The Derivative - Protecting the Portfolio not with Long Vol, but with Long Gamma, with Convexitas

Episode Date: January 27, 2022

When in Rome do as the Romans do?...Did they have convexity? They had the word, convexitas, and in this episode, we are joined by not one, but TWO brainiacs in the option and vol space, Devin Anderson and Zed Francis from Convexitas. Devin and Zed making noise in the derivative world by launching the first true discretionary, all separate account implemented, derivative manager into existence. Tune in as Devin and Zed talk us through constructing Convexitas, their long gamma tail liquidity strategy, why short deltas can often be better than long vega (volatility), including why and how logistics, design and structural impacts – including tax consideration – matter when choosing protection for your stock-heavy portfolio. We go on to ask where we are on the institutional vol selling popularity curve, and what’s wrong with some of the popular portfolio protection strategies such as the behemoth hedge equity program. We close out this episode with their hottest takes, where you'll want to listen to see who thinks The Beatles are overrated and who is a semi-pro shooter. Chapters: 00:00-00:55= Intro 00:56-24:25=  The first, true discretionary, all separate account implemented, derivative manager in existence 24:26-56:57= Tail Liquidity and “they can’t participate in that long gamma” 56:58-01:08:22= What’s smart money using to hedge? Is dumb money back on short vol side? 01:08:23-01:18:32= Tell us what’s wrong with the friendly neighborhood hedged equity program? 01:18:33-01:26:29= Hottest Take Highlights from this week's episode include: Learn how Convexitas designed its tail liquidity to reinvest capital during drawdown events and be the excess return driver Vol expansion and what happens when people are overpaying and all utilizing the same instruments to protect The different dynamics of hedgers reacting to where the market goes and how Convexitas responds What derivative managers get wrong when it comes to tax, why they shouldn’t bring institutional thinking into the family office and retail world, and how to understand the benefits of derivative investing, plus more! Don't forget to subscribe to The Derivative, and 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

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Okay, we are here with Devin Anderson and Zed Francis of Convexitas. Welcome, guys. Thanks for having us. Yeah, thanks for being here. My p-bra brain goes immediately to Zed's dead, baby. Zed's dead every time we chat. How long did you get that for after Pulp Fiction came out, Zed? I mean, how long? It's obviously still a long time. I think for the entire 36 years of my life, that's been how I'm introduced to everybody.

I love it. when did that nobody and by the way jeff no one knows where the name even came from oh maybe maybe that was it i can't i don't have my dates aligned correctly i was about i was about eight when that movie came out uh but yeah no as devin said it was uh we best guess, it's a family name that nobody knows where it came from, but our best guess is it's an Ellis Island correction. It was 12 letters with no vowels

from somewhere in Central Eastern Europe. They're like, nah, America can't do that. He's the fourth. He's the fourth Zed. Really? Zed the fourth fourth which i would have gone with zod after like uh superman 2 that's that's a deep cut dude that's a deep deep deep cut um and so let's do some quick five minute backgrounds on uh how both you got into the

derivative space how convexitas came to be. Who wants to go first? Devin, we'll go alphabetical. Devin gets it on both accounts, first name and last name. Got it. So I came to the finance world after business school. I'd already had a 10-year career in the technology world where I helped start two internet companies. And I also did a stint at Lycos, the search engine. That's even a deeper cut. Yeah, 1999 to 2001 back. So when people talk about the internet bubble, I was there, baby, right on the front line of it.

But I went to business school and found the derivatives world there. Then I came out of Carnegie Mellon and spent 15 years at Deutsche Bank in a bunch of different equity derivative related roles. The second to last of which was the head of the solutions business in the Americas, which was everything from fund structuring to exotics to investable indexes to retail structured products. And then actually my last job at Deutsche Bank was in the bad bank, unwinding all that stuff. So I had both the building and disposing of it aspects, which were each interesting in their own right. But we spent a lot of time in the solutions business talking to the family office, institutional space. And interestingly, I'm going to let Zed do his background, but a lot of why ConvexTusk was created was lessons learned from that experience. And what I was slowly figuring out over that period was a lot of the same things that Zed was figuring out, although from a different style of

seat. And when it came to an end for us at the equity derivatives, well, really all of equities, Deutsche Bank, we put our heads together and realized that, you know, kind of our unique take on how to do the derivative management business maybe made some sense and was unique and a little different than what the world is seeing. So with that, I'll let Zed talk about his background. And real quick, did you start when you were eight? Like there was a lot of history for a young looking buck. I did. I had to be driven to my first interview with technology. Dead like us. I'm much more boring having an entire career in the financial services space.

And Devin can attest, the only thing I'm good at in technology is breaking it. World-class uat tester uh but yeah no my my random walk without you know doing too much linkedin page is credit sales pm a long short distress credit hedge fund a large uh uk asset manager boutique derivative overlay manager and then we got to here at comex and i would say you know what I think is unique about my background, especially when you compare it to call it our vol peers, is that my foundation is definitely in credit. You know, two thirds of everything I've traded throughout my career has definitely been equity related derivatives and equity vol related derivatives. But all the background of how I think about the world is driven by the fundamental credit view from the foundation of my kind of career. So it gives us, I think, a little bit of a different view of things, having that being the backdrop rather

than being equity and equity vol only focused. But as Evan said, to kind of transition into the firm, we've known each other since the start of our financial services careers, especially back in 2007. Devin covered me when I was at that long, short, distressed hedge fund. He was one of his first dozen or so clients when he got into that seat. And he's happily followed me as I moved around different buy side shops throughout my career. But we really came to the conclusion that what the world was missing from a correct implementation of distributive strategy seat is somebody that's very, very tax aware, designs the operational structure within that tax aware wrapper, and then is focused on, you know, positive returns rather than sales process, which we'll dig into a bunch into. But everything that we're operating from a strategy side, you know, we actually think has positive expected return and has a fundamental backdrop of why we design things that way. It wasn't a

