The Derivative - Carmika Partners Unpack the August Volatility Spike and Complexities of Options Trading

Episode Date: October 17, 2024

In this episode, we explore the world of options trading with Martin Vestergaard and Michael Cameron from Carmika Partners. The conversation begins with an in-depth analysis of the volatility spike that occurred in early August, as Vestergaard and Cameron share their insights on the market dynamics and the impact on their trading strategies. The discussion then delves into the growing influence of daily options and the challenges of navigating a highly electronic and technical market. Vestergaard and Cameron provide valuable perspectives on the importance of understanding current market conditions and adapting trading approaches accordingly. Listeners will get an inside look into Carmika’s quantitative approach to options trading, with a focus on modeling implied volatility and skew across the options curve. We also discuss their industry backgrounds, where volatility trading may be heading next, and more. Whether you're an experienced options trader or looking to expand your knowledge, this episode offers a wealth of practical information and thought-provoking perspectives on the complexities in today's options landscape. SEND IT! Chapters: 00:00-01:38 = Intro 01:39-24:15 = August 24’ Vol spike recap 24:16-38:40 = a Quantitative Approach to Options trading 38:41-50:10= Complexities in Options landscape in 2022 50:11-01:05:43= Experience & Expertise – Backgrounds & Approach 01:05:44-01:13:38= Evolving Options 01:13:39-01:28:37= Navigating Volatility & Skew 01:28:38-01:33:31= Lessons Learned Follow along with Carmika Partners on LinkedIn with Martin Vestergaard & Michael Cameron and check out their website at carmikapartners.com for more information! 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. Welcome back. Happy October. Hard to believe we're in the last quarter of 24 here, but we're actually going to go back in time a bit today, talking about that weird vol spike in early August. One option printed a 500 vol in we recorded with them before that spike,

but I thought it was a bit pointless to have guys who trade vol and skew and options and not talk about what happened there. So brought them back on for a quick talk through that spike and the hit they took. And then we'll give you the whole original pod going through their backgrounds and the strategy. Sound good? Send it. This episode is brought to you by RCM's Managed Futures Group. Looking at fall traders, question about why one program or another performed this way or that during an event like early August. Give our team of specialists a call and get the inside scoop on dozens of funds and CTAs we work closely with. Visit martin from karmica um and like we said in the intro did a pod with them last week of july uh then right after that we had a bit of a crazy last day of July, beginning of August in the vol markets.

So before everyone hears their full story and what they're doing with the model, I thought it'd be good to bring them back on for a quick little talk. Their program took a little bit of a hit. A lot of other vol traders took a bit of a hit. So I wanted to get their look at what the market was actually doing those days before you hear all the frills story. So welcome back, guys. Thank you. Thanks for having me.

All right. So let's dive in. I don't know who wants to take it first. But now that we've had a month plus after that crazy ball spike, what was happening there? And was it even a ball spike? There's a bit of material out there that was saying it was a bit of a head fake itself yeah i think what it uh our understanding of what it was um it was definitely a vix event more than anything else uh obviously the curve

kind of moved around but you know for instance on Friday, vol started going up and skew started going up. I mean, probably don't need to explain this to everybody, skew is, but skew obviously is puts getting more expensive relatively to call. So people are grabbing forward downside convexity. That started happening on Friday. So I mean, what we did on Friday, we caught our risk a lot and like, okay, went in with what we thought was a very tight book in terms of margin and everything coming into Monday. And then obviously Monday, I think one of the things that happened as well, which seems a lot of people don't really talk about is the SIBO didn't really open until 2.30. So nobody could really trade. So when you look at the VIX, that pre-market was up 150%.

Realities, nobody could really trade that because the option market, things were quoted, I mean, daily options were quoted really, really wide. And it was just basically the first two to three months of the S&P curve that went completely auto-lipolistic. From what we heard from a ball guy over here, supposedly it's September, so this was obviously on August 5th, the September 2500 put in the S&P on that Monday

traded at 10 ticks. That's the equivalent of 500 ball. I've never seen S&P above 100 ball. With the market down less than 5%? What was the market down? Yeah, mine's probably down 4%. Yeah, and 500 ball. I think one of the bigger things to really have an understanding of,

obviously when something like this happens, you think, can it go on to happen again? And the old school guys would say, when it you think, can it go on to happen again? And, you know, the old school guys would say, you know, when it happens once, it doesn't tend to happen again. But I think one of the reasons why this, from what I would say, again, it was two OTC call spreads that somebody had on with the banks and the VIX

that obviously blew up when VIX started going up. But again, it was probably a little bit more of a head fake because things obviously haded back out. And what also didn't seem to, the back end wasn't really reacting. And one of the things we had on back then was we were kind of short bit in the front and long in the back.

And that obviously didn't work. So the thing is to think about why can this happen again and i my my basic view is i mean we've just seen it in the last like two or three months i mean we're seeing more of these erratic wall spikes where you really don't get a underlying move and a lot of times for instance what we really need as we trade primarily skewed. So what we really need is we need a movement to come in the marketplace so you can have the gamma and whatnot set in. And if vol just sits and moves around erratically, obviously, if you're short vol, you're going to lose money. And if you are long vol, it's going to go up. But over time,

even if you're long vol, the market doesn't move. It's going to be hard for you to pay for that long ball. Right. You'll have to have perfect timing. Yeah. So it does feel a bit to me like the market's a bit broken. I hate to just say that just because you kind of, when you lose money, but there's something very radical how I think the ball market is reacting. And my feeling is a bit, I think some of these daily options are playing in on it a lot. It doesn't feel like there's a lot of activity. And I mean, Mike, I think you have the numbers for the numbers of daily options that's traded on the CBO. I mean, the amount of gamma and delta hedging that has to accompany that would have to be amazing.

I mean, the numbers would have to be big. And I think the real question that everybody should answer is, let's say the market actually, instead of being down 3% or 4%, which it was, was down 10% and limit down. What would be the effect of all this daily stuff, now daily options on the VIX? I mean, so the reality is one of the things as a risk scenario just kind of i gotta have in place is irrational big spikes so that's actually

sorry go ahead martin no no sorry go ahead mike i was gonna say i was gonna say actually with with all this that went on, right, so obviously August was disappointing and it was a VIX-led spike that we saw. We didn't see kind of the same current sort of move on kind of the downside, right? So as you mentioned, the downside was pretty shallow. It was like a 4% or 5% sell-off in the S&P. So not really a massive drawdown compared to the level of vix that we saw i think we saw spot vix touched 65

it never traded up there but you know given that level you would expect the market to be down at least 10 percent right as you kind of to it and it wasn't. As we kind of talk to investors, it's interesting, right? Because everybody wants the profile that you are long volatility and we were long volatility coming into this event. So it's amazing that we kind of had this performance result, even though we were long volatility, what we had on was a spread. So we had like a, a little bit of September, um, relatively small too, uh, cause we needed some carry. And we had talked about in the podcast, all of that front month, short ball exposure that was out there. And against that, we had longer dated optionality. Not that far out, though. I mean, I think June 2025, Martin was kind of the furthest that we had. So we modeled

up that spread and looked at the ratio over time. And it's interesting, right? Because even during COVID-2022, you know, our measurements and anticipations of where that spread would move was fairly contained. And we were fairly confident that we would get a nice result in a market drawdown. But this was just such a massive outlier and an abnormal event that had never taken place in the market. It was more than a six standard deviation event and that was just something that was never modeled over time and couldn't have been spotted um which is unfortunate well one quick thing to clear martin you were saying cboe not till 2 30 you're talking london time right yeah yeah yeah yeah like, what? Was it closed here in Chicago? No, you know what? There were prices on screen,

but they were 50 to 150 points wide. Some of the daily offers. That's probably highly likely why that option ended up trading at such a stupid price because somebody just had to do something and there was no real liquidity. But liquidity started coming in as soon as the floor kicked in at yeah two so 230 i gotta what do i gotta subtract six hours so yeah 8 30 aren't 8 30 yeah yeah we talked with a large firm that was trying to sell those vix futures they were saying 46 or something right trying to sell it they i don't think they could actually get filled till 28 or something so even in the vix futures that

spike was a little uh unreal so and you know i mean i think the the the takeaway from this obviously when something like this happens i mean i've traded options for probably too many years but i've never you know i've never had a a a you know real like any any significant you know, real, like any, any significant, you know, you know, loss. And, and most things like, yeah, we've had weird things happen. I mean, 2008 was obviously weird, but it happened in a, in a, in a controlled way. I mean, it was a massive spike in VIX and we saw COVID where we saw VIX spike up as well. And I mean, during COVID we were, I mean were i mean that that particular day i can't remember

how much we were we were up a lot and um i mean uh it was just a very different move yeah this was definitely associated with vix uh and for some reason uh everything else just i mean it was like the correlation kind of broke down across the curve in some shape or form. There's also like, I think of it like an airplane, right? Like it's the engine blew out in your crash landing, right? That's everyone's panicking. It's scary as hell. Yeah.

