The Derivative - Overheard at a Vol Conference, breaking down EQD Global 2020

Episode Date: November 27, 2020

One of the leading volatility trading and derivatives investing events of the year wrapped up last month and we have lots of thoughts. From new vol dispersion products to  portfolio design, tail-risk management and structural vol; if it’s been a hot topic in 2020 – Global EQD covered it. We’re joined by Jim Carroll, Senior Vice President at Toroso Advisors and John Cummings, Director of Research at RCM Alternatives. There were sessions we agreed with, opinions from some of our favorite finfluencers,  and even some sessions that straight up made us scratch our head. So what was talked about by the likes of Benn Eifert, Chris Cole, Vineer Bhansali, PIMCO, the CBOE, and more?  Take a listen and find out. Chapters: 00:00-02:45 = Intro 02:46-14:21 = Quick Takeaways that Caught Attention 14:22-29:54 = Learning 2020s Lessons / Tail Hedge Protection 29:55-35:20 = Largest Risks for 2021 / What Possible Grenades could be Coming? 35:21-59:56 = Vol Strategies in a Mad World Follow along with Jim (@vixologist) & John (@cummingsjohnb) on Twitter, and make sure to keep up with the team at EQDerivatives (@EQDerivatives) so you don’t miss their next great event. Here’s the event page over at EQD = https://eqderivatives.com/events/global-eqd-2020 And last but not least, don't forget to subscribe to The Derivative, and follow us on Twitter, 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

Thanks for listening to The Derivative. 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 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. 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. This was some Chris Cole commentary, but I think it's echoed by the other participants on both panels. Just the magnitude of option flows currently versus, pick a a number five years ago, 10 years ago. Yeah. And both institutional and retail, obviously, the Robinhood stuff has gotten a lot of

publicity this year. But the thing that that brought home to me is options are inherently a source of leverage. And that's good when it works. Good. Right. But it's, you know, it's it's essentially increasing leverage in the system. And that cuts both ways. Right. And so we see these reactions in the market, these V-shaped recoveries and these precipitous drops. You know, we're used to people saying you take the escalator up and the elevator down. Well, we're now seeing, you know, elevators going in both directions. And I think a decent chunk of that is the implicit leverage that we've added to the system over time.

Hello, welcome back, everybody. We're doing something a little different today and are breaking down some of the highlights and best things we heard at the recent virtual EQ derivatives conference. We're vol trading heavyweights like Vaneer Bansali, Chris Cole, Ben Eifert, and Jem Carson. We're dishing on all things volatility trading from what March looked like down in the trenches to what worries them most moving forward to what alternative risk premium strategies we're able to do or not do in the recent crisis. Joining us to talk about it all is Jim Carroll, Vice President at Toroso Advisors, and better

known to our listeners perhaps as Vixologist on Twitter. Welcome, Jim. Hey, Jeff. How are you? Good. Thanks. And we've got RCM Alternatives Head of Research, John Cummings, who's been analyzing vol trading strategies and managers for years. So welcome to you, John. Thanks, Jeff. Good to meet you, Jim. First time. Thanks. So yeah, both of you virtually attended the conference with me. So let's just get into it.

Three of us just want to talk through some opinions we agreed with, thoughts that made us scratch our heads, things that made us go, hmm, to quote crash test dummies. So anyway, on to the, so I think for myself, the two money panels were A, the Ben Eifert panel, and Jim Carson, and B, the Veneer-Bonsali panel, where I think the bulk of the vol trading and portfolio construction pieces were talked about. So I think we're likely to spend most of our time on those. So I want to push those aside for a second and just kind of say what were, besides those two panels,

what else caught your attention? John, what stuck out to you? I didn't know much. I thought it was very interesting. But, no, for me, the risk premium, the last session, I thought was interesting just because it reminded me so much of our discussions at UNIHF and our investors at Head of Managed Futures over the last five, seven, 10 years, you know, the complaints that those guys are having right now, you know, is the trade beta underperforming the S&P, not really performing when it's supposed to, all kinds of things, challenges that, you know, we've been dealing with now for a while on the managed future side of the business. And after I got off that conference, I was doing a little Googling on Reese Premium,

and one of the comments I think was an institutional magazine was a institutional investor magazine was a risk premium is just a managed futures with better marketing. So maybe that's why it made a lot of sense. At some point there was like managed futures. It's just X with better, better marketing. That was, that was us in 20, 2009. Yeah. What I couldn't understand from some of those panels

whether they were saying the risk premium strategies are underperforming the premium, the base, or they're just underperforming overall and people expected them to have gone up. It wasn't clear for me whether they're saying the whole premium is not performing or whether their distinct strategies are underperforming the premium they're trying to capture or perhaps both did you guys catch either side of that maybe both i mean it seems

