing hedging solutions around tail hedging costs and frameworks like generalized optionality and how the firm evaluates basis risk. This discussion also covers challenges measuring counterparty risk and the interplay between explicit and implicit hedging strategies. Sit back and look at how professionals interpret shifting market dynamics and construct diversified portfolios using alternative risk mitigation approaches. SEND IT! Chapters: 00:00-02:24=Intro 02:25-08:40= Cal vs Can cost of living & backgrounds among the tails 08:41-18:11= Generalized optionality & Risk mitigation  – Long vol, the core of basis risk 18:12-24:25= Diversifying strategies, hedging Nasdaq, customized approach, & tail risk hedging 24:26-37:24= Keeping tabs on all type of Vol – why does it matter? Basis risk across all asset classes 37:25-51:32= Implied vs realized Volatility, Volatility skew & short-term vol 51:33-01:00:44= The Vol selling influx / 0DTE 01:00:45-01:15:27= The shake out & blending all pieces together From the episode: Taming the tails with LongTail Alpha’s Vineer Bhansali on The Derivative  LongTail Alpha Whitepaper: Option Total Return and Active Option Portfolio Management  Follow along with LongTail Alpha on Twitter with Vineer Bhansali @longtailalpha , on ⁠LinkedIn⁠ with Jeremie Holdom & Colin Suvak & also check out there website for more information: LongTailAlpha.com Don't forget to subscribe to ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠The Derivative⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠, follow us on Twitter at ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠@rcmAlts⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ and our host Jeff at ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠@AttainCap2⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠, or ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠LinkedIn⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ , and ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠Facebook⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠, and ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠sign-up for our blog digest⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. Disclaimer: This podcast is provided for informational purposes only and should not be relied upon as legal, business, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations, nor reference past or potential profits. And listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. For more information, visit ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠www.rcmalternatives.com/disclaimer⁠

Welcome to The Derivative by RCM Alternatives, where we dive into what makes alternative investments go, analyze the strategies of unique hedge fund managers, and chat with interesting guests from across the investment world. Hello there. We are back. Had a bit of an unintended delay there for a couple weeks. Couldn't get the guest spring break schedules to line up. But we're back and we're doing something a little bit different in this episode.

We work with the folks over at Long Tail Alpha to implement tail risk hedging strategies for some clients. And they had some cool looking ball charts in their latest client presentation a few weeks ago that I was on the call. So I said, hey, let's get those on the pod and get some of the long-tail pros to come talk through what they're seeing and what the current state of all is. So what followed here is a great combo with Jeremy Holden and Colin Subic of Long Tail Alpha, where we indeed looked at the charts, but also talked quite a bit about tail protection, structuring hedges, zero DTE, and more. So listen on. But if you also want to see the charts on the podcast, head on over to our YouTube channel, youtube.com slash at the

derivative by RCM alternatives. Not sure if we could have gotten a longer name, but that's youtube.com slash at symbol, the derivative by RCM alternatives, all those letters. This episode is brought to you by that RCM YouTube channel where we host the podcast weekly, but also have some other videos and around our work in China and whatnot. And if you're into vol and volatility, hit the playlist button on the channel and you can see all our vol pods over the years

in the VIX volatility playlist. And now back to the show. All right, everyone, we are here with Colin Suvek and Jeremy Holdom of Long Tail Alpha. How are you guys? Very good. Thank you for having us, Jeff. No worries. And tell us where you're at in beautiful Southern California. That's right. That's me. I'm in our office today, although it's not very beautiful. It's actually quite great. You can barely see even a mile outside. I don't know, Jeremy, where you are, if it's a little bit nicer, hopefully. Well, I'm in Toronto, Canada on the East Coast here and it's a lovely summer day. Not as nice as Newport,

but almost there. Are you in Toronto all the time, Jeremy? Most of the time. Yep. Oh, I didn't know that. All right. Hey, we're learning new stuff on the pod already. But Colin, the main office is there in Newport Beach, right? Yeah, exactly right. Exactly right. A couple of miles from the beach here so we can sort of see down to the harbor. As I say that today, not great. So I don't know if I should share any images, I guess. It's not doing it any favors. And how did things end up there? Because Veneer had been working down that way. Exactly right. Exactly right. Yeah. He was as many others. He was previously at PIMCO, which is sort of just across the street from us.

He's kind of been in and around the area, I think for something like 20 years. So I think it sort of felt like a natural fit for him to kind of stay here. I think there's a story of him. He was being recruited in Chicago and he kind of got the pitch and everything. And he looked outside and it was raining. He's like, nah, not doing that. I think he's california native for life um and then you guys could have a uh little cost of living battle right like you would think off the top of my head newport beach higher but toronto is climbing the charts right isn't there a bit of a housing issue in in toronto that's right yeah

housing issue probably i think it's expensive in newport as well so yeah there's a good battle all right who do we give the win to newport i think newport yep yes uh so i'll tell people if you haven't listened yet we'll put it in the show notes we did a pod with long tail alpha's founder veneer bonsali two years ago ish um so we'll put a link to that and go here all the good background from veneer um but colin and jeremy are here in the weeds every day and had a nice little uh deck they put out for me the other day on the kind of state of all so we want to go through that but first uh let's get into your guys background and tie it in with the firm background uh who wants to jump on that grenade first i'll jump on the grenade so yeah as you mentioned

we're both in the weeds and it's nice for us to do a little podcast to see everything uh in a fresh perspective you know stick our head out exactly but um just a recap perspective, you know, stick our head out. Yeah, exactly. But just a recap on Longtail. So our focus is diversifying strategies and it was founded by our founder, Vinir Bansali, in about 2015. He's a market veteran in derivatives, tail risk hedging, risk mitigation, et cetera.

Has several books on those topics. His career background is solomon brothers credit suisse etc before starting long tail alpha he was a managing director at pimco and our core strategies include option overlays so tail risk hedging on the left side right tail hedging for market melt-, strategies like trend following, where we consider that implicit optionality, and then strategies that kind of combine all of these ingredients and best practices of risk management. So the overarching theme of what Colin and I work on every day is generalized optionality

and being along the tails or long ball basically and a little bit about me so i'm the director of risk management at long tail and head of research did my math undergrad at university of toronto canada worked at a large canadian pension fund before doing my master's in finance at princeton when i finished that i wanted to go work for a small firm. And I contacted Veneer at the time. The conversation basically went like he said, don't be silly. Don't do this. Go work at a more reputable firm.