marketing exercise to see what we thought was really digestible by the public and easy to scale. And that's a little bit of early flavor, Jeff, just for some of your later thoughts of what other things are out there and what do you think about them. But let the table be set there and pass it back to Devin for a little bit more of an overview of the firm before we jump to the next steps. What are the the name convexitas? Was it hedge fund name generator? It would have had a river or a bay in it. Yeah, no, we we I think we actually were we were pretty orthogonal on that one we uh you know there were there were many ideas we were actually both shocked that the latin word for convexity was not in use um like we went to the lawyers and said do the work on this and they went no you're clear we went

yeah why don't you be sure yeah um but yeah no we uh we came up with that one just uh you know with uh the google translate andlate. And were the Romans even dealing with convexity? That's a whole other concept for another podcast. I think there's actually, I don't remember well enough, but I'm pretty sure

that there's records of futures transactions going all the way back to that period of time. I love it. And the fall of an empire is the ultimate convex moment. Yeah. Or Mount Etna. What was the volcano that buried all the people?

Yeah, there's a couple of tail events happened there. So dig into the firm a little more. Yeah. So what we do and what we believe that we're different at is our whole viewpoint is that there's a couple of things you have to swallow to really get the best implementation and the best benefit set and access to the best opportunity set in the derivatives management space. And it requires bringing a couple pieces together. So we set out to launch, as far as we're aware, the first true discretionary, all separate account implemented derivative manager in existence. And there's certainly people that kind of take one box or

maybe a little bit of both boxes, but we're really not aware of anybody that does it quite like us. And the reason that those things are important, Jeff, is that there's no funded solution that you don't end up making really big compromises on in the investment opportunity set. Okay. So, you know, you take your traditional tail fund, for example, if, if you're, first of all, there's all kinds of weird models of AUM and funding and so forth, but the bottom line is if you have to put a lot of cash into it, right. And you have to take money away from an existing asset allocation portfolio, wherever you think your real health is coming from to put on, for example, a risk mitigating strategy.

Then right off the bat, we've got a big problem. There's a problem that you've now taken capital away from the primary assets. There's a problem that for the manager and that it restricts their opportunity set because now they've got to come up with things that are going to return 10,000%. So, you know, the point is these things can't be funded. And that means that you've got to run your mandate in a separate account. And that comes with a pretty big list of operational challenges that a lot of managers, particularly in the hedge fund world, just have decided that they're not interested in dealing with. I mean, and frankly, you go through some onboarding exercises with four or five custodians,

like you don't understand why. But we've just chosen to bite off that apple and do it. We do run fully discretionary strategies. We do support, you know, at this point, I think six custodians, five, five to six right now with three more coming, like, you know, so we're going to have we're going to have support across all of the primary custodians here within a few months. But the concept there's also is the mainly rebalancing of okay if i'm paying out on my edge and we might have buried the lead a little bit of like the main thing you're trying to do

is protect protect downside well i wouldn't say that i mean that on the risk mitigating strategy that's it but we also have other products um that all operate off of the same principles so we have beta replacement products we run a product uh for one of the same principles. So we have beta replacement products. We run a product for one of the biggest RAs in the country that replaces semiconductor exposure in a very convex, nonlinear way due to the particular options market microstructure that you can lean on in order to create that profile. Then of course, our flagship product, Tail Equality, which is a risk mitigating strategy we'll probably spend the most time on here. And then we do some concentrated stock and single name, large position risk mitigation and tax aware risk mitigation stuff as well.

If there's a reasonable opportunity in that name or in the name in question. But the point is all of these things have a theme and to get the benefits that you really want, kind of ranging from tax to liquidity to the correct investment opportunity set, it's really got to be unfunded. It's really got to be in separate accounts. So the manager's got to bite the bullet and just do the work and put the pipes in place and write the code to be able to support it, which we have. And talk to me a little bit of, you'd say unfunded, but there needs to be some funding in that account. You're just saying the money in the same account, but it needs to have some funding, correct?

Well, so it depends. It depends on the custodian and the product and the specific situation. But when I say unfunded, I mean, we're not kind of creating, if you, for example, if you wanted a hundred million dollars of, of tail risk, of, of tail of our risk mitigation strategy, tail liquidity, you're not writing us a hundred million dollar check, right. Or you're not, or even a $50 million check. We're collateralizing it with the assets that you already have in your account. So, you know,. So depending on your specific situation and your custodian, we actually might be able to get the collateral requirements all the way down to zero encumbered cash, or we might need some amount, low single digits of percentage of encumbered cash. But it's nothing like kind of the traditional world where you go out and you buy a pulled vehicle.

Right, where I'd have to sell 10% of my beta funded in this separate fund and then deal with the rebalancing and the monetization. Yeah, I mean, there's really three key things. It's, you know, as Devin said, day one, we're not pulling capital from elsewhere in your portfolio. Your current portfolio is collateralizing all of our operations. There's no day one tax event. There's no lost opportunity benefit of not being fully invested. Step number two is because it's your current portfolio collateral supporting our operations, it allows us to actually design a, we'll call it, you know, more likely to produce value strategy rather than something that's fully funded.