like they're underperforming the risk-free right so i guess that would be the exchange right you're giving up the risk-free for some type of risk premium, a minor standing, I could be wrong there. But, you know, looking at like AQR's mutual fund, you know, and I think they're allocated like 55% or something to long equities of some sort. So, you know, when a market crashes like it did in March, wouldn't necessarily expect those strategies to be uncorrelated or

lowly correlated to stocks. You expect pretty much what happens. Yeah. And I snuck the question in there on one of the panels of like, hold on, are you saying risk premium wasn't designed and won't perform in a large volatility spike? Cause they were kind of making some excuses of, you know, the market moves so fast, so quickly. The risk premium strategy, their models aren't designed to kind of handle those types of dislocations. And I feel from the investor's standpoint, they're like, what are you talking about? They're marketed as alternative investments and, you know, things you would look to to handle that kind of thing.

Jim, what do you think? Jim? Well, there are a couple of sort of recurring themes that goowments, a whole host of folk who are perhaps dipping their toes or started dipping their toes five, seven years ago into areas that maybe they hadn't been in before. Looking for less correlated, uncorrelated, alternative sources of alpha. And as we've seen, particularly this year, sometimes that leads you down the wrong path. And you wake up and find out you've got a giant hole blown into your portfolio. Selling variant swaps or something for yield. Right. And I think it's writ large in part because fixed income allocations aren't doing

what they traditionally have done. They're not providing income, that's for sure. And they're not providing the negative correlation to moves in equities that sometimes people are used to seeing. You know, just recently, we've seen Treasury selling off with equities. You know, that's unfair. That's not what we're used to. But I think where people have used bonds as a source of risk management historically, you know, the 60-40 portfolio, bonds are not managing risk the way they used to, and it's causing people to look other places. And when they start looking other places, they're not necessarily, well, they're catching up on the necessary homework to put money into some of these quote unquote alternative strategies. So I think what they're getting maybe is not what's been advertised and certainly not what they were expecting. To me, I always think of alternative risk premium as like the salad bar,

right? Or the buffet. And you can go right up. Sometimes I just want to order the Caesar salad and I get it served up to me nicely and it's all prepared. But the risk premium, you can go pick whichever pieces you want, put in your own salad. Then you get back to the table and you're like,

this doesn't taste like I wanted it to taste. So a lot of it to me is the own investor's fault of like, you're the ones, you kind of demanded it got broken out into these individual sleeves. You're the ones accessing the individual sleeves. You know, if it doesn't work out, it's kind of on you. It's not necessarily on the people devising the sleeves although on the flip side if they're saying they underperform the actual premium and they the panels john read they i don't think they got into that as much of like there's some research out there that the more money that goes into a risk premium the less that risk premium exists i don't think they got into that as much no they didn't but they did mention that as much. No, they didn't.

They did mention, I think they did say, crowded trading as a passing comment. I don't know how much they could really get into it without injuring their business. That's true. I think that the classic one there is liquidity or illiquidity risk premium.

So if you make that all of a sudden into a liquid product, are you necessarily taking away from that premium? And then part of the end of that panel I was interested in, they were talking about commodities. Can commodities be an inflation hedge? What are your thoughts on that, John? You were tying that back to trend as well for managed futures? Yeah. I thought that there's, I don't know. We haven't seen an inflationary environment in a long time. So it's hard to say. This

is a classic when people are looking at futures like, well, I want long commodity and I'm sure we'll talk about it, Chris Cole's white paper having this long commodity piece doesn't really perform over the long haul, obviously, and then having long commodity trend by itself,

we don't see many CTAs doing that because this looks so bad on paper. I think there's like two, maybe three groups out there I'm aware of. So I'm skeptical, but, you know, it would make sense in theory. Well, hasn't it been a case, not unlike the sort of long haul allocation that has just been a bleeder since 2008, when everybody decided they needed to have a long ball allocation after they were clubbed by the 2008 crisis. It seems to me that a lot of the CTA world has suffered from that same bias. Everybody wants to jump in right after the performance has been great and doesn't recognize that there may be meaningful periods

of time where the performance is okay, but you'd rather be in the S&P 500. Right. And I think in the panel, the more they were saying the, like I'm in this carry risk premium, or I'm in these, all these things that kind of have this in a crisis correlations go to one and have that correlation

where their investors are coming back to them. Like, hey, I didn't know, I didn't know this trade had so much beta in it. Which again, I'm like, well, you know, be careful grabbing the beats off the salad bar then that's on you um all right so talk to those i'll mention one other thing that caught my attention before we go into those good panels was the uh right off the bat the urex was talking about how they survived march and they they mentioned the stat that margin went from 60 billion to 120 billion overnight,

which was eye-opening to me. And it's just, I don't think maybe the people at this conference get it, but I don't think the investing world as a whole gets it, that these derivatives markets are functioning with high, high level of efficiency, safety, counterparty risk has been nearly removed. So right when we think back 20, 30 years to a crisis, there was a lot of body bags, people getting taken out. And nowadays, it seems like it gets handled relatively orderly. All right.