And I kept on harassing him, basically. And I'm very fortunate that I did that because it's been great helping build the firm from the bottom up to where we are today. And we've maintained our focus on diversifying strategies over the last eight years. And we've built a great team, including Colin. Awesome. All right, Colin, your turn. I got some questions. I'm going to come back to you, Jeremy, but we'll let Colin weigh in again. Sounds good. I'll be relatively brief then. So my name is Colin, everybody. I am actually sort of previously from kind of a more like classic value background. My dad worked

at a GMO and asset manager sort of based in Boston from like the mid to late 90s to sort of the mid or late 2000s. So sort of during the heyday of value in particular. And when I started my career, I actually started at an allocator, an OCIO firm based in Charlottesville, Virginia, so opposite coast investor. And really where I came to sort of appreciate strategies like the ones we operate here and just risk mitigation in general, as we were looking at trend following during the time when I was an investor and I was kind of, among others, of course, leading that effort to sort of diversify the portfolio to a certain degree. So I sort of fell into all these different strategies that I think I sort of had previously never even considered. And after a couple of years there, I decided I wanted to try something new. I went back to grad school like Jeremy, did a master's of finance at MIT. And my thesis advisor

there knew Vaneer very, very well. And so connected us and i just immediately hit it off with him and the team and so i ended up joining about a year ago now so relatively newer to the firm than jeremy but as i say it's kind of been a nice transition from what has definitely been a background of sort of more classic value investing uh for me so you're a stock guy from the stock town in boston yes exactly right they, I think. There's some more alt shops, more stuff going on in Boston these days. So Jeremy, a few things you mentioned just popped out to me. One, generalized optionality. What do you mean by that? Either of you can take that if you want.

Yes. So everything we do, we're trying to view through the lens of optionality. And obviously, explicit optionality is the direct purchases of options where you have a net premium inflow. And there's a slider between reliability and cost and something that's less reliable, but will cost less. And so on the far right, on the far left side of the slider, if you spend direct premium on an option, you have a guaranteed payoff to the underlying reference index. But if you want to try and reduce that cost, you have to take some sort of basis risk. And so as you move along that spectrum, you can move towards other strategies like trend following, which we would call implicit optionality, because you are basically replicating straddles. You're trying to bet on realized vol expanding much more than what it currently is

today. And then you can move on to things that we call structural optionality, which is more global macro type trades where the payoffs look like option-like in nature. So we're trying to put everything through the view of optionality, and that's why we call it generalized optionality. I love it. And I usually think of that more as like a pyramid or three-dimensional, right? So you have convexity as one of those pillars too on the slider, right? Because you could take a lot of basis risk and not have a lot of convexity or you have more convexity. So do you guys view it as that way? You might have even more than three dimensions, but. Absolutely. I mean, actually, so you can think about the slider

across strategies, you know, broadly, but then it also definitely applies inside of options within option trading. So if you have a reference option that you have as your benchmark, you can slide along the spectrum. So you can work from the direct hedge, which will cost you a certain amount of premium, but it's going to be a guaranteed payoff against the market falling. Let's say if it's an S&P 500, your direct hedge would be a put like 10% on the money put, right? And you can move to something that's more like soft and directs, where you're on the same S&P 500 surface, but now you're allowed to move across all the different tenors and moneyness to try and beat that direct hedge. You're not going to have the same type of payoff. So you're taking a risk, basis risk. And then lastly, and there's a trade-off of convexity,

but then you can move on to the highest order of basis risk, which is moving to different asset classes, where now you're introducing a new element of basis risk, which is correlation, or what is the expectation of your new market paying off, given that the main one that you're trying to hedge pays off. And Colin, bring it back to you. So what attracted you and are you, as you're talking to clients, are they getting risk mitigation? Like what is the appetite both before you got into this and now that you've been into it? Are people getting it more than they used to, or is it still a battle to even explain trend following much less these complex option strategies? Yeah, that's a very good question.

I would say it's bifurcated in the allocator community. So on the one hand, I think, and this is just my experience, I was sort of in an endowment, so I can speak to that maybe the most. I think those sorts of places are still coming around to risk mitigation, diversifying strategy generally. So your point about, are they accepting of trend following? I would say they're coming around to it, but not fully just yet. Certainly when you have great years of trend following performance, 2022 obviously being one of them, when more traditional assets like stocks and bonds sort of didn't do well, that clearly helps the situation. But what doesn't help is this, you know, long 2010s period where trend kind of didn't really do that much. So I think that's sort of in the back of allocators

minds. I think the next frontier and maybe pensions and others are sort of exploring this to a greater degree than endowments, at least at this stage, is kind of more complex strategies. So explicit tail risk hedging, global macro, but with a sort of more risk mitigation bent, etc. I think these are things that are sort of on the up, if I would say from my observation. And but do you feel there's more, right, OK, then you have to explain the basis risk, and not only theoretically, but then after the fact, you're going to be like, OK, x happened.

We actually had coverage in y, and you didn't get as much pop as you wanted to, but stick with it because next time, right? Do you? Yeah. That's the danger there, of course, right? Of course. I completely agree. And I think what we would say in response to that is to say, well, it's probably best

to have a kind of a diversified source of diversification. Even explicit tail risk hedging is, of course, going to pay off sort of programmatically when you hit, for example, your strike price, say you're 20% of the money. When you hit that, obviously, it's going to pay off. But as Jeremy was kind of alluding to, different options will pay off in different scenarios. And I don't want to sort of jump the gun too much because I know we're going to kind of go to those sorts of questions later on. But for example, shorter dated options kind of didn't really pay off during, for example, the popping of the dot-com bubble. So the point here is to illustrate that even with an explicit tail risk hedging mandate,

it's still the case it's probably good to have some amount of diversification within that. And so likewise, that analogy can obviously be extended to have diversification among your diversification strategies making it increasingly likely that you're going to have that payoff that you're talking about and you don't have to have as you say sort of a tough conversation with clients you know why did my why did my risk mitigation strategy not risk mitigate for lack of a better description yeah and i'm forgetting his last name but j Jason at Makita, he was formerly at Makita and he had a nice construct, right? For that, if the trend followers are, or the option trades are kind of the first responders in this emergency, the trend following is the longer term responder. Exactly. Yeah. I mean, to your point, the,

I think the language has shifted slightly. You know, you're starting to see institutional consultants speak this language a little bit, you know, diversifiers, risk mitigation buckets. So there's a slow trend. It's not very strong yet. There's still a long ways to go. Which blows my mind because I've been doing this 20 years. We've been talking to people about it for 20 years who've been super excited about it,

including endowments and institutional money. But I guess I'm blinded. I'm having so many of those conversations. I'm blinded to all the other stock-focused or just global asset-focused folks who say like, why do I need this? And just finish up that subject, Con. In the endowment model that you've seen,

they feel like they're diversified because they have, using a blunt example, like foreign equities, value, growth, right? They feel that is diversified enough. Yeah, I would say so. It's also been a combination of that and the fact that privates have done so well. And as we know, that mark-to-market effect, for me, it's personally kind of a feature there. I think it probably is, you know, dampening to long run expected returns because there seems to be some almost like perverse benefit of having no marks on the portfolio. And so, you know, those two things when you when you have an endowment, I think the average endowment, I would say certainly for larger institutions, larger colleges is at least 30 to 40 percent privates today. That is obviously going to have a significant volatility dampening effect on the portfolio. So I know that's sort of not a novel comment.