Because if it's fully funded, you have a very limited opportunity set. And if I have the ability to operate a strategy that's collateralized by our current portfolio, I have a vast opportunity set. So, you know, step one, you know, we're not taking money away from anywhere else, allowing to be fully invested, not creating tax expense. Two, because of the structure, I have much better opportunities than other folks to try to deliver positive P&L. And then step three, which is the, we'll call it the most important piece and is the piece that when we speak with folks, takes a little bit of hand-holding and get on the finish line, is we are that liquidity provider during,

market correction is even too strong a word, even market sneezes. holding and get them to finish line is we are that liquidity provider during, you know, market correction is even too strong a word, even market sneezes, these little, you know, three, four or 5% pullbacks, we're providing, you know, reasonably substantial capital considering the level of those moves for folks to take that cash and either service, you know, lifestyle, they sell, you know, 25 basic places of portfolio every month to live, larger family offices, service capital calls during drawdown events. You have to sell stuff. We have cash sitting there. We're just plain vanilla redeployment of capital, which a bunch of our current investors do. Whenever we create 5% cash in their portfolio, they take that cash and they buy more S&P 500 like risk. And that's three kind of steps of, again, unfunded, meaning we're not

taking money away from you. It's your current assets supporting what we do, a better opportunity set, and cash to go ahead and be an opportunistic redeployer of capital during market drawdowns. That's why the operational structure is incredibly important for not only our delivery, our P&O and isolation, but more importantly, a client's holistic portfolio. Because once you hit those three steps right, we actually believe that we're ending up with a situation where your expected returns are going up, even though day one, this is risk mitigating strategy. So we don know, we don't want to like over-promise, but in theory, if everything works as it's intended, we think we have something that's going to increase the absolute returns of the portfolio while having a realized volatility of that portfolio of about half or, you know,

reducing the mark-to-market risk of that portfolio in half. And if we're able to obviously achieve that with a mix of our discretionary management with the correct operational structure, then we really have something. Then you've hit a home run. And what are the limits of that? Say I have the 500 founders or CEOs of the S&P 500, and they're heavily invested in the stocks of each of those companies. Are you customizing to each of those holdings, to each of those customers, or there's some limit of the amount of customization that's possible? It's different.

I think you're asking a slightly different question. I mean, if they have truly concentrated positions in single stocks, we have a different answer for that um it may be depending on the single stock um we we could add some value and maybe we can't um depending on the whole surface of that particular name but for the tail for tail liquidity for the for the primary product it's all linked to s p beta. So in order for us to really feel good about us providing a portfolio level impact that we can anticipate and control, we're really looking to operate it on the S&P equivalent beta of your portfolio. Got it. Okay. So you're not messing around with Robinhood Holdings or something? No one would look at the alpha side of the house and not think that security selection and acting on the opportunity set that's available to you in the market is the most important thing.

Right. But then all of a sudden, when it comes to the head to the risk mitigating side of the house, then it's, well, we're going to create this custom thing. Well, I mean, shouldn't the primary concern on the risk-money gaining side of the house also be what opportunity the market is presenting to you? And that has absolutely nothing to do with the contents of your asset allocation portfolio. You know, what the S&P surface is giving us and the biases and dislocations on the S&P surface are that we can lean on in order to create the kind of convex and risk-controlled delta exposure that Zed's talking about earlier, that has nothing to do with the contents of your portfolio. That has everything to do with the opportunities being provided to us. Now, we can do a lot with sizing, right? And we can say, how does your portfolio behave in S&P terms? And in what scenarios are those correlations going to be high you have this, so we're going to do something completely different.

It just doesn't make a lot of sense to us. And furthermore, most, having worked at an investment bank dealing desk, most of the, quote, custom things that someone's going to call the bank up for and ask for a price on end up reducing almost entirely to S&P anyway, right? Like, you know, you're not hedging MSCI world puts with some complicated basket of, I mean, it's just not, it ends up, it's like 80 to 95% S&P anyway, right? I'm thinking of the arc, right? All these charts on Twitter now of like, here's all the holdings. A lot of them are down 80%. Like for sure, there's tens of thousands of investors out there where each of those down 80, 70, 60% line items are their main holding, right? Their concentrated holding, which I think

I hear you saying like, well, that was done. That shouldn't have been your concentrated holding. Well, yeah. So I mean, but that doesn't, so sure. Okay. But that doesn't mean that there's an opportunity for a derivative manager to come in and put something together that actually makes sense. Right. Like if the prices of those single stocks and ETFs aren't tenable for a long-term risk mitigating strategy, it kind of doesn't matter, right? So then the answer is probably be a good example. Yeah. You need to just reduce the risk of the cash holdings in the base allocation, right? So I guess what I'm saying is that the risk mitigating strategy doesn't work everywhere, right? It has to be, you know, it has to be treated with the same portfolio management and pursuit of alpha that the asset allocation side of the house gets. And that's not always possible depending on the underlying. Yeah. I mean, there's two different conversations. So say you're a $50 million family and $45

million of the net worths in Tesla. He came to us and said, I would like to reduce my Tesla exposure for obvious reasons, but my cost basis is a dollar and that's a pretty hefty tax bill in California. What can we do? Well, we would look at Tesla vol service. We would say, you know what? I actually think there might be some edge here. If it was Microsoft, you'd be like, I got no edge. Like go go to some other provider that's just going to randomly buy puts because I, buy puts because that's probably going to be about as good as what I can do anyway

because I can't provide a lot of edge to Microsoft. But something like Tesla, maybe the outcome is, we do think we can provide some edge. And what we're going to say to them is your experience is expected to be about a two-thirds marked market risk reduction, both ways, stock up, we're going to have a lot of losses, stock down, we're hopefully doing our job and have a lot of gains. But the ultimate goal here is for you to tax efficiently sell that asset. And if folks aren't actually really interested in reducing that risk, then we're not the right folks either. We're taking two-thirds of the risk out day one without creating a day one tax event.

And over the long haul, if the stock goes up a bunch, we have a lot of losses, tax loss harvest. User losses sell down stock. If it's an event where the stock goes down a lot, hey, we have a lot of gains, that's cash, you've effectively just rebalanced your Tesla holding into cash and Tesla, again, reducing the amount of risk you have in single security. So certain names with certain individuals where they have the right, I would say, attitude that they're truly trying to de-risk the security and they're trying to sell down 25, 50, 75% over time in just a tax efficient manner. We're absolutely able to help those folks, but it's definitely a name by name basis rather than broad strokes. The other piece that I was talking about is our core offering and tail liquidity.