But versus the plane just blows up in midair and you fall to the ground, right? This was more of the latter. It just happened very fast. Well, you know, the lesson from it really is you know as much as as a kind of mention the beginning when something tends to happen i mean i remember one of the the companies i used to work at the guy always says so stupid we're sitting here in 2005 and stress testing our portfolio in the 1987 scenario or the 2000 scenario because they've already happened we need to find a

new scenario to test on and that's obviously how the world works we react to to the current information then everybody reacts to that and then probably from positioning that that it happens in in some shape or form well I think we have to really acknowledge that these markets are becoming incredibly electronically driven. I don't think, I mean, I think market makers and you have all the, you have ETF and you have all these other flow in there. You have short ball products, you have daily options, you have options on every single thing in there, all traded. And I think majority of the trading in the future, it would not surprise me if that's really just this delta hedging compared to people buying or want exposure to the market or want to do something else. And I think that makes it a very technical market. And I think that's one of the reasons

why we're seeing these. I mean, I think it was last week we had another where VIX was up 17% and the market was down 0.7%. we used to at least not see those things. I mean, and I can say that it started in 22 where we had several days where market was down and VIX was down. Does it make you want to flip your whole, right? Is it better to be long the front end consistently or it's too expensive to do that? Is that what you were saying? You know what? You obviously have to belong in some shape or form.

So we kind of come up with what we think is quite a good way because I think right now, for instance, to talk a little bit current about the market, I mean, SKU is very, very high. I mean, according to our own model, we are seeing SKU touch up to the level we last time saw in 21. And 21 was an outlier we haven't seen in a very long time. And I also think that's part of the reasons why we get a market that's really been sitting in a 50, 60 kind of point range. Market goes down 1%, goes up 1%, kind of sits there. But you got VIX at 22. I mean, that's obviously means the market can move 1.3%, 1.4% a day. And in theory,

people should be okay if you're short the gamma. But there's obviously a bid to the vol. And it seems to be coming primarily from the skew. So you've been doing this, you said, almost too long. Two things I think of there. One, is it maybe just it's terminally break-even, right? Overall, any option strategy? We used to say that all was about short option sellers. Like, oh, they'll make money for five years, but then they'll lose it all back. Like, it almost makes me think, is any option strategy terminally break-even?

And you can do well for a while until some dimension hits you what are your thoughts on that no I think I mean obviously I think strategies all work for a bit and then they don't I mean I think a very good trade example of that is the dispersion correlation trade

it can work really well for a long time and then all of a sudden it just does not I mean it will not compute correlation trade, it can work really well for a long time. And then all of a sudden it just does not, I mean, it will not compute. But then obviously that means there's a time to it because it's, you know, options are obviously very different than a stock. If you buy a stock and we all have these trading accounts where you own a stock forever, that's where it goes because you got wrong on it. But with options, I mean, it has to be some kind of quantitative measure

on the realm of it because they obviously have an expiration date. And, I mean, so I think like right now, for instance, it's a bit tough right now because SKU is so high, but SKU can't stay up there unless we get a move. So the thing is with options is it can stay obviously high for a while. And so what we're looking at right now, for instance, a vault looks okay to us, but SKU is what's expensive. So you really want to run a book now where you're long vault and short SKU.

And on that top, time be long, gamma, if we break out of the ranges. Because right now it seems like we've got this range trading. But to go back to your questions, no, I think it's the same thing with stocks. I mean, everything goes in and out of fashion. I think we just all, anybody that really trades options now really just have to be aware of the impact, I think, of this dailiness of options that's coming in, because I do think it's affecting the market in some shape or form. And then, Mike, maybe Wayne here, how's something like this weigh on the psyche of a manager, of a CTA, of a hedge fund, right? Of like, how do you keep your mental abilities and say hey it was just a blip right how do you keep confidence in yourself and in the model

i think you have to kind of analyze the event right and figure out what went on i mean the reality is is like even the best trading models are going to be subject to to kind of a loss at some point right so the essence of a good manager be subject to kind of a loss at some point, right? So the essence of a good manager is how they kind of come back from that, learn from that, put different risk measures in place to kind of circumvent that from happening once again. And, you know, I think the model over time, I mean, you know, we've got a lengthy track record, right, which can't just be thrown out the window over one month performance. So, you know, I think it takes time to kind of, when you do experience a loss, you know, I think people tend to back away and kind of are very short dated in terms of their thought process and thinking.

But that just comes back over time, right? Showing kind of what you can do, how the product performs, et cetera. Because the reality is we got a great model when it comes to looking at, you know, the overpricing and underpricing of these out-of-the-money options, right? Which is what we look at, the SKU. It's a unique model that really looks at the S&P 500, the most liquid index in the world, right, for index options. And we get a lot of intel just in terms of the way investors are kind of positioned, thinking about the market, et cetera, from the proprietary measures that we have on our side.

You think it's possible that skew can't be, right? Is it properly priced? Like the market's saying what its price should be, right? So your models are saying it's highly priced or that it's high, quote unquote high, but right at the market saying, no, this is where it should be given, right? There's a question here somewhere I'll get to it, but right at the market saying, no, this is where it should be given. There's a question here somewhere. I'll get to it. But say the market is putting in those zero DTE and all these other factors, and that's why the skew is priced there. And so it's not actually high. It's just where it should be given all these other factors.

That's a valid point. But obviously, the thing is, when the VIX kind of moves on a day-to-day basis, the VIX is essentially you gliding up and down the ball curve. So if you go down, you glide up that curve. At the same time, put options that are sitting further down has to glide down that curve. So when skew tends to get too high, it's just the debt at the money ball can't go up by that amount. So that does become a mathematical, you know, certainty. But I think the reality, as you just said, if people gotten burned on this and, you know, obviously also now you got the Middle East, you got an election, there's a lot of events going on. Yeah, things can stay out of whack for longer

than you think. But options do, on the other hand, have to expire. And obviously, the thing is, you can essentially construct trades now where you're short skew, long ball, and long gamma, and you pay very little for that gamma. So you're basically getting that gamma, not for free, but you pay much, much reduced cost for it because that skew is so high. And that's how we're basically constructing the trades now, whereas the trades before were more like pure skew bets. So now they're basically,

the SaaS will long ball and convert to see against it do you think a lot of zero dte traders lost money that day or you think it was just one otc that had to blow out i mean obviously if you were you know down at the local pop or on vacation and you came back a few days later i mean you all were good yeah but the market to market on that day would have been horrible yeah that's always the frustrating part the uh responsible people analyzing it took the hit yeah what's interesting is just the liquidity of the zero dts right i asked i got from the sebo just the daily volumes that have taken place and i mean on that fr and Monday,

they dropped down dramatically. So, you know, people always talked about the open interest and how, not the open interest, but just the daily volume in terms of percentage of total volume of S&P 500 options. And that was always 50% or higher, right? Zero DT options. I think on August 5th, that Monday,

it was less than 26%. So liquidity dried up. Yeah, which always makes me think, it feels like there's a period between that August 5th, where there are a bunch of traders sitting there like, oh, if it snaps back, we're all good. And then if it, as you said, like oh if it snaps back we're all good and then if it as you said martin if it goes another five percent like some of your some of these other trades would have started to kick in the long end would have started to rise right so it seems like there's like a buffer period we were holding outright outright puts too that were further down short dated uh they just didn't get a chance to kick in right so i'd wonder if the part of the casino of the zero tte they're like building in or waiting for that buffer right that's the risk they're taking on of like let's not panic if it's pre-market if it's such and such just let it play

out but to me that imagine individuals like i mean traders to sit at home in their underwear probably did okay because they're probably less like ooh I hope this thing and then they were right and they got bailed out by another by the dip whereas the guy who probably sat and had a risk manager by his desk two minutes after this thing had to

close it out which is just bad lessons right that'll mean next time you'll buy the dip again and if it legs a time, that's when we have a market here that's very close to an all-time high. And at the same time, you're not having VIX anywhere near the lows. I mean, it's sitting well in the middle of the range. And that should probably tell us something

of what's going on. I do do all I could do not to sing the wicked play, Defying Gravity, there. Yeah. They're coming out with... Sing it for us, they're coming out with you have the microphone yeah the movie's coming out right it looks good um well thank you guys for coming back on i think we'll leave it there um give us some color and then for everyone you can go now listen to the full pod where they talk about the strategy in more detail. Okay, that was the new recording we just did talking about early August and the vol spike.