Others have written a lot more extensively about this, but I think that, and as you say, just being diversified across countries and other equity-like asset classes have been pretty sufficient for the last 10 to 15 years for votes and endowments. And frankly, it's paid off as well, just given the state of the markets. the funny thing about the dampening of the private equity volatility is now it's out in the right everyone's talking about i think everyone knew but now everyone's talking about it on both sides right like the investors are admitting like yeah that's why we invest in this stuff it's we like that effect like don't you care if it's actually down what it's not really right if we don't have to put it in

there we don't care but the implicit in that is if it comes back correct so i'm going off kilter a little here but have you guys done anything and had any conversations with people like how do i hedge that private risk is it we have we have. And it's very difficult. The tracking error is very high between privates and publics. And so it really is a more nuanced conversation. If you feel like you are going to be a for seller of your privates, you almost have to hedge using publics and you have to take that basis risk. Otherwise, there's really not much you can do. You kind of just have to hold onto it.

Right, because no one, to me, simple would be get some market on like some swap where if the deal goes wrong, you get paid out or something like that. But you'd probably get killed on the bid ask on that. Yeah. killed on the bid ask on that yeah anything else on the firm wide approach and how you guys are handling this let's no i mean i think yeah i think we've covered most of it so you know we're starting to see a slow trend towards and you've noticed it as well towards diversifying strategies we loved your new white papers you know it's very similar to what we advocate for, like Colin mentioned,

just a diversified approach amongst your different diversifiers. And then within Taylor risk hedging, which is just one of the strategies we offer, there's also a basis risk mandate. So Taylor risk hedging, in our view, should be thought of as a very customized approach to hedge the overall portfolio. And so you should have the choice to how much basis risk you want.

Because like you said, if you're uncomfortable with that scenario where your underlying portfolio does poorly, and there's too much basis risk in the hedge and it doesn't perform well, then you need to dampen that basis risk amount. And that's going to cost explicitly more. But those are the trade-offs that you have to have. And I think we're a leader at. And talk to me, say I have tons of NASDAQ exposure. I've run up the AI boom. Everything's roses on my portfolio past couple of weeks withstanding.

Right. And like, hey, but do I would you guys hedge that in the S&P and size it up to kind of equal NASDAQ or in the NASDAQ itself? You would start as your direct hedge on the NASDAQ. Now, it's easier to start on S&P as your direct hedge because it's the most liquid options market across all the different options market out there. NASDAQ is pretty high, but it's surprisingly not as high as people would think in terms of liquidity. But you would start there with the NASDAQ as your direct hedge. And then following the framework, you would move across either within the NASDAQ surface, depending on the basis risk guidelines, and then outside of that surface to other equities within US, maybe other equities globally. And then you would start to make the leap across asset classes.

And who's, probably that's the wrong question, but how do you guys scale? It sounds like you're saying we're super customized. Each mandate has different wants and needs for their basis or for their exposure, and you're creating a custom solution for each of those mandates? Is that correct? Yeah, so that's the main business in tail risk hedging, and it's a very customized, hand-on approach. And because of that, a lot of our clients have appreciated the nuances in tail risk hedging, because it's difficult, especially when you have to select between

reliability and cost. You do need to really customize it to your underlying exposure. A lot of pensions or institutional investors, they have generally similar tilts, but some of them, if you look underneath the hood, are actually have quite different exposures. And then we talked, we'll jump in this. We talked about this the other day. It's odd to me. You mentioned the other day, we'll get to it. When we look at some of your charts of there's been a increase in institutional option selling so it's odd to me that those same groups are like hey we're doing way more options selling but we also want to look at tail hedging so like out of those mesh it seems to me

if I'm buying and selling the options at the same time I'm just net zero yeah right and that simplistic example, but how can they be doing both? It seemed like you would have to choose. You either want to sell vol or you want to buy vol. You can't do both. Exactly. And that conversation probably starts at the top down. And so if the institution, the CIO, they have a philosophical bent towards the only way to make returns is to capture risk premia. And so you have to be a seller of options to capture volatility risk premia. Then adding tail hedging to your allocation is going to be next to impossible. However, if you do believe in this diversification

framework where you need something to defend against your equity exposure, credit exposure, et cetera, then you'll probably be more of a supporter of diversifying strategies such as tailors hedging. Got it. And last question before we dig into some charts. Paint me an example of Joe Schmoe Endowment, institutional investor wants to have tail hedging. What are they typically looking to spend on that? Right. With the caveat that it's probably all over the board and there's different mandates like we just talked about. But if you could, like an average investor and given current market conditions, like what what does the spend look like? The spend varies, like you said, but a high level approach that we've seen happen a couple times is they'll start with their total overall equity exposure, and then they'll try and

hedge a portion of that, say half on a notional basis. And that comes to about 50 basis points to 25 basis points relative to the overall portfolio. So that's for like very large institutional investors, but it varies per year. Do you think that blows most people's mind? I think that most, right, we need to take out an ad in the Superbowl or something, right? Because most of these groups, I think like, oh, it'd be prohibitively expensive to buy tail hedging coverage. It's going to cost me three, four, five, 6% a year or something like that. And we're saying, hey, no, it could be 50 bit. Yeah, that's true. And on the flip side, though, the capital market assumptions that many of these

groups have, their target is about 7%. So you do have to be sensitive to how much you can eat from that. And so there is a delicate balance there. Because they're right, if they have 7%, you're taking 1%. Now they're at six, it throws their whole model. It's a whole separate podcast of whether that seven percent is realistic exactly yeah yeah all right so i'm reminded of the old uh michael keaton batman movie where jack nicholson was the joker you guys are too young for that but right and bat and joker's like where does he get these wonderful toys so i look at your guys charts and i'm like where do they get these wonderful charts um so let's start there you guys do all this in-house and you're probably like this is simple dude what it's no big deal, but you guys create all this in-house? That's right. Yes. Colin, the team, the research team, we are creating various reports like these to screen what's going on

across all of the option markets and asset classes. And this ball dashboard that you're showing here is just a view into what has happened historically for different volatility metrics. And here we're just showing 90-day realized vol as well as different implied vol metrics for the four core asset classes, equities, interest rates, currencies, and commodities. What we could do is instead of going into all of these specifically, I could maybe speak at a high level, kind of what has happened and then pass it on to Colin. Yeah. And my question, I'll throw it now, or you can answer it later. Like, why do you care? Right. We're just talking about NASDAQ ball. And so why do we care? Why do we have all of this when we're only mostly interested in equity ball? No one's coming to you and saying, hey, I need help hedging my commodities, are they?

Yeah, for the most part, commodities definitely lie outside of what is acceptable on the basis risk spectrum, with the exception of some of the precious metals but maybe what we can do yeah let's address that first we'll talk about why does it matter so it really ties to our approach at long tail especially in the strategies that are related to explicit optionality and it ties to what we kind of talked about in the intro, which is basis risk, right? So our approach depends on the mandate, but at a high level, what we're trying to do is we have a reference underlying portfolio that we're trying to hedge, NASDAQ, S&P 500, MSCI Acqui, and we have a target event.