And when we get like often, he got a ton in his previous life is, oh, you know, my portfolio is an S&P 500. It's MSCI all country world. And we would say, well, that's essentially the same risk. And would you really want to use MSCI all country world securities rather than S&P securities. If we said that choice is reducing our expected return by over, you know, 150 basis points per annum, and you're giving up a ton of liquidity. And if you hopefully go back through that exercise and say, now the point of having this year is liquidity during drawdown event. And you're saying there's edge in S&P 500. I'm willing to accept a little tiny bit of correlation risk between NCIL country world and S&P 500, I'm willing to accept a little tiny bit of correlation risk between NCIL, Country World, and S&P 500. So those are the kind of like two completely different categories,

but how we think about our strategies interacting with those portfolios. So let's build on the tail risk mitigation strategy. That's the official name. What's the flagship's official name? Tail liquidity. Tail liquidity. So let's build on tail liquidity. I think of it as a gamma delta hedge play.

We'll let you expand on that. But it's kind of like everyone's talking about, right? The market makers these days, and they're getting all this option flow and they have to Delta hedge it. And that's driving flows. That's driving market prices. I somewhat see you guys in that same spot

from seeing some of your trades, but you're choosing to be long ball and short the Delta. So talk to me a little bit about the different dynamics there of kind of hedgers reacting to where the market goes and you're kind of doing what you do and reacting as well to where the market goes, but on purpose, so to speak. Well, I think what I first say is that the very significant difference between us and the more traditional tail risk approaches is that we are

relying on a delta position that's there all the time. So there's a reliable, let's call it base beta to tail liquidity that's always present. And then we're managing the amount of convexity of that delta and the amount of convexity that we carry all the time. So that's a lot different than most of our competitors that are relying on changes in vol or vol convexity in order to generate returns in really significant events. And it's just basically our point of view that the correlation between spot and vol, I mean, first of all, is in a completely different regime that's not even debatable. Just look at the last decade of data. So the idea that you could design a strategy and then pretend like you know what's

going to happen when we had if we have a 2008 like event like you know we just we just don't buy it given uh almost you know a decade now of of very different spot ball dynamics so this you know this idea that you can rely on on fall expansion to provide to provide these tail outcomes, we just think is very, very challenged, right? But not just because of the market microstructure dynamics, but because really what you want in a program like this as an asset owner or a professional portfolio manager that has allocated to it is some predictable behavior so that you know how it's going to interact with the rest of your portfolio. So we set very clear guideposts about what you should expect in terms of returns from

us given a move in the market. And the expectation is the clients can then take that and because it's in a separate account it generates it throws off cash and assets that are immediately fungible and usable you can go out and rebalance immediately right so instead of having an event on the 10th of a month on the on the you know the 10th day of a month and then you get a statement at the end of the month saying well this is how much you're up right on the 10th day of the month, and then you get a statement at the end of the month saying, well, this is how much you're up, right? On the 11th of the month with us, you can take cashes in your account, take it and go buy some more assets, right? Well, rebalance your portfolio or do what you need to do. And that has that long-term compounding time and market, that viewpoint is a significant departure from the allocate, wait for it to expand, and then maybe redeem it style of thinking and model.

And that's only possible if we started this whole question around Delta and managing a convex Delta position, that's only possible inside of that framework. So we're coming at the risk mitigating question in a completely different way than most of our peers. And it's really intended to be a tax aware portfolio level tool, right? So our goal is to set our goal is, if the market's down 10%, you should expect the overlay to give you 5% of returns back. But also, you should be ready to deploy that into the asset mix that you've identified at that time. So it's a whole different way of thinking. So yes, it is very Delta or in option speed, convexity, gamma focused. have much to do with kind of the flow and facilitation world where dealers are facilitating options trades for clients and then instantly hedging their risks. Those flows are byproducts

of that facilitation flow. And generally speaking, Jeff, I'd say that people make way too much of it. Having been on a flow dealing desk for a decade and facilitating some of the largest trades that were out there in the S&P and the VIX on our desk, I'm here to tell you that those types of flows may generate, let's call it four to eight handle impacts on the S&P futures in pretty extreme situations. No one who's listening to this podcast, unless you happen to run a high frequency training shop, really stands to benefit from those types of very short-term dislocations, particularly when you're focused at the portfolio level, right? Like if you're a high frequency trader and you can lean your deltas and you can provide liquidity into that, what might be 30 second to 15 minute event, maybe, that's the opportunity. But kind of otherwise people make just far too much of the dealer flow impacts.

Not to say that they are never important. They can be important to single stocks. They can be important in really extreme situations. But for the most part, it's a magician's cant of distraction. Yeah. But I think my question is more of your like it seems to me you're the same as a market maker who's constantly buying puts from the public right um who's facilitating selling of puts and you have that same profile and you're i mean kind of the mechanisms are the same of how you handle that exposure but you have the exposure on purpose in a way i mean we're we're reacting to the dislocations presented to us from different players. You know, there's a big community of people selling options on the short ends, which does depress the price of options, right?