Let's get into the good stuff and talk about the first real panel to me was this learning 2020s lessons, portfolio design and tail risk management. So it had Ben Eifert of QVR, Jim Carson of AGEA and Roxton McNeil of UPS Investment Trust. So this panel to me was just great. You had Ben and Jim trading nuggets of wisdom and then Roxton just sort of comes over the top and says, hey, I do this with billions of dollars and, you know, basically in-house. So it was all pretty darn good.

John, what were your kind of main takeaways from those three guys? Roxton? Roxton doesn't like to pay fees. He pretty much came out and said that, you know, I can do all this what you guys are doing. I don't pay fees. You know, I think for all these guys, I think the most interesting thing now, don't pay fees um you know uh i think i think for all these guys i think the most interesting thing now and i think what you know to be seen um you know from

chen and i can pronounce the name right uh shem right um jim sorry sorry jim you listen to this um you know he's basically talking about like you know looking right now he said the banks are hedged now right and so it seems like the common theme with these guys is you needed a big vol compression to come back down and then you know get everyone feeling like safe and sound see some volatility option writing types of scenarios but now you know post-March and, you know, people are talking about the potential for a second, like down type of move. And from this panel to me, it seemed like they're not so much worried about that. They feel like everyone's hedged out and that, you know,

in the unlikely event of a surprise victory tomorrow, or, you know, second wave COVID the, it doesn't seem like the second wave, at least in my opinion, it doesn't seem like the second wave, at least in my opinion, it doesn't seem like the second wave now concerns these gentlemen as much as maybe potentially some other investors that are out there. Jim, what do you think?

Yeah, I think that was my takeaway in general as well. I think I was sort of blown away by Ruxton's piece of the presentation. Yeah. I'm not sure. The UPS Pension Trust, you're thinking about guys running around in brown trucks and brown uniforms,

and this guy comes out just blazing. Yeah. I was not, I think I might have heard his name once before, but very clearly he is, well, you guys probably have a better perspective than I do on the talent across the pension frontier. But he struck me as somebody who knew his stuff in great depth and was implementing strategies at a level that is probably unusual. Yeah. I wrote in my notes here that he basically gave a master's degree in tail risk hedging strategies in about five minutes, you know, rifling through all the ways he sees it. And we can do it all in-house. Yeah. so we can just start with some of the things he said

because i regret he said you need a diversified set of hedges to be effective um and he said hedge across any tool that's available to you so he's kind of saying he has some things that are available to him that aren't available to the rest of us but um that could include fixed income uh strips vanilla options over-the-counter stuff um and then he was was interesting to me he was kind of saying they target dollar values of vega gamma uh i can't remember which other greeks he used but basically they're constructing the hedge to do those um they're crazy about addressing the cost in each of those risk budgets, funding legs with carry trades,

selling vol and intraday hedge. What else was he saying? And they said they're always looking to reduce the path dependency. So adding as many pieces as possible. Yeah, it just sounded incredibly complex to me. One of my Twitter buddies sits inside of a much larger state organization.

And he was just blown away. He said, I understand what this guy's doing. And I also can tell you that we wouldn't ever get close to the level of, uh, sort of use, uh, diversification, uh, you know, detail, and probably in large part because the guys upstairs just simply don't understand it. Yeah, right. Well, that's the thing. He's not only brilliant on being able to structure the tail hedge,

but he must have a second PhD in being able to sell it to the investment board, right? That's almost the harder piece. Well, I would hazard a guess that, you know, he's established a track record and demonstrated that he knows what he's doing and therefore probably has, you know, a fairly long leash to get stuff done. I doubt that he's having to get stuff approved on a day-to-day basis. No.

Yeah, but overall. Yeah, I'm sure he's, again, I'm sure he's, because he did talk about budgets, both in terms of, you know, how they're managing risk and how they're managing the cost of the hedging program. So I'm sure he's established parameters, and within those parameters, he's probably got free reign to get stuff done. And so coming back John, you were saying both Jem and Ben were kind of saying

coming into March the spring was compressed, everyone had been trying to sell SKU, sell vol to generate yield. And now that it's kind of disappeared. What did they say about, are those, uh, natural sellers still out there? Uh, yeah, I think they're slowly maybe coming back. I think when I took away from it, but definitely not at the level of where they were. So it sounds like to me you kind of need like this constant, I'd say, I don't know what word I'm looking for, but basically a cycle. That's what I'm saying. Like kind of a cycle where, you know, you have lots of low volatility, lots of option writing in the market.