So the target event is if the market falls 10%, what is the desired multiple 8x, let's say, or 5x or something like that. And you've defined that. And then what you were looking to do is you want to compare your like, what availability, what different options do you have compared to this benchmark hedge or direct hedge, which in my example would be, you know, just pick one, one year, 10% out of the money option, one year, 20% of the money option. And so that is the reference index. It has a cost and you can measure the reliability. It is going to have a guaranteed payoff if the S&P is going to fall. But then the next degrees of basis risk come in two forms. The first one is what we call soft indirect. So now within the same surface, S&P 500 ball surface,

instead of looking at just the one year, 20% out of money option, you can consider put spreads. So you can move around that same expiration strip and see, okay, what kind of put spreads are actually screening a bit better? The objective is to maximize the multiple per unit of premium spent. So you're comparing everything relative to the direct hedge. And then on the third rung, and this is where kind of the more global asset class ball comes into play is now you're moving to surfaces across asset classes outside of the main equity index that you're trying to hedge or fixed income index that you're trying to hedge.

And you're going to take the most amount of basis risk here comes typically in the form of correlation. But you have to now kind of compare everything. And so for example, historically, it used to be a good trade to hedge equity risk, a good basis trade to hedge equity risk was to buy calls on interest rates for basically betting that interest rates were going to fall. But now if you study that as a basis trade, it has very high levels of volatility. So it's costing quite a bit. And we'll talk about this in more detail. That's kind of what we want to talk about. But the equity fixed income correlation is no longer negative.

It's actually potentially positive. So this basis trade probably screens very poorly on two aspects. So that's just high level why it matters. Yeah. Yeah. And just that's basically blowing up the whole idea of the 60-40 there, right? Of like, not just buying calls to have a plate quality bid, and you're going to pay out on that. But if your 40 protection is interest rates,

you might be in trouble on that end too. Yeah, exactly. Colin, you looked at this quite a bit, right? Yeah, that's exactly right. I mean, by some measures, for example, in 2022, just to set the stage a little bit, that was obviously when the Fed started to raise rates, when inflation really started to take hold and become part of the market narrative. By some measures, the real drawdown after inflation, that is, of the 60-40 portfolio going back 100 years across all sorts of countries, was effectively the worst that it has ever been in that year. And I guess it just illustrates the point that Jeremy was making, which is, yeah, historically in the last 20 years during this period of kind of negative equity and interest rate correlation, equity and fixed income correlation, that's been a very beneficial hedge. But possibly, and it certainly wasn't the case in 2022,

that's not necessarily the case going forward. And I guess that's obviously, as you say, Jeff, major implications for not only just the hedging that we do and specific things, but sort of for asset allocation generally. Love it. I'm going to move on. The one thing I'll say that jumps out to me here is corn, right? Like everything else seems noisy. Corn seems like it's somewhat on a 60 year uptrend in volatility. Yes. Corn is definitely an interesting one. It has the seasonality with the harvesting of the crop. So volatility, a little bit like when you look at equities, single name equities, there's a seasonality around earnings. Corn, soy, those eggs have similar kinds of patterns that kind of matter in pricing options it has an uptrend but there are others that have interesting trends as well

one of them which is almost the reverse trend is like for example japanese bonds or japanese bond futures ball on, that has been artificially compressed due to the policy there. That's not on this chart though, right? It's not on this chart, but I'm just pointing out specific trends that can be, they can last a long time. Colin, how long did that trend last? Yeah, that lower vol trend probably has been around

since the 2000s, really post 2000s, early, sort of the volatility that, you know, would indicate this is a very sort of non-volatile asset. What percentage of these have been in those sorts of periods in the last 10 years? And at one point it got up to something like 80% across the 100 most liquid futures markets. And I guess the point here is to illustrate that this kind of low volatility regime has kind of been pervasive across asset classes.

But as Jeremy said, specifically, in Japanese government bonds in the sort of easy monetary policy period of the 2000s and certainly 2010s onward. Right. Yeah. And actually, so that sets the stage really nicely to where we are today, 2022, 2023,

following those two years. So the most important thing everyone knows has been the Fed tightening policy, right? From SOFR going from 0% to 5.25%. And given that rates were at the lowest levels before the tightening move, what you witness with interest rates was, by some historical records, the worst price movements of all time, the worst losses on record, depending on how you measure it.

And so as you can imagine, the realized ball and implied balls across the curve for the entire interest rate complex just completely exploded. And that's kind of what's really distorted markets. And then another thing that's distorted markets, which is definitely overlooked in terms of option pricing and volatility broadly, is that now we're at very high rate levels. And that impacts the forwards. And forwards are the main mark for all option pricing. And so to the degree that the high interest rates we're seeing are impacting the forwards, it's also impacting the relative pricing of options across all these different markets. And I'll just speak intro like an example that Colin's going to cover more deeply here.

But an example here is just looking at equities. So with interest rates so far at 5%, that's starting to be meaningfully different than dividend yields. And when you have that divergence, it means that your forward is actually priced high relative to the spot. And so what that does is it pushes calls, the prices of calls high, and it pushes the prices of puts low. And so what we're seeing is relative pricing between calls and puts, you could sell a 10% out of money call for one year, a tenner, and buy a one year 10% out of money put, and you can actually collect net premium in. And this type of a dynamic has not been seen for the first time since pre-GFC. So we could speak on and on about

before. We have a lot of content on this, but the forward, not just on equities, is distorted. This is distorted in FX, it's distorted in many different markets. And when you say forward there, you're talking just the future contracts on the futures or actual forwards that are traded. What do you mean exactly by forwards? All the above? All the above. So when you are buying an option because of the implicit leverage, you are implicitly financing a position yeah and so because forwards you know options are more fundamental units like financing units than a forward you can construct a forward from options

but you can't construct options from forwards and so options are being priced off of the forward and the futures is the best gauge of like futures and equities tend to be the best gauge of the actual forward that's being traded today. And all options get marked to the futures by put-call parity and no arbitrage. They have to be linked. And so an easy example of that is, hey, I want to buy crude oil three months out. Whether it's through the forward or through an option, I'm essentially financing that buy and I have to pay some interest rate. And with rates at 5%, that's what I'm going to pay. Yeah. Well, exactly. With crude oil,

the shape of the futures curve is in contango. So in commodity markets, you don't just have the interest rate differential between say say, rates and dividends. It's a bit more nuanced. You have the carry and the shift, the curve and the contango. But the idea is the same. Exactly. So if you're going to go out for a one-year tenor, your option is being priced off of the one-year forward. And where the one-year forward sits relative to your spot, that has an impact today.

This is really starting to show. And why, in as few words as possible, why does it drive the cost of puts down in equity? It's just very simple. So the pricing is based off of the forward and the forward is higher today. So it's kind of like saying the forward is up, means my call is worth more and the forward is up means my put is worth less. Got it. So the forward, basically you're pushing your strikes kind of out. Exactly.