And that's a big part of our strategy. There's a big community of insurance that's buying the middle parts of the curve. That's an important part of our strategy. So, I mean, there are persistent dislocations that matter, but, you know, these kind of very short-term flows resulting from Delta impacts, you know, like I said, it's just a lot, way too much gets made of it. Yeah, I mean, I think, you know, the quick summary is the option flows, especially systematized option flows, have almost no impact on market direction, but they do have significant impact on option pricing. And those are two very, very different things. I think a lot of people extrapolate that and say like, oh, the reason my S&P was up, down, whatever today was because of these predominant know, predominant option holdings. And that, you know, I would say as a board sales guy needing to print a note rather than something that's actual, but they do obscure pricing of specific options. And that's the piece that we

pay attention to because, you know, Delta's kind of whatever you want it to be. I mean, we can add futures, subtract futures. We can make it a long leaning productaning product, a short-leaning product. We're harvesting what we think is relative value within the volatility surface with the main components, as Devin said. We think shorter-dated stuff's too cheap from all these systematized option sellers. And we think mid-curve stuff is too expensive from known quantity of insurance players that are, you know, systematized buyers. And we're extracting a little bit of, you know, what we see as relative value in that surface, but we could, you know, package that expression into any product we want. The point of designing Tail Equity as we did is we think we have a relative

value expression that has a positive expect to return. What the marketplace is probably in need for is a means of risk mitigation rather than the traditional format of just diversified portfolio bonds, whatever the heck you want to throw in there, probably not going to work really great. So we need to come up with a new way to diversify portfolio. And we think having a negatively correlated, asymmetric, unfunded overlay is the best way to go ahead and achieve what the market needs. And then the final step is, we don't want our product to be the driver of the excess returns in your portfolio. Sure, we want to have a positive P&L over time. That'd be great. But what we want is the reinvestment of our capital that we delivered during drawdown events to be the excess return driver, the buying the dip and holding onto those assets for the long haul, i.e. their unrealized

long-term gains. Because if all the excess returns were in options in a taxable environment, that's not very attractive. Half of that's going to the tax man. So we designed this again, foundation, we think we actually have some edge from a relative value standpoint. We believe the marketplace is looking for a new means of diversification with yields, almost a 2% in tens, but where they are. And we think we're providing that as a new fulcrum within their portfolio to achieve better outcomes for diversification. And then finally, how we designed, we'll call it the core delta lean within the portfolio,

which is totally fungible. We can make whatever we want. But the point of it is we want most of the returns to be from reinvestment of capital because that's tax efficient versus if all the P&L is coming from options, that's problematic for a taxable investor. So that's the waterfall of kind of how we ended up to where we are with tail liquidity. Right. But it's mostly always, or you tell me, always short deltas and long gamma in long vega. No, not always long vega. Got it.

Okay. In fact, normally short vega. Okay. So that short vega is paying for the other two in essence. The short vega is definitely in there because we think most folks are overpaying for, we'll call it meaty options, you know, Vega-driven options. A shorter-dated option, the implied volatility or, you know, quote-unquote Vega is almost meaningless to, you know, factoring into the price of that option. When you start adding a significant amount of time, you know,

maturity to options, then the weight of Vega to the pricing of that option increases. And we believe that generally people are overpaying for that vega component in the longer mid mid-tiered even you know longer dated options driven by a lot of systematized flows that again are economical for the end user um but ultimately you know that's why we're leaning on that what we see as a mispricing within the portfolio. And that systematized, you're saying basically people don't want to buy five-year leaps, too expensive, too much data. They've come into this middle zone where they think they're getting value for that downside

protection. It's mostly a regulatory issue for the insurance folks. Those are the options they have to buy because those are the options that give them the regulatory relief that they need. Okay. And very specifically, most of it's driven by annuity product, which annuity product is incredibly high fee. So if they're overpaying for their regulatory hedge of 25 basis points, who really cares? Go sell some more six point front load product and we're okay with giving up a little bit of edge on the regulatory hedge. But you're basically saying, all right, I'm a bank,

I sold some index link annuities. And I'm covering if the market goes down more than X is how the annuity is set up. So I have to buy those puts in order to protect myself. It's more unlike, well, they want true Vega rather than necessarily anything directional, right? Because if you have a 30 year annuity, the biggest risk for the annuity provider is, you know, mark to market, you know, path is the problem. So they're trying to hedge path. And the easiest way to hedge path is to own Vega. And historically, they own Vega via variance swaps, longer dated variance swaps, but that market has dissipated to almost nothing outside of kind of

two-year maturities. So they've shifted that Vega exposure that they need within that product, both from a risk management, but also regulatory side of the house into listed options. And so they're just trying to replicate the Vega component of the variance swaps that they utilized previously, just now using S&P 500 options. Why did variance swaps go away? Alberta? Well, because banks, the amount of capital they have to carry against the other side increased astronomically post the financial crisis. Okay. And speaking of the options, I wanted to touch on, well, two things. One, the Delta

hedging, it's always seemed to me, how do you get that timing right? If you did it every second, every tick the market moved, you'd get eaten up in costs and whipsawed. If you do it monthly, there's going to be moves you can't monetize and can't take advantage of. So how do you thread that needle and get the Delta hedging exactly right? Or mostly right? Yeah, mostly right is even strong. Long gamma scalping, everybody will have a completely different answer of the right way to do it because there really isn't any right answer. And the truth is, we have two components indicating for us to go ahead and gamma scalp. We do that rebalancing. We'll call it the scientific side of it, which is our guardrails, which is a forced rebalance. And that's if the portfolio is going from short to long.

That's not why we're here. We're supposed to be negatively correlated. That's a forced rebalance. And if the portfolio is getting too short, and what we mean by that is if somebody is allocating $10 million to tail liquidity and all of a sudden the portfolio is short $10 million and $1, that's oversized. That's not why we're here for. That's a forced rebalance.