Then you have some volatile event, which then resets everything, banks hedge themselves. And then we kind of maybe go through this choppy period for a while until investors get complacent again, and then begin to load up more on the shortfall strategies, which then cycles back into another potential volatility event, which seems to be, based on the next panel's comments, like a three to five year time horizon is what they kind of look at.

But, you know, in terms of the institutional side of it, you know, I think Jim's good point though was a lot of these institutions were working or looking at this over the last 20 years of market history. That's, you know, they're trying to catch up maybe to Rockston and maybe some of the other guys out there, you know, been volatility specialists the whole career trying to catch up and get roxton and maybe some of the other guys out there you know been volatility specialists with the whole career trying to catch up and get to that level but i think jen's point was like they're already so far behind behind the curve and then two the recent data points they had

to work with over the last 20 years if it was even relevant for the next volatility event right and he was uh and ben was kind of on the institutional flows. That's all looking like call overwrites, secured puts, you know, things that are viewed as a diversifier, but institutions kind of taking a step back from that. option demand um both for hedging and equity replacement basically no decent jan here um kind of for the reasons you said of the election second wave of the pandemic uh and he was saying until now there's been no real new option demand you know just kind of option selling and then they also got into a bit of the retail flow the sang stocks and whatnot right um so that leads into they also talked about was it because it sounds from what you're saying like hey it's too late for tail hedge protection but they were asked that um what do you guys remember from from that discussion well i think um uh they weren't my recollection is that they they weren't shutting it down completely

um you know there's been there's been sort of a twitter debate going on about whether everybody's all hedged up going into this thing or whether there is room for, you know, kind of a further surge to the upside and, and implied ball. And, you know, even in the last couple of months, you know, whether it's, it's the June, we had the little burst in June, the end of August, first week of September. And then just this last 10 days or so, you know, we've seen these little mini surges, where two things have happened, vol has kind of compressed, just in a range. And at the same time, you know, like, I remember pointing out to people on Twitter, at the end of August, we've got this giant spread between implied and realized.

And, you know, it's just way wider than it normally is. And so everybody says, well, yeah, because implied are coming down. They're going to follow realized down. Okay. Well, what if it happens the other way? Right, right. Realize it's come up. Yeah, and that's, you know, that is what happened at the end of August into the level of implied volatility and saying implied vol is just too high, implied vol is too high, it's got to come in, it's got to come in. But it's gotten very stubborn. One of the things, you know, very kind of naive analysis, if you just take the VIX index

and you look back, you know, to when it started and you say, where's the one year moving average of the VIX index? When that one year moving average gets above 20, it's a small sample set, but it tends to stay there for a little while. And guess what? We went back above 20 this year and we'd been above 20 for, wow, I forget how many days now, but you know, basically since, you know, the end of February VIX has been above 20. And so just because VIX is above average, doesn't mean it's going to crash back down to the teens right I think that Ben Eifert had a line there that higher vol isn't always more expensive vol

exactly sometimes depends what the landscape looks like and sometimes it's higher on purpose because it's higher now obviously you'd rather you, you know, if you're going to take long ball, do you want to start with VIX at 12 or with VIX at 30? Well, gee, I guess I'd rather start with it at 12. Right. You know, that doesn't mean you can't, you know, make some money. It may just be a little trickier. You may have to be a little more nimble. Yeah.

And I think overall, they were sort of saying, John, correct me if I'm wrong, but it felt like they're saying like, no, it's not too late. I think Eifert said you got to be a little more choosy. Things aren't as cheap. And then Jim had some stuff about the middle period and some charts.

You remember that, John? Yeah. He basically said I had a chart. I believe it was the best times, worst environments, best and worst, the sell implied volatility. He showed that out there. I don't remember exactly. Yeah, which is interesting because he likes to look at the world through the lens of an at-the-money SPX straddle, which is not unlike the Logica guys. They love to play the straddles, and I think it's a great way to look at levels of implied ball. And yeah, that chart was interesting. You know, clearly, there is a point at which people have bid up implied vol to a level where it almost has to mean revert over some

reasonable period of time. You know, but does anybody really want to be the first one to sell? And so his chart said, hey, if you get high enough in your implied vol, you're going to get a return from selling straddles. And the worst place to sell straddles was in that 20 to 28 level um you know which basically says that's where you can get caught offside yeah which you'd think for coming from 12 you'd think that's a great place to sell straddles i was just at 12 now i'm at twice as high in the ball 24 right gotta sell these things his research is showing that it can spike more from those middle levels, I think he was calling them. Yeah, that's exactly right. You know, and that's the problem is, is you're in these middle levels. And you don't know whether you're on the way down,

or you're still on the way up. Right. Or, or sideways. Well, sideways being the worst, arguably. Yeah. You don't make money either. Well, sideways for vol, I meant. Yeah. Yeah. Because sideways for the market would be down for vol, right? Right, right.