So further away from the put price. The way you can think about it is if you were to short versus buy a put, those kind of give the same effective payoff during, say, a drawdown. So what's happening here is if you wanted to short, you know, say a drawdown. So what's happening here is if you wanted a short, you would need to invest that, you know, those proceeds that you get earn interest. And so it makes sort of the buying of an option somewhat less attractive relative to just that outright short. And since it's somewhat less attractive, basically push the price down. Just another way to think about it. I like that way. Right. Like, hey, why would I

buy it when I can sell and earn that five percent exactly that's exactly right all right this is the chart that got me started on our idea here which i haven't seen things laid out like this so kudos to you guys i must be a sucker for colors and squiggly lines and this looks like my kids uh right little like uh finger paint back in the day but um so essentially you're showing here each of the little finger paint dots is kind of a heat map of where things tend to cluster how far back does this go it varies on the index but we're trying to go back as far as possible okay so it sort of ties back to this so in the s&p back here i forgot to mention you go back to 1930 right for realized vol yep yeah um so what's cool here right so this is an

easy dashboard of like okay where are things where is vol high where's vol low so it jumps off the page more to me than the previous chart that yeah three months so far is incredibly hot and we actually updated this when we first looked at this two weeks ago i think it was in that very top right right yeah um so what are your guys main takeaways from from looking at these yeah exactly i mean i'll say two simple little takeaways, and then Colin can definitely dive into the calls versus puts examples. But, okay, so relative to the context of interest rates, interest rate volatility is still quite high. But what's surprising is the low levels of vol in FX and equities. Now, over the last couple of weeks, equity vol has moved a little bit. It used to be in the 10th

percentile. Now it's 25, 40. But relative to the backdrop and how high interest rate volatility is, it's still quite low. And then FX is definitely very, very low on almost all measures. And I just read something from UBS today that last week was the smallest VIX move ever on a week where the S&P was down over 3%. Exactly, exactly. So to your point, right? Like it just went from the 10th to 25th percent down, not to the 50th or 60th percent down. Yeah yeah and there's a lot of interesting stuff going on in equities it seems like if you measure realized vol on a close to close basis so from yesterday's close to today's close you just look at the percentage change and you do vol on that

it's very low very very low 12 annualized in u.s equities maybe 11 annualized in US equities, maybe 11% annualized in European equities. But if you look at an intraday measure of vol, depending on how you do it, you're starting to get more like a 16% vol, which is much more in line with the implied vols in the markets. And so what that's telling us is it seems like there's a lot of mean reversion algos or systematic vol sellers that have come in in the last couple of weeks to manifest that stat you just brought up. And all of that would entail if we're at highs or lows of the day, they're going to sell into those, buy into those, drive things back towards the

median. So the closes are reasonable, but the intraday is not? Exactly. Exactly. And what, what are your thoughts? Like that works until it doesn't, obviously, right. Until someone with a bigger book comes along and says, well, we're actually selling here. Exactly. I mean, it's all, you know, everyone wants to predict what everyone else is going to do in the future.

Yeah. If the pension funds who are systematic sellers or the institutions who are systematic sellers view this as a great opportunity at 18, 20, 22 vol, and there's not enough demand, yeah, vol is going to go down. So you mentioned there, sorry, Khan, did you have something to add on these two? No, the only thing really that stands out to me here, and I'll just make a quick side point on it, is the low volatility of sort of European equities in particular. Among all the markets, that's really where both realized and implied volatility has been kind of the lowest. And I'd say that within not only equities, but really across asset classes too. I can't remember the exact stat,

but I think for implied volatility, so forward-looking volatility, it's something like below its first quartile. So in other words, it's the cheapest 25% of the time that it's sort of ever been. And I guess that really stands out for a couple reasons. One, because that's kind of been a very good trade. Of course, in the past few months, it's been one of the sort of the winners this year. And it's in particular been a winner for CTAs, who I believe are sort of sized up in those positions, certainly benefiting from strong European equities. So that's one that sort of really stands out. And you can see from this chart, it's pretty much in the lowest that it's ever been, at least on realized measures. So maybe that's just one I'd highlight.

And you believe that's simply because they've been going up? Or is there something? Yeah, I think it's just been a case of it's just been a very strong market there. There's more hope for rate cuts there relative to, for example, in the US, where I think rate cut hopes have definitely been kind of dashed. I mean, you've gone from basically six to seven implied cuts from Fed funds futures markets to very few, maybe two at this point. And there's some speculation that there'd be almost none. Whereas in Europe, admittedly, you've had a somewhat weaker economy. But ironically, this is fueling hope for kind of a rate cut there. That's obviously a bit supportive for equities.

So it's probably that and a combination of a few other things, but that's maybe just one that sort of stands out in particular as sort of bucking the trend, even within equities is what I would say. And then I'll add my own looking at gold there, right? I would expect gold to be higher with the run it's had. And it doesn't really have the same profile or does it

when it's rising vol is lower yeah that's so gold is complicated on on the whole dynamics it sometimes has a people call smile so when uh when price of gold goes, vol can tend to go up. And then it also goes up when gold prices fall, whereas equities, it's almost just it goes down when equities rally and it goes up when equities fall. So gold tends to have the smile, but we've done a lot of research on this. It depends on how you measure it and over what time period sometimes gold actually looks a lot like equities on the ball surface where it's just uh the left tail that's being overpriced or yeah or that has the skew i should say not overpriced um and so these two were realized right exactly And then next you have Implied.

Yeah. Yes. And the takeaways between Implied and Realized should generally be the same, but there are a lot of nuances between Implied and Realized. I think we covered a couple items, right? Like depends how you measure realized. And then implied also has, so realized has your backward looking events into the time series when you're calculating vol.

Implied is trying to forecast what the forward events are going to look like. So I'm talking about like seasonality things like earnings, single name equities, or central bank meetings in FX and even equity indices, all these kinds of events that are known ahead of time that people are trying to price. So that will impact the implied vol, which is obviously not reflected in the realized vol. But by far, the biggest predictor or the biggest co-predictor of implied ball is realized well generally and these and just eyeballing here you have way less observations

here right so that's just a function of options data correct yeah i think that when did option markets first trade i think in the early 80s yeah uh whereas realize we can go as far back as the price series itself right you'll just take the actual you're not using options at all just the the difference right in the uh ranges or whatnot exactly uh so more equity vol in points what what's the so this is in percent or quartiles or percentiles? Yes. So the how hot charts are just relative to their own history. And then we have a little line over the last year, I believe.