So those are our set in stone, we'll call it driven uh rebalance is driven by those guardrails inside of that you know it's it's we'll call it the art art bit and the art bit the main driver is what we see happening to fixed strike vol uh on any you know given day so yeah when we see fixed strike vol absolutely collapse, that might afford us a little bit more, we'll say, time before we balance. We'll let things drift more towards those guardrails rather than trying to chop things up pretty aggressively intraday. When you have a significant move and fixed strike vol higher, that's probably a moment to go ahead and additionally capture inside of those guardrails. So the art side of things. So, you know, everybody loves things that are formulaic but if it was formulaic, then it probably wouldn't have much, much true edge to it. So we have the duo component of product driven rebalancing that,

you know, that is hard coded. That is a guardrail along with allowing us the discretion to utilize a little bit of art from what we see intraday to hopefully add some value. And just talk through how that works for a second. So I'm day one, I buy puts, I sell futures, I'm delta neutral, or I buy less futures and I'm short some deltas.

Just talk through how that works of when the market moves down towards your strikes, you become more short and vice versa. Yeah. So we have, we have three, you know, set in stone drivers of our guardrails. One is Delta again, can't be long and can't be shorter than a hundred deltas. Two is long gamma all on there really means is as the market falls, we get shorter and shorter and shorter as the market rallies,

we get less short, less short, less short. And then we're always net long put contracts. So there's no hidden jump risk in there. You know, October 87 happens and you're like, oh, oops, like it went down too fast. That's not a thing. We're always net long puts. And so we're always in that situation, even in a jump risk scenario that we're always going to have improving P&L as the market goes down.

So those are our set in stone guardrails. How we are delivering our expression is we're basically buying shorter dated, closer to the money puts. We're selling, you know, mid dated, we call it six to 12, you know, six to 12 month zone out of the money puts. So buying close to the money, short dated, selling mid dated out of the money puts. So buying close to the money, short dated, selling mid-dated out of the money. And again, always net long puts. Always own a little bit more than we're shorting. So what this means is when the market rallies, that initial trade most likely is collecting premium, which means at some point in time during a rally, we actually flipped to long because we net collected cash.

If the market went to an infinity, we'd just get that cash, essentially. We'd collect it from day one. So as the market rallies, because of that expression, you will potentially hit a moment where we're actually long-leaning for us to rebalance. The side that you care more about is when the market goes down. And so we're long again, shorter dated, closer to the money puts, which means as the market falls,

the delta of those shorter day puts is accelerating much, much faster than the puts that were short, i.e. this long gamma. And as the market falls 1%, 2%, 3% when we're in a relatively low implied vol environment, that creates a pretty significant shift in delta.

I mean, we can go from short 20 to 100 deltas and a 3% move with these low implies and how we're expressing our portfolio, which would incur a guardrail induced rebalance if we make it to 100. So by buying the beta, buying stocks or buying futures. Right. And so the way we can rebalance is in our core offering of telequidity, we're just going to roll down the puts. You know, the puts that we originally bought, you know, we'll call it 30 delta puts.

So now there's 60 delta puts. Sell the 60 delta puts, buy new 30 delta puts. Like that's going to be the normal rebalancing is just, hey, you know, the fulcrum that drove the long convexity within this portfolio and drove a majority of the positive returns as the market fall, just rebalance it. And that's going to be just moving the strikes lower of those puts in nine out of 10 cases. And so I was confused. So at trade inception, you're not long futures delta or SPY delta or whatever. It's just an options position. Yeah. No, we're in tail equity. We're only holding SPX options.

Why is it so hard? What do people get wrong about that dynamic? So I think there's two main categories and we'll call it, there's the tail risk hedge fund folks. And those folks are only going to get a one, two, 3% allocation of your total portfolio. And that means that they have to have, you know, thousand percent returns during the event or else it's just not material. You know, you allocate 2% to somebody, March, 2020 happens. They're up a hundred percent like, Oh, that's great. And then you look at a portfolio level and you're like, that's up 2%.

Why the heck have I been carrying this thing all these years? It didn't actually provide me any benefit. So they can't afford to roll it down. They got to hold it. So those folks, you know, we're not saying that they're, you know, not brilliant vol guys and are looking for the best expression of what they need to provide in that fully funded format. That's not what we're saying at all, but they can't participate in long gamma because long gamma just does not have that

convexity in that portfolio for those types of events. They need anything that is a half delta option, which basically the only pricing of that option is the beta component. And it goes to a three delta option and a 10% draw, 20% draw, 30% draw, and they have 10 X returns. They have to participate in a different environment than what we are simply because it's fully funded. And you're not saying a 50 Delta, you're saying a 0.5 Delta. Half of one Delta. Yeah. So like a 2,500.

Exactly. The other side of the house, there's, there's, there's players out there that have, you know, done the legwork on the operational side to be able to provide derivative overlays and separately managed accounts, even in the, you know, we'll call it traditionally retail setting. There are a handful of folks that have gone through that operational exercise. The issue is long gamma requires a decent amount of attention.

And I think Jeff, you've seen it from our interactions. If the market starts moving, there's going to be one, two, five transactions, possibly in a single day. And these other folks may have built a great operational framework to be able to do execution focused mandates across all these custodians and retail environments, but they're not very well set up for something that is actively managed. And so most of the products that they create are things that actually net sell optionality, not buy optionality, because when you sell optionality, usually just freezing is an okay seat to be in.

And so that's why, you know, what you would probably think of a traditional derivative overlay manager, especially down the wealth channel, are people doing collars or put spread collars because they're quasi set it and forget it, you know, six, 12, 18 month type transactions. And, you know, again, these folks have did a great job from an operational standpoint to be able to implement these execution based mandates. But they're definitely not set up to be able to handle something that has a pretty high level of attention and activity around those pipes. And so, you know, we, again, think we're threading that needle of we're providing the asymmetry at a portfolio level that in theory, a fully funded tail hedge provider,

you know, is trying to do. We think we're obviously better at it because we're participating in a totally different environment. But then we're also did the legwork from an operational side to be able to do server-led managed accounts like some of the handful of other folks out there.