Yeah, but sideways for the straddle, whether you're a buyer or a seller, you're doing nothing. And then I remembered our guy Rockston again. He said basically just as an allocator, he has no idea what's going to happen tomorrow and he just wants the hedge on. So he wants this tail protection to be part of his diversified set of hedges and it's going to be on there no matter what the VIX level is, no matter what the narrative is, he just wants it on. Well, I would guess that he's got some dials where he's probably dialing that up or down. I mean, it sounds like he's very clearly an active manager of that hedge position.

So I would suspect he's, you know, he's got a little dial that goes to 11. Yeah. All right, moving on. The other, I kind of finished this panel with the largest risk for 2021. John, you got notes on that? The largest risk for 2021?

Yeah, so I think, you know, Ifer was saying he was looking at antitrust risk. You know, obviously, Amazon, other big tech companies, Google, Apple, I guess a great example, you know, with what's going on there with, you know, Apple, pretty much getting paid to promote Google through its through its platform, through the phones as a search option, stuff like that. I think all those things are paying 10 billion a year now or something. Yeah. Are they paying $10 billion a year now or something? Yeah, basically. The default iPhone. Yeah, which Apple's not going to want to give that up anytime soon. No, correct, right? That's real money.

And I think it sounds like there is a lot of potential for that. I would agree. To go along with that, I don't think they really talked about it here but I think you could also tie that to you know the social and rest factors that a lot of people have been talking about where you know through COVID and probably a long time before COVID they really got exasperated during COVID is obviously there's a lot of people doing really really well right now and there's a lot of people who are not and that's going to be i think from my perspective uh you know a real huge issue you know in the markets and society here no matter what happens with the elections over the next couple weeks yeah just my um

forgot my word i was trying to say but my just from a few friends and people i've been talking to just the last two days in chicago they're like, they're boarding up this shop, they're doing this. Where are you going to go for the, after the election? Like people are, I think more worried about the riot potential for riots afterwards than the, the actual election result. But I think Ben also, It's not clear, you know, which outcome is going to foment the more biggest unrest yeah because i i could see

it going either way yeah that's gay and i think to ben's thing on the monopoly breakup he was saying there's kind of movement on both sides of the aisle there right so no matter who gets uh control of everything he's thinking that could be an item. What else? Jim, which we've had on our pod discussing, ad nauseum, he was going towards fiscal policy and thinks kind of the world's underestimating the move from monetary, you know, the Fed cutting rates to the effects of fiscal policy of sending people checks. But I think we've already seen that last two months of markets up, markets down, vols up, vols down, because either Pelosi got a deal done or didn't get a deal done. I think what's interesting there, and I think the point that Jim has made more than once is

we're starting to push on a string with monetary policy. And clearly the Fed is not looking to be more active than they already have been. And it's trying to, they've done everything they can to encourage Congress to pick up the ball. And this is where the outcome, not only of the presidential piece, but the Senate races is going to be a big factor in sort of setting the stage for what is likely to happen. You know, Trump has been promising a big fiscal package.

Please reelect me and I'll give you all the money you're asking for. Clearly, the Democrats have an agenda to push forward um and and so do we have a divided uh setup you know do we have a president on one side and the senate still on the other side um you know do we that which which creates potential roadblocks for fiscal policy? Do we have some mega spend that tosses a different kind of hand grenade into the picture? Because somehow the Treasury's got to go out and finance that. And we've seen a backup in rates. I think part of the reason that we've seen Treasuries not behaving the way people expect them to is because people are looking down the road saying, holy crap, the treasury is going to have to be issuing trillions

and trillions of dollars of bonds. Why do we want to own these things? Yeah. And the better, the less we got to pay, the lower the rate. Exactly. Sorry, what were you saying, John? No, I was just going to add, you know, Roxton, you know, I think he's coming at this from a very advantageous angle. It looks like he says, I don't know. So I'm going to have production against the left side of distribution, keep my costs low, have risk budgets, gamma, vega, those types of distribution, keep my costs low, have risk budgets, Gamma Vega, those types of things, but all the stuff where

he's got a little advantage over the rest of us where he's not necessarily reporting returns back to investors every month, at least not publicly. It seems like he has the biggest sandbox to play off with what we've been talking about, but I think that was kind of his ad.

It was like, we don't know what it's going to be, so protect against everything. Great. All right. Any other thoughts on those three or we move on to the next money panel? All good. Move it on.