Now we'll go back in time and give you original pod with Carmica talking through their bios and strategy. Send it. Again. All right, everyone. We're here with Martin Vestegaard and Michael Cameron from Carmica Partners. How are you guys? Good. How are you? Good. And Martin is in London, that's correct? Yeah, that's correct. Yeah.

And Michael is traveling. You're usually in London, Mike, but now you're in Toronto. I'm in between the two. I also spend time in Spain. Yeah, that's correct. I'm in Toronto. What part of Spain? Palma. It's in Mallorca. That's right. Sounds exotic.

That's nice. Can't complain. It's the island where they're kicking out the tourists now. I got it. And then I'm a bit of a Tour de France nerd. We just came off the Tour de France. But Vestegaard or Vestigo? No, Vestegaard.

So you're looking at the Danish guy that won a few times in a row, I guess. I unfortunately know nothing about it besides I know that it was a Danish guy that won last year. I don't even know if he's on track to winning this year. He got a, spoiler alert for anyone who hasn't watched the replays yet, but he got second this year. Oh, he did? Yeah. After he got in a big hurt. But they, yeah, that's a big thing.

They're always like, it's Spelgar. He had a big accident in February or March, didn't he? So people thought like he shouldn't really even be broke like rips and whatnot i think yeah i think major major breakage but back at it um all right so people didn't if you came here to listen about the tour de france stay on um we're gonna get into all the good stuff these guys are doing but martin why don't you start out a little personal background, where you got from, how you got here? Okay. You know, I studied in Denmark and had a year abroad in 95, 96, and ended up going to the U.S. to study for a bit. And there I, you know, I was taking a class,

a finance class about options, went back to Denmark, finished out my degree in basically financial engineering. And when I was done in 98, I decided to go to Chicago and try and get a job there. And I interviewed with a few companies and started out with a company which I don't think actually doesn't exist now, Arbitrate. It got bought by Knight in, I think, 99. I think Knight

doesn't exist either. No, I think Knight was the one that had the trick blip. whoops yeah where they the first flash crash we had where they went they kept away on that one um but i then started on the on the floor uh working for a dpm so for people that don't know that there's no primary market maker so we were responsible for 16 or 17 symbols. And my job there was to run the ball curves and work with the traders in terms of managing the risk. I mean, the biggest symbols we had back then was Nortel Network, which probably doesn't exist now again, one of the Canadian stocks, and then Broadcom and Charles Schwab. And obviously Broadcom is now a beast. I was there for about 10 months and I realized

the floor is just not me. You stood around 90% of the times and 10% of the times, obviously, you were super busy. Without saying too much, I think in the pit we were in that we were running, if 80% of the people had an alcohol problem, I'm probably estimating that relatively low. But it was a fun 10 months. And I then left them and started at Hall Trading. And I decided I wanted to go a little bit more into the engineering side. Long story short, Hall Trading went to London, because obviously at that time, this was 2001, there was a big electronic push in Europe and Hall was obviously one of the pioneers in electronic trading and actually had a fantastic system compared to what I came from at Arbitrate. So in London, that was the role trying to help them build that out. And we were market

makers over there on all the European indices and left them in 2002 to work for a hedge fund called Horizon Asset Limited. They were primarily trading credit and asset swaps. So essentially asset swaps are call options on credit. So you build up like,

so we value those and figured out that they offer a lot of value. So instead of being long the CDS, say, at 1,000 points over, you could be long it at 750 points over. So what you did, so Horizon Asset was primarily a convert art fund. So what you do is you get the convert, but you get rid of the credit element, and you just kind of own the equity asset element. But you have the credit element in terms of a call option. So that was interesting. And I was building out an option business there as well.

I then left them in 2004 or five. I can't really remember. Went to another hedge fund called Horizon Asset Limited, where, no, not the Centaurus Capital, sorry. Where my job was to be essentially a risk manager, but we ended up trading a lot of options skew because Centaurus Capital was an event-driven fund. So their primary risk was, deal breaks and it goes to buoy. So it was very natural to use options to kind of hedge that so you can get that asymptotic payout. But obviously you can't just sit and buy options because, you know,

then you're going to go broke. So we had to come up with certain ways of doing that. And back then, you know, similar to kind of what we do now, we traded a lot of convexity in indices to kind of hedge the book. And then I left them to go and work with the third partner in our business, which is Manjeet Mudan, at a company that he had helped found called ADG.

And there we were basically just prop trading whatever we could in options. I mean, we're primary focus on interest rates. So a Euro dollar, short sterling, your Riper, all that stuff, a bit of commodities through the ETF, so gold and oil, and then obviously S&P and Eurostox and CAC and DAX and whatnot. But the thing is, you started finding out at this point in time was liquidity in Europe, besides basically the Eurostox index is not great.

I mean, it's nothing like what you see in the US. I mean, looking at the S&P. And yeah, then I left that, I think, in 2012. And I think Mike and I kind of got in touch in 15. And he had like an idea because he had a family office that he knew out in Californiaifornia yeah and then i think 17 i mean i'm not good with the dates um i think we kind of started uh kamika partners and and then yeah that's it love it uh and i've always been calling it karmica karmica you know what to be honest a weird story because we originally were called like another name, Convexity Capital Partners.

And then we figured out that somebody else had already taken that name. So that didn't really work. So the point is, we were sitting overnight, Manjeet and I was like, OK, we got to find another name. And Manjeet was like, let's look in Sanskrit because anytime you want to find something that involves convexity and partners, all the names are taken. Yeah, all the great names. We went into Sanskrit and figured out that

Kamika or Kamika, depending on, I'm not a Sanskrit expert, actually means shield bearer. Hmm. There you go. Some of the protective nature of what we do comes out of that name, obviously. I'll stick with

Carmichael then. Sounds like I'm not totally, totally off. Might be interesting because India has obviously seen massive growth, so maybe it'd be a household name over there. Right. I know. A few questions I'll come back to to but uh mike let's go with you and uh kind of your background and then into the the firm's background as well if you could

yeah okay so in my career i started off in the 90s i started off my career in equity derivative equity derivatives sales trading. I worked for the bulge bracket banks, so SocGen, Deutsche Bank. My last stint on the bulge bracket side was at BAML. And really what I focused on was covering both pension plans and volatility arbitrage accounts. So providing them with trading ideas. Typically, a lot of the relative value volatility managers were trading at the time index spread. So looking for cheap value in Europe and Asia, and spreading that against the US market. Also, dispersion at the time was quite big. So taking advantage of, you know, the implied correlation levels. So it was great.

I mean, I had a different range of clients. I got to see a lot of different flows. And it's interesting because, you know, after the financial crisis, a lot of those types of trades broke down. And I think the trading styles really adapted and changed. After that, I moved on to the ETF side where I covered alternatives. So I headed up a, it was a European based manager. I was based out of New York. And essentially, I was speaking to a lot of family offices, RIAs, and really giving them investment solutions for some of the problematics that they were trying to address.