And what's that look like? What's the worst-case scenario if you're down 3%, up 3%, down 3%, some sort of WPSI thing like that? That would be excellent. That's the worst-case scenario. Give me more of that. That's what happened in the first two and a half weeks of this year is exactly what we love. We're, as you say, we're moving.

Because then you get to monetize, then it bounces back. We're monetizing something every single day. So, I mean, that's the fantastic situation where your underlying asset portfolio, if we'll just call it S&P or S&P-like securities, is flat to up. But we've been able to monetize positions through time just from market movements. And you end up with the stocks up, tail hedge up, and maybe even redeploy some capital somewhere in the middle. You get all three as a win. So anything with the market moving is great, which obviously means the bad environment is when the market does not move. And I'd say the worst case scenario

from recent memory of something along those lines is 2017. So, you know, 2017 had fantastic returns for risk assets. And, you know, we tell folks that our expected delivery is a 50% capture of the downside and 20% drag on the upside. And then in 2017, you know, with the market at mid 20%, you'd be like, okay, I'm expecting you to be down five. And yeah, we're probably down more like seven or eight because it was a incredibly low realized year. Now you as an end user are still have a mid teens, you know, equity return. So that's nothing to scoff at, but yeah, you're not going to be happy about our performance during that environment without a doubt. Wasn't that the record number of days without a 1% move, like 70?

I can't remember what it was, 60, 70. It was a very quiet year. Yeah. And I've also, you mentioned the 20 and 50. I view you as a different bespoke product, but, you know, losing 50% of the upside, capturing 100% of the downside, which I guess is the same thing, right? Capturing 50% of the return, multiply it by 100%, multiply it by negative 50%, that was actually was a positive return, which seems a little bit counterintuitive, especially in these years where you've had kind of seemed like a runaway train up.

That was a positive return. I think it was over the last five years, which speaks to your like, this isn't just capturing that it's an absolute return strategy. As long as there's market movement, our goal is to, we'll say, be able to fight our way to a neutral seat, even when the market's appreciating. But again, the ultimate win for everybody involved is when we have these little bouts of you know obviously 2020 is the perfect right a really positive year with a lot of volatility but you know other years where we've had you know five and a couple ten percent corrections in there we're hopefully doing our job delivering you you know, two and a half to 5% cash in those five to down 10 market environments. And you're taking that cash and buying stuff and that stuff over the

rest of the year has hopefully appreciated with the rest of the market. So, you know, that, that dollar we gave you is now worth a dollar 20. And that's ultimately what's going to drive the accelerated returns over the long haul is that reinvestment of capital. And what about the flip scenario of like a 17 in reverse, right? If we just crawl lower over 12 months, that would make a lot of people unhappy on a lot of fronts. But what does that look like? Yeah, we would do okay inK environment. And the reason for that is where I think, again, a big differentiator between ourselves and our peers is our peers are really set up to only make money in super violent

scenarios or market down 10, 15, 20% plus scenarios. How our strategy is designed, because we'll call it day one short 20 deltas and it's long gamma as soon as the market starts falling we should start creating positive p and l now without a doubt a a low realized vol environment is worse than a high realized vol environment but we're still going to be achieving positive returns simply because our day one delta is negative and we're on gamma so it should be accelerating even if we're just going down you know 50 basis points every single day right we're still performing our job our job is just a lot harder than if we were moving two percent every day and then let's talk for me you mentioned retail somewhere back there like what is what are you guys seeing from your seats on

this huge explosion in retail option volume um how do you think that movie ends? Is it a good thing overall for the space? Is it a bad thing? Is it a bad thing for those retail investors? What are your thoughts? Yeah. Well, so first of all, most of that activity is concentrated in a handful of single names. And it's very, very short dated as in two weeks or less. So the actual surface impact at the S&P level doesn't exist really. So in terms of impact on our strategy, the answer is almost none. Now, there's literally only a two week period, which was at the end of August, beginning of September 2020, where a lot of that retail activity, which, as Devin said, is buying one, three, five-day call options. During that period, there was a lot of doing that in things like Amazon and Apple and Google, which did, for a very, very short period, affect implied volatilities and things like the S&P 500 and the NASDAQ. But outside of that little window, what we've seen from the, we'll call it new retail activity, has had no effect on the index level.

Now, you know, is it a good thing for the investing public to be, you know, to be trafficking in options in this way. I mean, you know, that's a bigger philosophy question. You know, it's funny, just today, I got a OCC disclosure booklet, this year's OCC disclosure booklet from one of the custodians in the mail, you know, and it's now, I don't, it used to be like a notebook calculator sized book. It is now a full eight and a half by 11 approaching binder of disclosures, which I don't believe is a mistake. So, you know, I, I, I don't believe in not letting, you know, in stopping people from, uh, from investing in, they want to invest in, uh, so long as they have, you know, some, some reasonable, uh, understanding of the modicum of risk that they're taking. And, uh, you know, as a former registered options principal at a broker dealer, I hope that the person signing,

the registered option principal signing the account opening forms is doing enough due diligence that says that the person on that form knows the risk that they're taking. And I'm just going to kind of leave it at that. Yeah. But surely that's robo stamped at Robinhood or something, right? No way they can sign $60 million. Yeah, it would seem unlikely that at that volume you can perform thoughtful due diligence, but no, that's for the regulators to decide.