And then the charts themselves are just like points, like vol points. So VIX 20 points means 20% annualized implied vol over the next year. Got it. And so what jumps to me here in these, so let's talk a little bit about the bottom row there of derivatives of vol, so the VVIX and the SKU. SKU jumps off the chart of that trending upwards. That's a really good point. That's definitely one we've noticed sort of in the past, and it is very high. I think it's in like its 90th percentile maybe now,

maybe a little lower than that. So it's definitely very high. And maybe just as a little bit of background for those listening, the SKU index, what it's basically measuring specifically here is the prices of out-of-the-money options, both puts and calls relative to the price of at the money options. So it's kind of trying to price this sort of skewness factor that we've sort of, that Jeremy was sort of discussing, for example, with cold, where it has maybe like a smirk or a smile. It's trying to basically price that, but it's specifically trying to price it for 30 day options. So relatively short options,-dated, excuse me, I should say, options. So that's definitely very elevated. It's sort of indicating that there's

buying pressure for volatility, implied volatility, that is, out of the money. But we actually don't see necessarily the same thing. I think this is interesting to me, and maybe Jeremy can add a comment if you would like. You don't necessarily see that same thing if you construct the same index or a similar index or similar measures when you look out a little bit further. So when you talk about, Jeremy mentioned the puts versus the calls trade, for example, where you already have equity exposure, you might want to hedge your downside. You can finance that by selling an out of money call. If you're doing that for more like a year or two, the skewness, the error is actually very normal, close to the 50th percentile relative industry. So pretty much at its average, at its medium. So it's really within shorter dated options

that you're seeing this kind of elevated level of skew. So I guess the implication for me at least is that, you know, market advertisements aren't necessarily looking beyond the next couple of months in terms of what risks they're sort of worried about. They're sort of worried about more of the short run. And do you think that's actually what's happening, or is it the influx of shorter term vol selling that's creating that sort of illusion that they

only care about the short term? Yeah, it's possibly a little bit of both. I mean, part of the issue as well is that the futures curve of the VIX is pretty flat right now. Maybe it's a little bit upward sloping. Obviously, to the extent you're sort of selling vol, the flatter the curve kind of gets, the little less attractive it kind of gets. But when it's sort of upward sloping, it's more attractive. So I guess there's a sort of tension playing out right now where as the curve gets a little bit flatter, it's a little bit less sort of productive to sell volatility on a forward basis.

Which, yeah, we can go keep going down the rabbit hole, but is it flattening because of that fall selling? Which the answer must be yes. Are you seeing institutions go further and further out to capture more and more of a spread there between further out months and VIX versus near month well the further out you go i guess my question maybe back to if you don't mind is you mean like for people that are trying to hedge or so i mean for the sellers right so if right if the curve steep i could go one month out and get a two percent carry or three percent or whatever

now if it's flat and i only get 50 bps there, maybe I go three months out to get the same 2%. Yeah, it's pretty flat out the curve as well. Really where you see the biggest amount of carry, and I haven't looked at it exactly today, so I suppose it was as of last week, is the month going into the election month. As you probably guessed, that's kind of a bit of a spike during that period. And so selling that ball would probably be among the more productive uses. But of course, there's sort of a, you know, a Venn risk going on there. So your convexity during that period um and so selling that ball would probably be among the more productive uses but of course there's sort of a you know a vent risk going on there so your convexity risk is quite a bit higher than perhaps sort of normal i think i'm a false seller there like we literally had people storming the capital and and they did nothing so it's like what's gonna i guess we don't

want to even want to know what would actually spike. It would be something truly terrible. Right, right. And here you go into the South African, Indian, Nikkei. Yes, so the ones that stick out within equities, Colin already mentioned Europe. But on the other side, the ones that have been pretty rich throughout the year relative to europe and um us have been within asia so definitely the hang seng and then the nikkei have been relatively expensive actually for opposite reasons so the hang seng is in a pretty massive bear market right now and so its level of volatility has been um has been what you would expect given the drawdown in that market so you should expect volatility to rise nikkei on the other hand has been a bit the opposite more on speculation it's been a vault up uh market up kind of market um

and it's also breaking out one of its longest bear markets of all time. So there's a lot of activity on upside speculation, which is driving that fall a little bit more relative to the other counterparts in Europe and in the U S. Yeah. That's an interesting match to me because we've seen, right. Trend followers have kind of been long japan short china for a while now right not on purpose just how the how the prices have trended but it's interesting you can be right back to our endowment that's like oh i'm

diversified i have asian equities um okay well are you short one and long the other because trend following is doing that automatically. But yeah, it's interesting. The Nikkei is more volatile than the Hang Seng, despite it being at its highs. Right. So let's dig more into what we talked about of this influx of all selling. Do you think it's problematic? Do you not care? Does it help your business? The more sellers, the cheaper what you're trying to tail hedge with? What are your thoughts just on the influx of all selling?

Yeah, I'll say a couple of comments. I'm curious if Colin, you have any thoughts, but Jeff, I think it's good for both of our businesses, broadly speaking, to see more option sellers, but we don't really see it as particularly out of line. quite balanced obviously famous last words watch the vix go to 90 next week but at the moment it seems kind of balanced and it's hard to estimate um people are always trying to estimate um what the other players are doing like where are the other players and stuff like that but you can kind of measure it through a couple ways so one you can do is if you have the trade data on options, big, big, big data set. But if you have the trade data, you can try and mark where everyone is by how close they trade relative to the bidder of the ask.

So if they're very close to the ask, you can say they're net buyers. There's an assumption you don't really know, but if they are, and if they're close to the bid, they're net sellers, sum that all up. and then you have some profile of where everyone is if you don't have that you can try and get estimates from dealers and they're probably just doing that on their side take that with a grain of salt though but you know it's the best you can do other ways would be um etfs so you can use etfs as proxies. So you can basically,

there's a lot of implicit, or not implicit, like explicit vol selling ETFs out there. And you can, it's all public information. You can look at the flows and then you can try and say, well, if the market on average is similar to the ETF,

this is the trend in vol selling today. But that's about it. You know, everyone's trying to have a best guess on how many sellers there are but in our view it seems slightly balanced and they have come in a little bit recently but as you say that i'm there's a couple of these sites and twitter handles that have popped up that are recreating the book they think of like here's how much gam is out there and whatnot. Like, what are your thoughts?

Just generally, is that doable with public available data or not really? No, I think it's totally doable. It's similar to another famous indicator, more on the trend space. But are you familiar with COT data, Commit Enough Traders data? Yeah, yeah. the trend space but are you familiar with cot data committed of traders data yeah yeah yeah so there are uh there's evidence of maybe just you want to call them discretionary traders using that very successfully systematic traders have had a hard time using that data the time markets i would imagine to it of like i've seen in real time of huge trend followers that

go through groups i work with and they're basically hiding their size from that report either either purposely or inadvertently um so that the whole meth the whole mechanism of like actually measuring that and who's a who's a bona fide hedger who's a commercial who's a speculator is fuzzy just at the best. So yeah, I don't put a lot of faith in that. So you're kind of same thing. Like how do we know which group is which? Everyone's playing games. So if you're hiding where you are in the futures market, you probably know how to hide where you are in the options market. And, you know, we use a lot of these techniques ourselves to hide volume from the

exchanges um because you know the last thing you want is to have dealers or market makers know where strikes are very concentrated yeah and you which is interesting and so like so you're using algos and kind of anti-gaming logic all that stuff to be like hey we can't show where we're at necessarily or we're going to get picked off right i mean that's that's the name of the game in execution um in terms of some numbers so for example cost of a direct hedge one year 20 of the money is about 120 basis points right colin something like that 130 right now yeah and then the uh bid-ask spread is probably five to ten basis points of that on calm periods but when you have big ball events um it can go up to 50 basis points so that eats up right so just naively following um benchmarks and just smashing the ask every day is it's gonna eat up it's gonna cost you a lot

over the long run which is not in any back test you know the back test is perfect you got the mid everything's clean but in reality that that difference can be quite large. So you're basically saying with 1.5x or even 2x or 3x your annual cost. Yeah. And let's talk, Colin, for a minute about zero DTE. Everyone wanted to talk about it this time last year. It seems like it's fallen off the news a little bit, but it, what do you, what are you guys seeing? It's still out there. It's still a big deal.