So I spent four years of that. I'd met Martin and Manjeet during my equity derivative sales and trading days. And we came into contact with a family office that I knew, which I guess is a segue to how the firm was developed. And essentially, they were looking for an investment solution. So they had invested in terrorist funds in the past. And you know, those hadn't really worked out. This is 2015 that we started talking about the idea, the actual trading and product that we're trading today came to fruition in 2017. But the discussions started in 2015. So they'd invested in tail risk funds, they had this kind of like perpetual bleed to it. And then they were looking at volatility managers and, you know,

volatility managers, when you get into kind of the space, there's a lot of complexities. So, you know, it comes down to trust. And really what they wanted was a liquid solution to giving them, you know, capital and a market drawdown so that they could take advantage of dislocated assets. So they had private equity, private credit in the portfolio, beta and real estate, right? Which is a lot of holdings that we see today with a lot of asset allocators. So they wanted something that was going to have minimal bleed, if not positive return, but do well during a market drawdown. So I introduced them to Martin and Manjeet and that's kind of how things got rolling

from there. I love it. So I introduced them to Martin and Manjeet, and that's kind of how things got rolling from there. I love it. I just popped in my head that your job would be infinitely easier these days. You'd just be like, yeah, we're just everyone's selling volatility. Just get in there and do it. Your old job, right, of selling option strategies. Yeah, exactly. I mean, when you're kind of sitting on the sales and trading side, you know, the job is to kind of generate flow.

And obviously, the short ball trade has been people have been piling into that. You know, history repeats itself, right? So exactly. It rhymes. It doesn't repeat itself. That's the old saying goes. And then, Martin, two questions I jotted down when you were given that one. Where was the U.s school that was actually uh it was because you know at my dorm in uh in denmark there's a guy coming over

and it was a little bit weird he was northern illinois university he was only there for like a year and actually took some accounting classes and realized the county is the most boring thing yeah ever on the planet but they had an options and futures class which i ended up taking this was actually quite interesting right for tudor so it i was gonna guess it was there or idaho has a place or right it's got to be some this is actually in decalb illinois and i remember the winter there i got there i mean i've never experienced anything in the vicinity of being that cold i mean this is my scandinavian winter clothes in denmark and it was just utterly useless yeah it gets that's yeah out in the plains out there yeah what happened is supposedly when the corn gets chopped down

the wind it was obscene i, people were putting stuff in the gas tank because otherwise the gas tanks were freezing up. And I mean, it was just crazy. And one question before we get into the strategy, both of you have kind of been in and around all these different types of options, right? Not just stock index options. So talk for a minute about is an option just an option at the end of the day? And once you understand the dynamics of each market, you can trade that market? Or do you see massive differences in index versus non-index options? And then as you said, U.S. versus European index options.

I think that liquidity-wise, I mean, I think the US is obviously fantastic. I mean, the S&P index and the E-minis, I think the liquidity there is great. I think there's a difference whether you're trading index, which I consider systematic risk, or you're trading individual names, which is idiosyncratic. Obviously, when you're at a bank and you are sitting on a desk, a lot of the flow comes in individual names. And all the times the flow, you got to kind of assume all trading at this point in time, we're sitting on the floor of Goldman Sachs. So you got to assume somehow it's quite informed flow. And in an index, without assuming too much, the index is not going to go to zero. Whereas an individual stock obviously very easily can go to zero or be taken out.

So in an individual name, you're just from sitting in that seat, you're a lot more concerned about your tails than you will be in an index. So I think that's obviously the difference with it, but I think it's very important to understand whether you're... So at Centaurus, we also looked at credit options. So they were all OTC, and we looked at FX options. And so FX option market is super liquid. So it's an enormous size. I mean, just fantastic size. And vol, you know, was much lower than, you know, I haven't looked at it for a few years, but it was much lower than index vol. So it's like in seven and eight. I don't know if you guys remember, but the yen and the Swiss franc, every time the market puked, the yen would just. Yeah, like the safety.

They are the freaking bankrupt. And it was the online of that carry trade. And we were at Centaurus and we were like, S&P vol at this point in time was 20, but you could buy a yen vol around nine when we started doing it, dollar yen vol. So you could go and buy call options or call spreads at like half the vol. And the craziest thing we actually saw back then was Swiss Euro. Stig Brodersen I think the first clip we bought, we paid under four vol for Euro-Swiss. But you looked at Euro-Swiss correlation with Euro stocks index was 98% to 99% in 2007, 2008. I mean, it was just crazy. And it tells you that people were just borrowing money in Swiss rank

and buying your stocks. And obviously, when the thing blew up, and I remember we had a day where the yen rallied 15% against the sterling. Yeah, I mean, it was brutal. And, but you know, so we made a lot of money having that unwind of that carry trade on,

because that really was how you were in, in my mind, we're hedging a book back then because it was very interesting without going into too much detail. We can go into that later, but going into 2007 and eight, like 2008, well,

everybody, everything blew up towards in the second half convexity was the wrong i mean it was very low there was no demand for put options none before it blew up or after it blew up before it blew up and even in like a few days into the blow up no demand i mean because back then everybody was like private equity is going to buy this, going to buy that, blah, blah, blah. And that's what they did. So everybody was just coming after the calls. But then it was like a two day window and the whole thing shifted.

And I mean, you got an enormous move up in SKU and it seemed like the market was a wash in like short gamma and short mole. That was needing to be covered super quick. And then you're also, when you were on the floor, CBOE, you were the guy who basically designed, everyone had their sheets in their pockets, right? With all their ball levels and matching it up. Yeah.

I do remember standing up every day was hard as i mean it was just it was incredible i mean i was it's a fun place i'm happy i tried it for the 10 months or 11 months or whatever it was but it was not for me love it um you you kind of touched upon an important point i i think you'd asked is an index option you know the same as any other option, something to that effect, correct? Yeah. And you're in your background of doing a lot of different option things. Yeah. So I think as it pertains to what we do, I mean, that's an important distinction between us and others in the marketplace. So one of the things that's most important to us is obviously liquidity, right? So we're all, we're only trading index exchange traded options. I mean, having lived through kind of like the financial crisis

of 2008 and watched a lot of the OTC unwinds with a lot of hedge funds and kind of the return stream that people were kind of producing up to that point. I think given the fact that, you know, both Martin and Manjeet are market makers by design, liquidity means everything. So that's number one, we only trade exchange traded. I think the other important point and distinction to what we do versus others kind of in the relative value hedge fund space is that we're trading the most liquid index options in the world, but we're not actually introducing other indices into what we do. So we only trade wood index. So the relative value aspect to what we do comes in terms of spreading that against different strikes. But the reason

why we actually only trade the S&P 500 is during kind of market drawdowns and market sell-offs, we aim to produce positive returns and provide this defensive mechanism within the portfolio. And by not introducing other products into the marketplace, we cut down on that basis and correlation risk, which I think is an important distinction and the issue is you're giving up those quote-unquote obvious trades like in the euro stocks for euro yen and and things like that where you see this cheap volatility yeah yeah i mean i think the problem with the fx options i mean it's it's it's i i haven't followed it for a long time but back back then it was solely OTC.

So yeah, credit party, right? I don't know if this is off-listed. I mean, it probably is the same thing today. I'm sure there's something listed there, but the size you could do back then was just, it was wild. I mean, it was a fantastic market to trade. And the thing

with it, it was very, you look at Eurostox and S&P. So Eurostox feels like it's ball guys. Europe doesn't have. I think if you walk around the street in Europe and you ask a random guy on the street and says, do you know the Eurostox 50 index? And people look at you like, huh? What?