So this one had a better name of all strategies in a mad world like that couldn't have written it better myself um and so on this panel you had veneer bansali of long tail alpha chris cole of artemis capital and vishnu karela of citadel so i didn't know they let citadel guys speak to the public. Although he was, you could tell he was for sure the most buttoned up of the three and a little guarded on what he'd be allowed to say. But what are your overall musings on those three? thought the piece that struck a chord with me was the notion of, okay, great. Let's say you catch a long ball position. How do you get out of it? Monetization. And that was Veneer's big theme because he's written a paper on it. So he was... And he was basically saying they wrote a somewhat simplistic for him

piece, academic piece, and like here's some simple models on how you could capture monetized long tail. And he said, yeah, that they've actually implemented some of those for their strategies. And voila, March serves up the perfect time to make sure you monetize earlier rather than later. Right. Well, and I think it's, I mean, everybody that I have talked to, met, you know, who plays in the volatility space long or short or both, there is a challenge, particularly on the long side,

to positioning and exit. What Ben-Hur refers to as monetization. Because in my view, if you catch lightning in a bottle, if you're there with a long position when the volcano erupts, I contend that nobody knows the two most important things, how far and how long you know is is vix going to go from uh 15 to 80 as it did in february march nobody was really expecting that um and how long is it going to take you know i think most people would say wow 15 to 80 that's going to take you know i don't know months yeah uh well it took weeks and so if you were riding that fucking bronco uh and all of a sudden you're in the money 2x 3x 4x pick a number um what do you do right and just And just think of it, if you're long, you're long, well, at 15, and it goes to 25. Right, you just made 80%. But hey, you can go to 60. And from 60, you can go to 100. And it did. And then I also think of that, if you'd bought,

like last November, right? Hey, we're a year out from this massive election. I'm going to buy some November puts or something a year out expensive, but I'm sure people are doing it. And then March happens. Now you've got those way out of the money. They're, they're coming close to the money. They're doing whatever. And what do I do now? Right. Do I monetize? Do I wait for my, my thesis was the election? Right. So I think that's the whole point of systematize that. So you're not having to have that mental arithmetic or mental gymnastics, actually, and saying in the heat of the moment, what am I supposed to do? Well, and I think that the one of the challenges that really didn't get focused specifically in this panel was you know

systematic monetization I think the nearest point is systematic monetization is better than unsystematic you know discretionary you know hold on the the other piece of it that unless it's just all your money, the other piece of it is, you know, how does it play with your clients? What are their expectations? And when the dust settles, you know, are they bitching at you because, you know, you monetize 3x and you could have had 6x my view has always been fire those clients but you know that's the other piece to the whole monetization is um you know where does it fall in terms of uh backward-looking expectations the the angina that may be created because you know you're perceived to have been you know less efficient in monetization than you might have been blah blah blah and i actually threw the question out there to the panel like well is that become a self-fulfilling you know prophecy is everyone monetizing sooner and that's what's led to like the smaller pops

and the quicker rebounds, which Chris Cole took that to the next level saying, well, if everyone's hedged, is anyone hedged essentially? He got a little philosophical about that, but that's an interesting- That's what he's want to do. Yeah, that's an interesting mental model of like, okay, if everyone's monetizing super quick,

can you even get a big vol spike or does it get sold into right away? Well, I can tell you from because I do traffic in a lot of vol traders, you know, some of them reasonably sophisticated and some not so, you know. But but nevertheless, you know, in aggregate, decent size. And, you know, over the last five years, you know, all of these little spikes have been little spikes for the most part. Yeah. Right. And so you've got, you know, people out there saying, OK, I'm going to short it when it goes through the upper Bollinger Band, right? Right, that's worked 17 times in a row. Until February. Yeah.

Or until December of 2018. But, you know, the buy the dip, you know, it's basically the buy the dip in reverse. Because rather than buying the dip in the S&P or the E-minis, you're shorting the spike in VIX. And most of the time that does work. And it builds up a mentality that that kind of that level of it's sort of the inverse of the monetization. You know, if you happen to be long in that set of circumstances, you're looking at the same thing saying, oh, this might be where I need to get out. And it's it's perfect timing most of the time. But then that one time where you bail out.

On February 28th, because you're up 80%. Yeah. Whoops. All of a sudden you don't want to tell anybody about your 80% win. Yeah. Well, what's worse if it was 8% or something. Well, yeah. And then the investors that you're talking about on the other side, they might need to rebalance into their equities and they need they have actual physical needs of of that money. Which I think we saw way back in 08, 09, John, with managed futures of that became people's piggy bank.

Right. They're like, hey, these things held up. These things made money. I'm going to cash out to refund my short ball trades. Exactly. Well, that can be a mismatch between what a strategist or a trader is trying to do and what their end investors are trying to do. Because if you're holding on to a position when your investors might want to rebalance, you've got a little mismatch in there. Right. Or if you want to buy an NFL football team, it might be more likely to monetize it. Right. As soon as you hit the magic number for the, who's he going to buy? The YOLO trade. That was good, Johnny.