Do you guys trade them? What are, what are some zero DTE thoughts? Yeah, go for it, Jeremy. Yeah. So on the zero D dte front we are not the we're not extremely active there we tend to go more weeklies monthlies and then longer dated options um but what you can do is you can um study zero dte activity um no surprise looking at the forwards. So what do I mean by that? So what you can do is you look at the interest rate differential, sulfur rate, dividend yields, and then you impute what the fair forward look like. And let's say it's 50-50 on the S&P 500. And then you look at where the actual forward trades.

And it actually trades 50 basis points richer on shorter dated tenors. And so what that implies is there is speculative, I shouldn't say speculative activity, it just is trading rich, which means it's difficult to finance a long position in underlying cash equities at the moment. So what can that come from? That can come from a couple of things. It can come from

swaps, a lot of swaps being offered. It can come from just brokers offering leverage to their clientele, or it can come from a shortage in collateral when people are buying calls so if people are buying calls the market maker who sold it to them um has to deliver the collateral the underlying shares if the calls finish in the money right and so when there's a scramble for collateral the cost for financing the collateral becomes more expensive. So it's not a, it's again, it's like this cot data. It's like the other data we talked about. It's not like perfect, but it can at least, you can speculate that it is activity where there's actually a lot of zero DTE call buying, which is somewhat contradictory, not contradictory, but just contrarian to what others think where

it's just a lot of all selling called right we're so called buying is by the market makers you're saying or that's by the institutional buying the yeah calls yeah and probably retail um right i i've had some talks and heard that it's mostly some institutional of like, hey, if I can sell 50 bps or 40 bps out of the money call on my portfolio today, I'm more than happy to make 40 bps every day. Yeah, that would be the sellers. Yeah. Yeah. Interesting. But do you in all this data we just looked at, do we think those zero DTE is leaving a footprint?

Is it suppressing vol? I don't know if it's suppressing vol because the term structure, which is just comparing at the money vols across different expirations, is not completely out of line. If you look at one day versus one week, it's trading quite fairly. Does it leave a mark? Absolutely. There's a saying that, you know,

vol is not exclusively pinned to your expiration strip. What that means is that a lot of activity in a shorter dated expiration strip can flow and move longer dated expiration strips and vice versa. So because zero DTE has seen a record inflow of volume over the last five years, that is maybe the most sensitive aspect of market maker books now. And so therefore, the inflows at zero DTE is going to impact the way they price longer dated options. Whereas maybe previously, it was the other way around, right? It was probably tail hedgers in the longer dated option space pricing the shorter dated options, but now it's probably the other way around so if we pick this up again in six months in a year and these charts are look completely different what would be the catalyst what's what are some things that could kind of

shake us out of this current well i guess i'll first ask what how long have we been in this current ball environment seems to me like maybe 18 months ish or something maybe that's a little too long but what would shake us out of that current environment do we do a phase shift lower a phase shift higher what are your thoughts with the with the caveat that nobody knows anything i'm having to take a little stab at it jeremy and then if you want to yeah please yeah i would say for me the main thing is definitely the fixed income equity correlation. I just think I know we've already sort of discussed it. I know it's sort of something that people are kind of aware of at this point, but I

just really think that that is such a huge impactor of so many other things. I mean, not least of which is the overall asset allocation structure of the majority of institutional investors today in the U.S. and globally as well, for that matter. And that's kind of coinciding at a time that trend followers, for example, are generally much longer term, using generally much longer term signals today. So they're generally longer equities. They're generally short rates. And those two things are kind of benefiting one another because the correlation is positive between equity and fixed income right now. When measured using a long horizon, if you're long equities and you're short something that is sort of positively correlated with that, you're kind of getting a benefit in terms of the portfolio's risks. So our impression is that therefore CTAs are generally pretty long equities and rates. And obviously, the implication here is that if that correlation goes back to kind

of what it has been in the sort of post-2000 period, the anchored inflation expectation period, it goes back to negative. That obviously portends significant shifts in at least systematic positioning. And to the extent it stays positive, I just think that really requires a rethink of whole asset allocation plans. So for us, I think that's definitely something we're watching, especially because when you measure vol over, or excuse me, when you measure correlation over a shorter window between those two asset classes, it's actually kind of reverted back to this negative region, the sort of more usual that people are kind of used to over the last 20,

30 years. So that's why I mentioned the CTAs are a little bit longer because it definitely matters what models they're kind of using. And our impression is that they're mostly using longer dated models right now. So I don't know if Jeremy, you would add to that or there's a follow up question there, but that's kind of maybe one thing I'd highlight. Well, my follow up comments, Jeremy, real quick, is just like it seems almost too obvious, right? I'm like, yes, everyone's reacting to what's happening with the Fed and whether they're going to cut this year or next. And so that's what's driving the stock market up or down. So it seems like almost too obvious that that's the catalyst, but such as C'est la vie, that's

where we're at, right? Yeah, I would say you're totally right. It's obviously the thing that's talked about, you know, every single day in the Wall Street Journal at this point, it seems like, you know, where is inflation going, where are rates going, et cetera. But it has a lot of implications for other assets. And it's primarily because of this inflation effect, you know, where is inflation going, where are rates going, et cetera. But it has a lot of implications for other assets. And it's primarily because of this inflation effect. You know, rates have risen at other times in the past 20 years when this correlation has stayed negative. The sort of mid to late 2000s, right before the financial crisis is one sort of such example. Another is, of course, when J&EL began tightening, and I think it was late 2015 was when they started. So these things have sort of occurred before, but the difference now is inflation.