A lot of people might not even know the S&P index, but they definitely won't necessarily know that. But it's a product where a lot of ball guys are in playing it. So it's very efficient. And it is liquid. I mean, you can do a lot of size in it, but it's just we don't see the same opportunities you see in the US. I think the US, the fantastic thing with the S&P is you got the VIX. You got triple long, triple short

ETFs. You got these massive stocks like Apple and Vita that's just going up and up and up. And you got people around the world doing something. These two dump or buy a boatload of Vega. They go to S&P. So you have all these actors in there. You got

daily options. There's so much rope for so many people to hang themselves so many times over. I think that causes these trading opportunities that we just see so many more of in the S&P index than the Eurostoxx index. Preston Pyshko I love it. I bet 40%, four out of 10 might say they know the S&P in the US if you're walking down the street. That's probably, yeah. I mean, to be honest with you, I mean, without saying anything, in this term here with Kameka or Kamaika, however we're going to pronounce it, I have met one or two people who didn't

really know it um so i think the eurostox 50 is just i mean nobody knows that one i think the big thing that people kind of underestimate on the s&p just in terms of our conversations is is just how much liquidity is in that marketplace right so i mean i don't have the exact figures from sebo but it's somewhere in the realm of over 1.2 trillion notional a day so it's a very deep liquid market larger than uh the underline do i read that right or just that the volume is larger than the underlying the nominal volume i believe the nominal volume correct also think, I mean, the key thing, reason why you're probably seeing that liquidity is because you got these individual stocks like, you know, whatever the magnificent seven

or whatever we call them. I mean, underlying liquidity just in individual stocks in the US is fantastic. Yeah. I mean, you can go on the screen and, you know, so I remember just as a little tidbit when I was on the CBO, that's when these exchanges were opening elsewhere. And these locals were obviously used

to either turn themselves on RACE, which stands for Retail Automated Executing System, and then go down to the Billy Goat Tavern and sit down there and just trade on the bid and offer and don't even have to do any delta hedging, which was always a nightmare

because the spreads were so wide. And then, you know, when a broker would come in, you basically give him the screen market and maybe you have to improve 10 cents. But in that just 10 months I was there, a broker would come in and he would have three or four exchanges in his headset. And a lot of times in the beginning, the locals and the pit will be like, we don't want to participate in that. Well, then you realize, huh, then it's just trading elsewhere. So spreads were definitely starting to come in. I mean, and I remember moving to Europe, we were trading Nokia. I mean, I think we were trading two cents wide market in enormous size. So I think this liquidity that's

definitely coming to the marketplace, I mean, it's great for the end user. Whether that's high frequency or what it is, don't know. But I think the end user is the winner in this game compared to in Europe. Because in Europe, I mean, I think, again, I might be overstepping a bit, but in EURUSDUX 50, you might have real liquidity on the 10, maybe the seven biggest name in that index. Nothing like in the US. On the options or overall? Yeah, options.

Yeah. Stocks probably okay. They're okay. But on the options, I mean, single name liquidity in Europe was, that's probably a handful. Yeah. Even back then. So we've started to touch on it a little bit. Let's dive into the main strategy, the main thing you guys are trying to do.

You've mentioned kind of be there in a market crisis, but how do you get from all this liquidity, trade and S&P to that endpoint? What we basically do, we have a quantum model that's been developed over X amount of years where we try and model the option prices. We aim to model the option prices. This model, we actually used that back in the days. There's a slight modification of that. It's probably been around for about 15 years. And what we can do is we can model essentially, we can price options, call options and put options across the curve. And given the fact that volatility is very much mean reverting element. So a lot of people will look and say, okay, vol is 16 and market is moving 20. So think that it's cheap in terms of implied. We don't necessarily care so much about that because it's more for us to sit here and say,

is the market overvalued? Is vol cheap or expensive? I mean, we know whether it's low or whether it's high, but we're not the type of people that's going to go in and buy a lot of all we tend to play a lot more in in in the wings of the options be you know of the curves and you know and that's where our strength come in is without getting too technical but we can use i guess we can use a term like skew smile yeah so smile is obviously the you know how rich are put options versus call options would be the simple way of looking at it. And one of our things come in in terms of modeling that. So pretty much, I would say 80 to 85 percent of our trades are happening in the put wing in the 10 to 30 delta. So pretty far out of the, like a decent amount out of the money, because that's the element we tend to see that reacts. It's the element you can own that.

Obviously you want to own SKU if, you know, if vol is low and SKU is low. But the problem, I think, that the reason why we can do what we're doing is because in the option market, I think a lot of people, when they go in, they look at the option price and they just see this is the price I'm going to pay for that. And they might look at that and say, well, they're going to sell that and they can look at that premium they get and they can annualize it. And that's how they

value the trade. We obviously don't necessarily care what the option costs, but we care about the underlying implied volatility. And when we compare that implied volatility historical data, like going back, say, 10, 15 years, and the same thing with a smile, and we can see we think that's too high that's too low so that's where our our edge comes in and 20 like going into 22 and even you know in covet which was a very interesting would you call it was probably the truest black swan we have had in i mean last time, 87, yeah. And the thing going into 20, skew was actually very high.

And in that sell-off, when the market started, obviously, news started coming out and headlines and market reacted quite fast to it. Put options, relatively speaking, got absolutely mullered in the move down. Ball went up. So what people saw, they saw VIX, so they saw at the money ball go up, the price of the put options versus at the money actually went down quite significantly in that move, which is obviously impressive given the fact that it was the truest of a black swan. But that gets to my point.

The point was good options were probably mispriced going into that event. And I think most of the times, obviously people must you know fearful at the time and getting long production that's what for me what option tends to do it's an emotional game and people tend to read it really wrong and be positioned wrong when they go in for an event and they hear there's a big event coming up there's a fed meeting on wednesday we all got to buy options for that. The guy who sits with the option head out, he's going to be looking to Monday, Tuesday, and Wednesday going into that meeting, selling those options. Do you feel like it's the convexity of the options which allows people to be less precise, right? Like, hey, this has so much convexity,

I don't really care if I'm overpaying by a little bit for those puts, right? Versus you're coming in and saying, hey, go ahead, overpay. That's what we're looking for. Yeah, no, I think that's likely it. I mean, the convexity obviously is, you know, I think it goes back to what I said before. I think a lot of people value options on the fact that just they don't understand the underlying implied volatility. They just see the price and they might think, OK, 10 ticks for this. It's fine. You know, I look at it like it's a sunk cost. Whereas from a wall perspective, I mean, we rarely look at, you know, we can look at premium sometimes.

But in general, we are much more, you know, what kind of skew parameters are we getting on here? Are we getting long or short skew? You know, what's going to be the effect if skew moves up one basis points to our P&L? You know, obviously we can look and see, are we net long or short vol depending on where vol is? But the point is, if you're short vol through skew and in a very simple example if the the smile is obviously always steeper to the puts

i mean in normal circumstance there will be times or not but in normal circumstance always steeper to the puts and one of the things that happened when the put wing is very very steep as the market goes down those put options have to glide down the curve and have to go on a lower ball. So unless the at the money ball goes up more than we glide down the curve, I mean,

that put option is not going to work. It's going to work on its own. It might work if you were just long that put option, but you're not going to make as much of it as you think

because you're getting a kick. You're getting a drawdown from the lowering of the convexity. But obviously, the fantastic thing about options, if you buy an out-of-the-money option when convexity involves cheap and you get a big event, and not only does the volatility go up, but the convexity kicks up as well, and you get the down move, that's when you get these outsized returns and options. But most of the times when you're going into events, options starts pricing this in. You know, the sell-off in 22 was a funny one because during that sell-off, I remember that every single day, besides like from February and forward, they just couldn't sell enough skew.

And I think this was one of these years that for a lot of people was a bit of a conundrum in the sense that it was the year where we a lot of times saw VIX underperform the market and people like, how can the market be down 2% and VIX is down? And that was down to a lot of people who don't necessarily get... In 2022 we're saying? Sorry? In 2022. Yeah. So as the market went down, VIX massively underperformed. And part of that is VIX is

obviously, I mean, essentially like a variance swap on... So it's weighted with more puts than calls because it gives you a very exposure constant as spot moves. And you just got destroyed. And that's why we had so many times where market was down, VIX was down. And I remember so many people of these analysts who says, market's not going to bottom them until we see a VIX 50 event. And we never saw a VIX 50 event. So I think it's a complex product, for sure. And I think it's, as I said, I think the reason why S&P is particularly driven in such a fantastic way is there's so many. I mean, even the VIX index obviously has a ton of liquidity and a lot of different players in there trying to express different views.

And a lot of that feeds straight into the S&P as well, which just adds to the liquidity. And Mike, if I'm trying to stupidly oversimplify it what can i just call you guys skew traders yeah i mean i would say i would say that's pretty accurate it's a it's a quantitative model that basically looks at up and downside skew right within the calls and puts and then there's a discretionary override to what we do so the overlay comes and i think this is an important distinction in terms of which volatility regime are we in and maybe we shouldn't be looking at the last 10 years of data because that's not again you know the market's in a new paradigm now And what's relevant is how it's been trading the last six months or a year.