That was my train of thought. The other big word on that panel was the Aurora Boris. Right? Which they couldn't get enough of. Which took Chris Colahal 30 seconds to say that word in that panel he couldn't he could chomp at the bit to say oroboros

um which you want to explain what it is john uh i probably do a very bad job but i'll try uh you know it's basically this concept that the oroboros is a snake that eats itself, right? And he's applying that context to the financial system and basically saying that, yeah,

I'm going to lose my turn of thought here now too, but saying like all these things that, you know, the Fed's doing and, you know,

various ways to, you know, impact, how they impact the market and various traders is that there's a cycle and it has the snake eating itself and I think that's what they started to talk to later is that has it

already happened, the snake eating itself and stuff like that. Right, with basically, Volmageddon was the first shot fired across the bow of like this whole system's designed to suppress volatility, suppress volatility suppress volatility snake eating its own tail to the point where it's been suppressed so much that the

that's where i start to get confused myself but does it get suppressed so much that the snake starts to eat on its own tail or is the fact that you're suppressing it is the snake eating its own tail one way or the other it's the whole concept is it's a it's a vicious cycle that creates more fragility in the end right we need phone a friend yeah phone a friend get chris on the line which right and he's convinced and and it's hard to argue with the fact set that he puts forward that we just haven't seen the end of the debt cycle that we, we're seeing what would appear to be a deterioration in the broad corporate credit environment, compounded by the likely impact of the COVID epidemic. Forget whether it gets worse again, the number of businesses that have gone kaput, the number of mortgages that are in forbearance,

the number of leases that are in forbearance, the number of buildings that are empty that have a lot of debt piled on top of them. Now he's, he's convinced that all of that stuff is going to well up and cause much bigger problems. Yeah. And he kept coming back to it's a solvency issue, right? He was saying the Fed's fixed the liquidity issue, but they've not come anywhere near touching the solvency issue.

My thought on that came back to that FANG concept and those bigger guys getting bigger and bigger is they don't have any solvency issues. And maybe that's behind the scenes of what's driving their massive increase of, right? You're going to buy the, you take away that issue if you just buy those big names. And then I also remember Apple. All of those guys are in many ways benefiting from the impact of COVID on the workplace. Microsoft certainly hasn't been hurt from a business perspective. They've got products, they've got a cloud.

Amazon's got a cloud. Amazon's got delivery. We're all using I'm using my iPad for the Zoom right here. And Zoom's worth more than Exxon. Exactly. You know, so so so those you know, those trades seem secure, but there are huge swaths of the economy that are indebted and in many respects or in many cases impaired in terms of their business models. I think he's right on that, you know, that the Fed can deal with liquidity. But do we, does the governmental enterprise, whether it's fiscal, monetary or otherwise, are they prepared to backstop solvency? Yeah, unknown. And then, sorry, go ahead, John. No, which I was going to throw out, you know,

one of the other managers we work with wasn't part of this conference, but his comment today, you know, Matt Labiel, breakout Fonzie, put out a quick note saying, Hey, we're all concentrated on the presidential election. And he was like, but I believe the real story this week is the Fed meeting. And what they say on Thursday is going to have a bigger impact on the markets for, you know, this election here. So good for thought there as well. And then Vishnu on this panel had said, yeah, basically said, yeah, there's,

there's still a two-way trade here. We kind of can't get lulled into sleep of the Fed put, and they're not going to let the market go down. He was kind of arguing there's still two-way risks with the second wave, with these bankruptcies, with real estate. And he was kind of bringing that back into rate and gold vol. And that was the other part of this panel, right? Of like, hey, we're at this point, we've got so much debt,

we either come out of it with a default or with inflation, both of which seemed like it would cause massive volatility right um and especially in rates and especially in gold maybe less so if it's if it's inflation and they're just suppressing s&p vol it might push it out of s&p and into those other instruments um yeah and i can't remember which panel, it might have been this one or probably maybe the one previously with Jim and Ben, but they were talking about currency vol as well. Yeah, I think it was this one. Which would make sense with the rates.

Yeah. I think it was Vaneer saying, yeah, when the currencies go, that can explode an economy. I think in hyperinflation and whatnot. And then it was also this panel that Veneer said, called it the GVC, the global virus crisis. I was like, what? Is that what we're

calling this? I'm not a big fan of that name. I want to go with either COVID crisis or Corona crash. I like Corona crash the best. You're the marketing guy. Yeah.