And we're seeing that kind of manifest itself in other ways. So I don't mean to open a whole can of worms here, but one asset that we've been following, I think was mentioned earlier in this talk, was gold, for example. As we sort of know, gold tends to be sort of a bet on real rates declining. The obvious reason here is that it doesn't have a convenience yield, doesn't have really a dividend yield. So ultimately, it's kind of this bet on real rates falling. But what we've seen is that real rates have increased this year. And at the same time, gold has been doing very well. It's among the best performing assets actually this entire year, even among equities. And in our view, this potentially pretends kind of a shift to what we would call like the fiscal policy regime. We've definitely been in

the monetary policy regime for a long time now, definitely since Volcker, in my opinion. But now we're going to this phase where like debt to GDP is very high. The budget deficit to GDP is very high. Rates are rising, et cetera. And the most similar periods that we can identify to today, and this is in a sort of mathematical sense as well, I'm not going to go into details, are actually the two world wars and Japan post 2000. So in other words, in an otherwise expansionary economy, great economy, great environment, you're spending like you have been spending in two world wars, the largest arguably events in human history. So I guess the point here that I'm making is you're absolutely right. This kind of narrative of the fixed income equity correlation is being talked about, but I think the difference nowadays relative

to other rate rising periods is this inflation impact and inflation is sort of spilling over into all these other sort of areas that of course have so many, so many potentially downstream effects. And it seems hidden in there is what I see in the student loan stuff, right? Like we can't stop. Like there's no way those student loans are ever going back. Like every time it's like, hey, we need to extend, extend, don't make them pay the back, which whatever, whatever your views politically are on that, who cares? But just the fact that there's no, neither side's willing to undo it. Exactly. That's the monetary policy, right? Like, hey, we need to keep giving this money away to keep things going. Exactly. Yeah.

I think for the first time in a while, I mean, of course, people have talked about, you know, the U.S. government debt for a long time now, and it just hasn't mattered, frankly. But I think it's primarily because, as you say, we've been in this monetary policy regime. We've been in the regime where monetary policy is the driver. Fiscal policy has really taken a backseat, you know, other than these sort of large bills that we all, you know, we'll think about post- GFC tax cuts in 2017, et cetera. It's kind of taken a bad seat to monetary policy, but all of a sudden it's kind of been thrust into the forefront. And there's been a lot of papers sort of written recently about, you know, just how seismic of a change this is. And one way that it's manifested itself so far is in the fixed income equity correlation. The other is in gold, as I was

mentioning, obviously many other examples sort of abound. But I guess that's kind of what I would say is what we're watching, I guess, quite closely. Love it. Jeremy, did we cover that? Got anything else on that? No, that is perfect. And I have one more question for you, Jeremy.

From your very beginning, you said that you guys do right tail hedging in equities or in all these assets. So that's just of interest. And I think I would catch a lot of people off guard. I'm like, who cares if we make 40% on the upside? Why are we hedging that? That's right. Yeah. So it's the opposite mindset. The reason why the strategy started was because there was a credit manager who I believe was high yield credit. And the names that they were in would generally lag equity market beta or credit beta. And so their mandate was, you know, to keep up with this benchmark, but they were buying relatively more quality names.

And so they needed something to catch up to that equity beta. And so that's kind of the intellectual idea, philosophy behind the fund. But it is also a powerful tool for reducing beta and only spending premium, which is known up front, to get it. It has the opposite profile to left-tail risk hedging in the sense that it is actually positive expected returns over time based on the fact that equities tend to go up. And then it has very different dynamics in terms of monetizations, because just the way equities rally, vol reacts very differently.

So you're not expecting vol to blow up when equity markets go up. So you have to be very careful on how you set your rules. It's not a mirror image to the left tail. That is interesting, right? It makes you think like, hey, reduce your, is it used in that way also? Hey, I'm going to reduce my equity exposure a little bit. I'm worried getting toppy, whatever that means. And instead I'll enlist this in case there is a huge move up, I can still participate. Yeah, that's exactly how it's used. It's used to also fund left tail. So you can use the proceeds to fund another side of the distribution. So it's not very talked a lot about, but it definitely fits into our overall business model of diversifying strategies because

it's all about changing the distribution of the underlying portfolio. Yeah, and I'll add one thing there. We talked about private equity earlier and obviously the benefits it has when it comes to sort of, in some sense, hedging. I'll use that word sort of lightly, obviously, the sort of downside ball, but it kind of has the same effect on the upside. Now we all know managers are sort of more quick to mark up than they are to mark down. But our experience has been that allocators do sort of feel this drag to a certain degree in up markets. And what we've actually also found is that up markets can be even more sort of like, I don't know if this is the right word to use,

but kind of vicious, I guess is maybe the word I would use, you know, sort of more pronounced in the short run. And so it's kind of a way to hedge your private equity exposure on the upside as well. Because if you, you know, have what is a mandate of, you know, effectively 10 years, but in reality is probably being measured over, you know, one to three year periods, that can be a pretty painful period of underperformance if your marks are not keeping up with, you know, a three year periods that can be a pretty painful period of underperformance if your marks are not keeping up with you know roaring public market seems like it's the window dressing strategy like hey you might get fired if you drastically underperform xyz index so you better do some right tail hedging uh and then to tie a nice little bow on it. Talk to me to finish up the, so all these different pieces

long tail alpha is using, how do they work together? Are you guys, you're using these charts, you're using, is there an investment committee? You're saying, Hey, we need to be more into trend following. We need to be more into tail hedging. We need to be in cash. How does that look structurally? How do you guys make those decisions? Right. So you're referring to the strategy we call it. Oh yeah. The strategy that kind of blends these ones. Basically it's through the generalized optionality framework. So everything has some sort of a cost.

And so there are moments where if you want to compare explicit optionality versus trend falling or implicit optionality, when implied vol is extremely low, but realized vol is maybe a bit higher, then it's always better to do explicit optionality because it's very cheap to buy those options. But in moments where implied vol gets very high and realized vol is very low um or like not as high and keeping up with implied ball that's when you could argue to size up trend following so there's definitely an interplay between the two um and then like always kind of be an example there like hey we had we had the initial ball the options spiked now if i buy those options it's going to be prohibitively expensive let's move into the uh what do we call them before the uh implicit

second responder yeah yeah the first responder did his job get him off the field add the second responder in here who's going to be cheaper and then what when and then if could both be prohibitively expensive then you're just in cash? Or what does that look like? I remember from the old pod, Veneer still likes cash, right? Exactly. That is the, in Veneer's framework, it's the, when all else fails, cash is the only thing that's reliable. And so, yeah, when everything is is expensive cash is the best diversifier you can yield and probably a little bit of a coupon depends what rates are and you can redeploy

those proceeds at other times when assets are very cheap not bitcoin cash cash i mean bitcoin and gold there's internal debates debates at our firm about that. But yes. We'll leave that for another day. Yeah. Awesome. I think we'll leave it there, guys, unless you got any last thoughts. No, thank you very much.

That was great. No, this was great. Got it. And we'll put links to Long Tail Alpha. And you guys just wrote a paper, too, on option pricing or option returns, right? So we'll put that link in the show notes as well. Thank you. All right.

Thanks very much. Really appreciate it. Thanks, guys. We'll talk to you soon. All right. That's it. Thanks to Jeremy. Thanks to Colin.

Thanks to Longtail Alpha. Thanks to Jeff Berger for producing. We've got Joe Kelly of Campbell & Co. coming on next week. That'll be fun. So go subscribe wherever you listen to to get that as soon as it drops. Peace. You've been listening to The Derivative. Links from this episode will be in the episode description of this channel.

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