And that's totally just you guys in your experience saying, hey, look, this is the normal models are out the window right now. This is a crazy time or a very uncrazy time. I mean, we can still with our model, we can still fit the market. And one of the things obviously going into 2007 and 2008, we did see a market back then that as market went up, skew puts went down and calls went up. I mean, this is kind of how you intuitively would think it should work. What we really have seen like in the last 10 years is as the market's gone up, skew's gone higher. And the market gone down, skews gone higher and the market gone down skews come down so it's kind of gotten reversed around a bit and obviously i mean anybody can kind of guess why that is you know it obviously makes sense people buying puts when

they're going up pockets going down they're selling the puts uh to some extent but i also think that the problem that happened in seven and eight was um particularly being in europe where market closes at 4 30. what we would see at 4 30 as the market would come down because we were at the time long gamma which basically meant we're going to be buying we were buying when the market was going down we're selling when the market was going up and at 4 30 we30, we had to flatten out our skew book we had. And you would see most of the times at the second half of 08, market would literally do a mini crash at 4.30. And what a lot of people thought that was, that was the guys hedging variance swapsaps because a lot of the structured product books uh blew up uh and uh that negative convexity i think forced like from 2009 on where banks basically said you

know we can't have that risk we can't be that short tails so i think one of the things that that's happened since then is the skew has always been at a perpetually higher level. Because at least, I mean, we learned something from back then in a sense that, you know, you saw how much the S&P fell. And I've always wondered, because I remember being told by a guy on the CBO that the AOL and the Microsoft pit could be more than 50% of the underlying shares trading. That was just guys that are catching Delta. So I wonder today, when you're looking at the market today, how much out there is people buying stocks and indices, and how much of it is vol guys managing their Delta and the Gamma?

And expand on that a little bit. Have we seen the growth of zero DTE, the growth of all these alternative income mutual funds and ETFs in the US, which are essentially option selling funds? Do you think that's driving more and more of this? I think some of those are covered call selling so they're not necessarily delta hedging but i think the covers call selling that probably doesn't matter that much but um i mean the zero dte and and and the shorter dated stuff i mean if you're a market maker and you're being you know sold options uh with a day or two to expiration. And you can't hold that. I mean, you're going to go out of business. You're going to keep buying. You have to sell something.

But I reckon, you know, and this is again, just me guessing, when the market, it seems like every dip we've had in the market for the last long time just gets bought. And I wouldn't be surprised. That's because the dealer gamut, I mean, they're the first ones to go in and hatch. And they are there as the first stuff to just buy whatever, you know, delta they have and they're short. And I think part of the reason, like, we're getting these moves up in some of these stocks, which have been quite impressive. I mean, just even look at GameStop, you know, obviously that's a slightly different story, but it's a big move up where we know that retail have been long call options on this. And I wouldn't be surprised if retail have been leaning towards buying call options on the index as well. And that all helps you get these squeezes because

a lot of times when the market's going up it feels like i don't know i've been sitting through a lot of gamma squeezes in my life and it does feel a bit like that i mean i particularly remember november last year where we came out of october the market was down a bit and then in november i mean the first 10 days i can't remember like 10 or something that. Like a bad out of hell. Yeah. I think through that end of the year, right, it was like the largest 30-day move in history, I think. It was crazy.

Yeah. So when these market makers, right, I'm buying my GameStop calls. I used to think, right, oh, I'm buying it from someone else who's trying to sell the calls. But I guess all Wall Street figured out, like, there's not enough money to be made if we're just waiting for someone to be on the other side of that trade let's create the volume we'll sell it to you mr retail right we'll sell you that call that's the market maker's job and then they have to have to cover that risk yeah i mean and that's

a question where they cover it by trying i mean, it becomes an idiosyncratic risk because GameStop can do what GameStop does. They obviously wiped out a lot of different people. The movie's good. Did you guys watch that movie? Yeah. It was pretty good. It was good. Yeah.

You know, the guy that had zero lack of risk management? I mean, that's unbelievable to get wiped out from one stock. I mean, that's just poor risk management. Yeah, Melvin Capital. Yeah. management i mean that's unbelievable to get wiped out from one stock i mean that's yeah melvin capital yeah in the movie is seth rogan who's like the perfect i don't know anything about the actual guy if that's what his personality is but seth rogan just seems like a an idiot managing money in that so will there be a game stop too though with a secondary ipo right maybe those producers you know i don't know what you would do if you are mark and make i mean if you Secondary IPO. Right. Maybe. Those producers hope so. You know, I don't know what you would do if you were a market maker.

I mean, if you say it, I don't know how big part of a book it will become. I mean, but you're obviously selling vol at, I don't know what the vol went up to. I think it went well above 100. Yeah. I mean, it's almost like you sell that and try and delta hedge it as well as you can. Maybe you actually sell the ball and run slightly long delta against it. Instead of, I mean, it's hard when you're a market maker to go and buy 160 ball. I mean, you'll probably go and buy it pretty much anywhere else,

even though it's obviously going to be so disconnected that you can't buy it anywhere else. But yeah, I'm not sure how to do that it's against your dna right yeah we're not paying 160. so you're trading the skew and maybe a simple example is going to like normally uh 20 out of out of the money, the puts would be probably, say, 10. I'm just throwing random numbers out there. And the call's 8. What's that spread look like? We don't trade the skew like that. We actually do more in just the puts.

And everything we tend to do is relative value. So we don't just go and buy individual options. We'll never go and buy, say, sell a call and buy a put to buy the skew. We'll never do that. So we do, you know, and you let me know. We like to do structures like, you know, fly structures. So basically what you do is you spend X amount of premium and that trade is, so you are not net short options, you're net flat options, but it becomes a relative value trade that sits in these options you're interested in. So the interested options, let's say you want to sell skew, and that's the 4,600 put. You think that put is too expensive. And let's say that's about a 15 delta put option.

Against that, you might be going and buying the 49 put one time. You might be selling the 46. And in order to kind of cover margin on that trade and make it so you're not net short options, you might go and buy the 3,800 put. So you essentially end up with a one to2-1, which in option terminology is obviously called a butterfly. So that tends to be the way we'll do it. Because if we want to go do the other way, we get way too much delta risk. And we don't trade, in our fund, we don't trade futures. So basically what we do when we do a relative value trade consisting of three different legs of options, where we make our money is that that structure, say we pay two ticks for that or three ticks for that, we can materialize that when that goes to five or six, assuming we get the move in the skew correct. you correct guys you're trying to get as close to a free free call option even though it's not a call

but uh as close to a free trade as you can get waiting for that dislocation to snap out within kind of our trading structure we don't take directional views on the market we don't take directional views on volatility for the most part it's's quite low. It's purely taking advantage of the option flows that come from these directional market structures that people trade, which is that we see within the SKU. And is that, so each of those trades has a zero delta or there becomes a little bit of delta in there and then you have to put some...

By construction, when we put them on, it tends to be zero delta, yes. And then the money is really made that we get the convexity move right. Let's say we are long or short skew and the skew moves our way. We get that right. Then the whole change in delta of that structure changes to what we want it

to be. So let's say, for instance, you have a put fly on where you're short skew. So that trade on the surface of it would be flat the market, but as the skew comes down, it gets shorter the market. And if you don't get a sell off, you can materialize that. So we like to write the delta exposure if it's because we got the convexity move right. Obviously, if we get it wrong, and your short skew and convexity goes up, your short skew trades become long, a lot of delta, very fast. And then either it's got to go because we basically cut things when the Delta

moves against what we had decided to move. We don't want to sit and be long at both low Delta even if the market is down 2% because we're not here to bet necessarily on a recovery. I like at the end of the day to be pretty, you know,

platish delta. And so when you get those deltas you don't want, you're not hedging them. You're just saying we're exiting the structure we put on. Either exiting or resetting it to log in the game. And then that's how you're from a portfolio level, you're positive convexity performing in a crisis-type period profile is getting those structures becoming short deltas and riding those in the direction you want. Yeah, so 22 was a funny example.