All right. Any other thoughts on this panel? No. Chris pretty well. I think he put out this white paper basically on this whole concept of Ouroboros and Serpent and the Hawk and all this stuff Chris pretty well. He put out this white paper basically on this whole concept, Ouroboros, Serpent and the Hawk and all this stuff. In January, I think

you and I, Jeff, are down in Miami and meeting with Chris and doing podcasts and attending a conference and literally did I expect to be talking about this whole thing in November. He's hit a point with a lot of investors, for sure. I, you know, both big and small. I mean, I can't remember any time in my career where I've had so many just like high net worth individuals, a lot of people who a lot of people consider read more

retail investors calling me about a white paper written by Chris Cole, who they probably never heard of before. But it's really, I think, kind of struck a chord with all these people in terms of, you know, it does make a lot of sense in terms of like, okay, you want to have these, but really at the end of the day, what he's saying is you want to have diversification, right? And I think, you know, after this period of run up in stocks, a lot of people are looking at their portfolios and like, huh, not really that diversified. So, you know, being long gold, having commodity trend exposure in there, you know, fixed income on these one point stocks, long volatility, which we really haven't talked about, but he's a long ball guy.

And then he also mentioned having some global macro in there, but he wasn't able to model that so all stuff that you and i talk about every day jeff and investors so this was interesting that uh kind of all come full circle for me personally reading this paper in january now still talking about today right i think his paper was looking across dozens of years a hundred years right of like hey you need to protect against these potential hyperinflationary periods these potential inflation deflation. And yeah, here we are at this inflection point of basically it could go any of those ways relatively soon. But I would, I'd argue those, those individual investors are maybe more in tune to that than institutional because they're seeing actual businesses they know go out of business and

they're more on that perhaps main street level of like this is really happening here. Yeah. There were two other things that I thought were important, if I may. Yeah, you may. One was, and this was some Chris Cole commentary, but I think it's, you know, echoed by the other participants on both panels, just the magnitude of option flows currently versus pick a number five years ago, 10 years ago. Yeah. And, and both, you know, institutional and retail,

obviously the Robin hood stuff has gotten a lot of publicity this year. But, you know, the thing that that brought home to me is options are inherently a source of leverage. And that's good when it works. Good. Right. But it's, you know, it's it's essentially increasing leverage in the system and that cuts both ways. Right. And so we see these reactions in the market, these V-shaped recoveries and these precipitous drops. You know, we're used to saying, you take the escalator up and the elevator down. Well, we're now seeing elevators going in both directions. And I think a decent chunk of that

is the implicit leverage that we've added to the system over time. And related to that, when they were talking about what happened in March, you know, I think there were three things that happened in March, right? Everybody says, oh, well, the Fed came to the rescue. And yes, okay, that's true. The Fed had been doing stuff since the first week of March, but they came out with their massive artillery on the 23rd or so. And Jim has made this point a couple of times.

There were a couple of other things the week prior. March 18th was the expiration of the VIX futures contract. So we had a VIX expiration, and we also had an options expiration, a big options expiration on, I think it was the 20th. 23rd. Yeah, and given the flows, just again, the derivative flows flows and the positioning of dealers going into and coming out of those things are having outsized impacts versus what we're in a free fall or when you're, you know, rocking and rolling the other direction, you know, I think the average investor has no clue when those events are coming up and what the potential impact might be. It's a natural point where some of that leverage is taken out of the system.

Right. Yeah. might be it's a natural point where some of that leverage is taken out of the system right yeah um my argument to that would be it's non-recourse leverage i guess if you're buying the options right uh which makes it a little less scary than margin leverage or something sure absolutely but yeah at the same point that's a good point i hadn't heard before like all this option activity is essentially just leverage activity well and I think it's amplifying some of these moves yeah um you know particularly as as you know obviously you've got a whole bunch of people out there dealing the other side of people's desire to buy and sell options uh and try to you know run books that don't blow up. And obviously we saw some blowups in March

in the derivatives community. But those folks were doing things that perhaps they look back and say, gee, why were we doing that? They were doing your VIX trade on the Bollinger Band. that perhaps they look back and say, gee, why were we doing that? They were doing your VIX trade on the Bollinger Band. In institutional size. Yeah, yeah, big size.

And you said he had two? What was your second one? No, it was just, it was, number one was just the sort of magnitude of the derivatives. And then the other one was the date-specific impact that some of those derivative flows can have on maybe causing things to find a bottom when the selling starts to dry up. The point was a simple one, which was that everybody looks at the headline that the Fed came to the rescue. Clearly, that was part of it, but there were some other things going on under the surface.

All right, guys. I think that's it. Any other last thoughts? No, but I got it. This is for Ali. Nice. There you go i was gonna ask i i i gotta do your job for you you know right i was gonna ask everyone's favorite uh who they want to hear more from but i think the answer was roxton he was a rocket star in my book yeah so we'll we'll try and get him on the pod next that would be a good move i think in the future all right thanks guys we'll talk to you

soon all right all right thanks john thanks jeff Thanks, Jeff. 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.