So 22, obviously, the market was down until, you know, it was down, I can't remember what it was down, 17% or something like that. It was down a decent amount. Yeah, I think 20 at one point. Yeah. And basically, I think every single day, I mean, the skew just went down. And what happened, like we would start the trade, you know, long two puts and short two, but as a relative value trade. And at the end of the day um that trade just from the moving skew will be super short delta then the market would trade down you take it off move it further

down reset it and then same thing would happen um and there will obviously be different kind of structures but you know structures that's essentially a short skew without taking any delta risk so worst case scenario for you guys is like a sawtooth, whipsaw stuff. So you're like getting too many deltas, you're exiting or resetting that, then it comes back the other way, then you're exiting, resetting that and then back the other way. Yeah. I mean, to be honest with you, the delta risk is probably less for us. I think to be honest with you, one of the things that really drives our P&L is the SKU.

And obviously, the problem that has persisted since 2017 is that as the market's been going up, SKU's kind of been going up. And SKU was already high. And the only time where you tend to see a little bit of release or ease in SKU in in in sell-offs until like we saw here in in this year we we had time i mean a few months ago i think skew hit back to one of the lowest levels it it was since the the 2008 crisis which is obviously interesting that is starting to do that up here theories why that is i mean that's obviously where you can look, maybe some of the wall selling that's coming in. I mean, what we saw in May was a bit of a surprise.

I mean, I think, you know, when Iran, so Israel attacked Iran on that Friday or whether that's Saturday. I mean, that Monday morning, the wall selling was just obscene. I mean, they couldn't sell vault fast enough. And the question is, obviously, was it somebody that had gotten long going into the event, was just getting out?

But, I mean, I can't remember in my career when I've seen vault being sold that aggressively in such a short period of time. And just curiously, how do you, quote unquote, see that? You're just seeing the pricing come down, down, down on the options you're looking at? Yeah. Are you seeing like huge offers in size coming? We see it in terms of we have a model that basically, you know, model fits to the screen in real time.

So we get live option prizes into our risk management system and we see those bits and offers on the screen in real time. So we get live option prices into our risk management system. And we see those bids and offers on the screen. And what we basically do is we have a system with this curve, we try and match the mid value across the curve. But we do that because we have five parameters we move around. So skew is one of them, vol and a few others. And what we see then, I mean, you couldn't lower vol enough you had to keep lowering vol that day but it's not like a you mentioned the 4600 put before you're not seeing like what's the normal market 10 000 by one issue i just look 11 000 the vol model okay look at everything involved in ball terms let's talk a little bit you've mentioned the magnificent seven all this right what's the

dispersion looking like and how does that play into what you guys are doing if at all or just what are your thoughts on it seems like we've gone super crazy of all these single names are still moving still having lots of volatility and the index ball has come way down. Yeah, I think you're right touching on that. I mean, we don't do dispersion, but I do know that and I do think that that has become a remarkably crowded trade over the last couple of years. Maybe more, probably more than that. And obviously, intuitively, it has been a great trade. It's obviously,

just to explain that, people don't know that, obviously correlation is a simple example. You have an index with two names in it. One goes to zero, the other goes to 100. The index obviously doesn't move. And that's you being short correlation because you're short the index.

So obviously, as correlation goes up, which it tends to do in prices like in seven and eight, and it tends to do it in, you know, it even did it obviously during COVID. But the problem obviously was when you're looking at the ball there, you were looking at through the VIX. But in general, I do think that has a massive effect as well, because dispersion guys are obviously selling index wall as well. On top of that, they're buying the individual names. They might not be buying the old 500 individual names. I don't know what the Magnificent 7 now is of the S&P if it's 20% more than that, but I reckon you can probably buy the top 20 names in the S&P and you probably got a good chunk of the market covered. So in essence, if it's huge coming down in individual names, it's going to come down the index because there's going to be ARP guys that's doing it.

I mean, there are a few people out there trying to read about, you know, write about what will potentially happen if the dispersion trade gets unwound. Obviously, I did see a chart a couple of weeks ago that correlation had come down to very, very low levels before the recent market turmoil. And there's obviously a natural level for correlation to kind of be at, and we're probably not at that level. And is that a structural thing? Are they putting those trades on every day?

It seems like it can't get too far out of whack because it's a rather short-term trade, or no? Am I confused on that? I don't know the maturity. I mean, back in the days at Hall and Goldman, I mean, every single index desk, what we were on, I mean, I was trading the OMX, so the OMX is the sweetest index. And against that, we were trading the whatever OMEX 30 stocks that were in there. But the reality is you could probably only trade five of them. And then obviously DAX was 30 stocks.

So they were all trading these individual names. So whenever you bought some individual ball, you would go and sell the index against that. That's just how you did it. Yeah, most guys used to kind of sell dispersion either six months out to a year and a half. I think people are running different types of dispersion books, though, right? They're kind of legging into the single stocks and selling index against it. I mean, it seems like the overall underlying theme right now, though,

is, you know, selling volatility, right? You've obviously seen that through covered calls and the big growth of kind of like all of these vol selling strategies is, you know, many people have seen through the Morningstar report. And I think the same thing is taking place at a lot of the multi-strats with dispersion trading so you know when that trade comes undone and timing is obviously unknown can be quite ugly out there right what um what else are we seeing in the option space that's of note as you guys are looking at it day in day out i mean it's hard to say i mean i think the i think uh i mean it's it's it's interesting what we're starting to see a little bit now a little bit now is uh skew has definitely uh come up a bit uh and it's it's reacting a bit more on the downside

in terms of not necessarily being sold when the market's going down. I mean, I think for me, I mean, that might not sound like a lot, but it's tidbits of a change. You know, the way I was schooled was, you know,

market puts go up when market goes down. I mean, skew goes up. I mean, that's how it works. And since basically 11 and 12, I mean, we've kind of seen the opposite. And we're starting to see in the last like six to eight months tidbits of more of a bid coming into skew. And I don't know if that means more of a normalizing. I mean, I think the jury is still out on these zero-day options. From our understanding, at least what SIBO seems to be under the impression of as well,

is the biggest ball selling is these overriders. That's not going to have an effect if the market goes down. That's irrelevant. So I'm not worried about that. What I'm more concerned about is who's playing around in zero-day options because I wouldn't know. Zero-day option for me is just a lottery ticket. I would even say like a weekly option unless, you know, particularly in an index. I mean, who knows anything there? And now you're coming out, supposedly, with zero-day options on the VIX. So I think these things, for the time being, have probably had a strangely stabilizing effect on the market.

I'm not sure they, I mean, the jury is still out because we haven't seen a big sell-off, really, with these things in the market. I'm not sure. The jury is still out because we haven't seen a big sell-off really with these things in the marketplace. Preston Pyshko But that begs the question, is it because they're in the marketplace that we haven't seen a big event? Peter Bell You know, and that could very well be. I do think a lot of the trading in the market right now is actually either it's CTAs out there doing arbitrage on futures, but I think a lot of flows come through the futures. I mean, look at the Russell 2000, what is it up? Like last, this month's 10% or something like it was up.

Yeah, it was crazy. Yeah. At the same time, we have one of the biggest days where NASDAQ was down 2% and that was up 5%. And obviously, that's an unwind of something that somebody had to trade on. And, you know, there's a good news writer out there called the Daily Dirt Nap, Joe Dillon. And he's been writing about that, that unwind of that trade could actually be taking a lot longer than it should be taking. But I think you obviously at the same time hear people who fundamentally says, you know, oh, okay, now it's probably time to buy Russell 2000 without kind of looking at... What I'm getting at is I think a lot of the stuff out here is so technical.

I mean, CTA is doing one thing, option guy is doing another thing, and then obviously you have all this zero day stuff out there going on do you feel like it's harder than it used to be right there's more competition there's more structures there's more durations there's more more of everything more competitors you know what to us i actually don't feel i don't feel like it's it's it's it's it's harder i mean we trade very differently than we used to do. We used to be the type of guy, everything was done in the futures.

And rarely you did trades that were delta neutral. I mean, you would go and look for the strikes that you wanted. And just, I mean, a lot of times you trade individuals or spreads or whatnot. We could also trade put flies, but everything was done with futures. I actually think there's a nice simplification element of it just doing the options. I feel like there's a lot more opportunities

than I've seen in a long time. A lot more. Yeah, I just feel like you guys are masochists. It's got to be the hardest game in the world, even if there's more opportunities, right? You're competing against this is the pro pro pro pro level yeah no that that that's true and that's to be honest you i think that as mike kind of touched on before i think one of our strengths is like we just focus on one index you know back in the days i remember we were at at

adg and we were trading euro stocks against s&p So one trade you would go and do is like, oh, now SKU is up in Europe. You know, boom, sell SKU in Europe, buy it in S&P, hold it for three weeks, maybe four weeks, take it off, make three or four SKU points. You know, vol went like a vol above in Eurostox or whatever. You buy Eurostox vol and sell S&P Vol and you make half a vol, you do that. But I remember just in 11 and 12, that spread just used to go like that, go out and it's like, holy shit, when do I cut it? Or when do I add to it? The divergence between names has just gone wild. And I think when you're seeing a day like we saw last week where nasdaq's down whatever two percent and russians are five percent i mean if you're trying to order that in ball space i mean you just uh you throw in the towel

yeah it's it's it's kind of an interesting space because obviously you've seen kind of the short sellers disappear right i mean big household names that kind of disappeared as a result of this market rally. We've got a nice strategy because essentially in this slow upward grinding market, that's obviously not great for a vol manager because you need episodes of volatility. But we hold our own quite well, mitigate the bleed through the relative value approach. And then when we get these periods of risk-off, market volatility type events, the strategy does quite well under those circumstances.

So I don't think there's a lot of decent, I think there's a lot of market worry out there, just kind of where we are in terms of valuation levels, in terms of equity markets. I mean, you know, people are going to kind of differ in terms of views on that. But I think in terms of having an uncorrelated strategy out there that's truly uncorrelated to bid. I think it's difficult to have products out there, and that's what I think we're doing well at. You mentioned before you saw all these tail investors jump out of their tail protection because they didn't like the bleed.

Well, I kind of led the witness there, but I was going to ask, right, was that the investor's fault or the manager's fault right did those tail products have too much bleed because the manager was doing something wrong or was the investor tail funds are just didn't have the patience tail funds are just constructed completely wrong because there are definitely times where you should be long the tail absolutely and there are times where you shouldn't be near it you know if you were long the tails in 22 you just you didn't do well i mean you had to be long if you were long those tails they had to be on a ton of short delta for you to make money yeah over delta yeah and i think that's the the problem obviously the the tail is kind of like you know when you go in and the market is nervous and skew is super high.

It's like going and calling up the insurance company when your house is on fire and can I get a fire insurance? I mean, you're going to pay for that. And it's highly likely not going to work. Yeah, I think the 40, we'll go back to that, whatever that, the 4,600 put at the beginning of the year. Right. Even though when we were down 20% in October, whatever, it was the same price that it was at the beginning of the year right even though when we were down 20 in october whatever it was the same price that it was at the beginning of the year yeah something like that yeah yeah 20 down movie you had no upside in in that put which is a disaster yeah that and that's obviously where

option can be a bit of a conundrum i mean we used to have the same going back to at centaurus capital i remember we would have you know obviously we're an event driven, so sometimes we had some information in stocks. And I remember we had a stock that an analyst was like, these guys are going to get bought. And it was on the front of the Financial Times. Not going to mention the stock, but it got bought over the weekend and we had bought call options. And we obviously made a bid in the cold options.

But when you went in and looked at the cold options on Friday, it was like, OK, clearly we are not the only one. Yeah, you weren't going to get bought. And I mean, that's I think that's the that's what well, options are pretty good because they're very emotional. And when people pile in because they believe something, they pile in. And then when it doesn't work, they pile out. And that's where we kind of sit in the middle of that. Yeah, tail funds are less value-driven, right? I mean, our strategy is completely value driven in terms of these out of the money

options. I mean, the mandate for a tail risk manager is they need to provide that protection no matter what. And I think the thinking of investors is, you know, this is going to work across all market conditions. And I think what we saw in 2022 is that's not necessarily the case, right? Where nothing really worked. And that's the big issue I have with tail risk funds is there's just this perpetual bleed over time. And, you know, when you do get that market event, when it comes, the expectations for what these products look to deliver might not be what they thought going into it yeah and did that open up the space for relative value say right like hey the tail risk is also a little bit of a relative value like they can't always be there for every down move

right they're just in one channel here so right my as an investor i might be like well relative value i can't count on you guys in a huge down move that would be the pan right and be like okay structurally we still put this stuff together and we think that but i get what you're saying but that proves kind of like well tail might not always be there in the down move anyway so maybe i take a look at these relative value guys that might not be there also. Yeah, I think people kind of need to look and construct a portfolio with several of these products, right? Because the reality is, no strategy is going to consistently be able to deliver with 100% certainty that objective. There's going to be things thrown into the equation which kind of could derail that. So to have different managers with different style buckets, with perhaps that

objective to make money on the downside, I think makes sense for an asset allocator. Such as our friends at Mutiny. Yeah. Exactly. exactly last thoughts Martin anything you want to oh I wanted to bring up Hull so when you're at Hull Trading that's Blair Hull we're talking about yes yes so we had a post this is like 15 years ago maybe

but there's a cool post out on our blog of his a picture of his trading card during 87 and I might mess up the story right but i think the the future the s&p was not was basically limit down whatever wasn't trading he was in the mmi index i believe which was kind of the precursor to the dow futures um and bought like 50 contracts or something and that just created this arb right of like hey chicago's moving and new york moved it came off limit and that's what started the uh the rally back from the 87 lows so we'll put a link to that to those who i met him a few

times i mean he was quite he was quite a funny uh man um and obviously obviously, Hall was very much like, quote, driven. I mean, we, so for instance, if we ran a book where we had the 500 names in the S&P index, we had the index, I mean, our system, if we sold index vol, our system would say you should buy vol in this name or this name or this name. I mean, it would same thing, you sold some futures, that the system will tell you which of the 500 stocks should you buy in the index. I mean, it's very quantitative. We have seasonality of vol in there. Like, when can you expect this boring what vol moves,

but like I said, kind of model just sitting in the middle saying, vol's cheap now, vol's going to go up now. And actually, one of the things that blew my mind the most is like, because i remember i think it was blair hall that came into the first one i just got hired and he was asking us what do you think we lose the most money on we were obviously all guessing gamma vega yeah it's dividends which is row no what's the game yeah that essentially becomes a row because uh it's obviously ever you know,

that's obviously the problem. I mean, everything's priced on the forward. And the dividend gets moved from one term to the other. And everyone's like, you guys are all like, oh, wait. We were always on the wrong side of the dividend trade. Every time. I mean, I don't think any time in my life I think I made

money one time on dividend that was pure lot now there's dividend futures you could delta hedge

your dividends with dividend futures yeah which obviously would be a different ball game but

you know that's obviously I mean I don't even know what the liquidity is but I imagine that's going to

be quite good yeah I think it's pretty good. Awesome, guys. I'll leave it there unless anyone's got some last tidbits to add, but I think we've covered a lot. Yeah, that's been great. Thank you, Jeff. Thank you for coming on, and we'll talk to you soon. We'll come visit you in London, Martin.

Yeah, you should. Whereabouts are you in London? I'm actually in, I mean, our office is down on Paul Mall, but I'm in Camden. Okay. I'll pretend, I'll nod my head like I know exactly where those two places are. For those who know London, they'll know it well. Exactly. Sounds good.

Appreciate your time. All right, guys. Thanks so much. We'll talk soon, guys. Take care. Bye-bye. sounds good appreciate your time all right guys thanks so much we'll talk soon guys take care okay that's it for the pod thanks to martin and mike thanks to rcm for sponsoring thanks and jeff berger for producing see you soon peace you've been listening to the derivative links from this episode will be in the episode description of this channel follow us on twitter

at rcm alts and visit our website to read our blog or subscribe to our newsletter at rcmalts.com. If you liked our show, introduce a friend and show them how to subscribe and be sure to leave comments. We'd love to hear from you. This podcast is provided for informational purposes only and should not be relied upon as legal, business, investment, or tax advice. All opinions expressed by podcast participants Thank you. 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.