Right. But to me, the actual end investor is going to quickly figure out of like, well, hold on, this doesn't make sense. They said if I buy calls and it goes up, I make money. And they're going to just keep experiencing these things of like, I bought calls, the stock went up, I doesn't make sense. They said, if I buy calls and it goes up, I make money. And they're going to just keep experiencing these things of like, I bought calls, the stock went up, I didn't make money. What the heck's going on? Right. And then they start getting into like, well, okay, there's more pieces to this than stock goes up, calls make money. So to me, it's going to like self-correct a little bit of, you know, that the vols got so high because

they're buying. I mean And it worked for a period, but it seems like it's just going to self-correct. Somebody I work with at Legal & General said one of the simplest and favorite phrases that I've ever heard in my career. And it's the problem with options is they expire. And I think something as simple as that is what these folks, as you say, might be learning along the way of, yes, you know, XYZ company went up 30% over a year. We kept buying five-day options and you might've not participated in that move because the problem is they expire. Yeah. Or the problem is it's already priced. It's like a game of probabilities. You guys know

better than anyone right like the option's telling you the probability of this event happening so it has to go greater than that event happens um anyway i think we're all preaching to the choir there we talked a bit about it i'm dealing just in the S&P. It's kind of the de facto world risk on hedge. But I've heard you, Zed, talk about the move by hedge funds away from CDS swaps and whatnot. So just dig into that a little bit more if you could have, like, why S&P, why people may be moving away from other risk choices. Yeah. So we'll say this is, we'll throw it in the theoretical camp rather than hard proven. That's it.

But I, you know, a vast majority of large hedge funds, even non-macro ones, fundamental hedge funds, tend to have some sort of, we'll call it teeny put embedded within their consistent exposures. And oftentimes that teeny put was credit of some variety, whether it was just linear CDX, buying IGCDX at whatever, 28 basis points, that's not a lot of negative carry. And when things get hairy, it goes to 400 over and there's a lot of convexity in that. Whether it's buying, you know, puts on high yield indices, whether it's, you know, HYG and or high yield CDX, things along those lines. They utilize credit as their main fulcrum within their portfolio to have that deep out of the money protection. And again, the two reasons for that are optically, it's cheap from a carry perspective. And two, it doesn't require much maintenance at all. You do CDX, the new contract comes out every

six months and you just go ahead and roll it to the new one. It's five minutes of work every six months. So it's pretty easy to go ahead and implement as part of your overall portfolio. What finally changed in March 2020, the Fed rather than just buying MBS, CBS, treasuries bills, so on and so forth. We'll call it government, government plus securities. They bought IG and even high yield ETFs. And I think folks conviction that those teeny puts, if you will, in credit are going to work in the next crisis is at least lessened simply because the Fed has already opened the kimono that they can just buy stuff and stop it from widening and you need you need this stuff to work you know like you're you're good old ackman persian why they had that gallivant 2020 year is they produced 20 30 40 percent

portfolio level returns on the cS and they monetized it. And then they bought a bunch of stock, right? You know, it's like the perfect flip because it actually like does work. And that's what, you know, these hedge funds are hoping to have in there. And if you don't think that the Fed is potentially going to allow credit to widen, but you still want that exposure within your book, you got to go down the risk ladder. It's what the Fed's very good at doing. It's forcing people up the risk ladder. It's even working on the hedges. So rather than utilizing credit, they're buying teenies and the S&P 500. And we would argue that

the last, especially like call it nine months, your longer dated deep out of the money puts are astronomically expensive considering the realized volatility of what's taken place in the S&P 500. You know, the last six, nine months realized volatility is like a 12 and a half, you know, the average is 16. So it's been very quiet along with,

you know, we've had little sneezes here and there, but generally an uptrend market. And yet these deep out of the money puts continue to get more and more expensive from an implied volatility standpoint. So my, you know, we'll call it thesis here is if I was running a $10 billion macro driven hedge fund, and I need some teenies in my book, and I used to implement it via credit, I'm scared that that's not going to work next round. So I got to go up the risk curve to equities. And that's going to be teeny puts in the S&P 500. And then couldn't I argue the Fed next time maybe just steps in and

buys S&P 500? And then the whole cycle starts over. Like now where do I go? You got to buy puts and lever private equity. Just keep going up that risk curve. And to that point, so if all this hedge funds, if everyone owns these puts, 10 years ago, 20 years ago, we wouldn't be having this conversation. There was just a few groups focused on kind of tail hedging. Is it going to feed on itself? Can we not get the cascade down and the big jump down because there's so much protection? So again, our pretty confident view is flows and

holdings and options market is not going to drive Delta in any significant way. So if everybody's protected so that stops the market from falling further, not really. That's just a storyline in our view. It's not really driving changes in market. Well, imagine if you were an $80 billion fund, right? And even larger, $800 billion fund,

and you're remonetizing and going back in and buying, right? It would have an effect. It would be putting a floor under there. So forced liquidations is a different construct. I would agree. The forced liquidations can trigger different unwind events for sure. But the more important piece, again, is rather than, we'll say, folks overpaying for this

deep, deep, deep out of the money, you know, catastrophe insurance and the S&P 500 creating an effect on where the S&P 500 is going. It does, in our view, have a significant effect on option pricing and the option pricing during that set event. And what we mean by that is we actually think that the implied volatility on those options falls when the market falls. And, you know, folks, again, if you're buying a deep out of the money put, you know, 12 month, five delta put, the driver of the price of that option is not the move in the delta. It's not the move in the stock market. It's vol expansion. And what we actually think is going to happen is because you're quote unquote overpaying for it today, market goes down five, six, 7%. In vol on those options is actually going to contract,

not expand. And the entire point of owning those is expansion of vol. And so you're going to have a move in the market. We'll call it a moderate drawdown. I'm sure if the market goes 50%, it's a totally different story. But market down 5%, 7%, maybe even 10%. We actually think those options just don't make any money. And that's ultimately the problem when too many folks are utilizing the same instrument. And I think we saw that in September, October of 20, right? With all the election vol bid up and everything. And then the market did go down, but it was like,

it was a nothing burger in terms of vol. Yeah, you said December, 2018, fixed drag vol came in during, you know, a reasonably choppy and downward month. You know, you saw it, as you said, around the election. That was an event that rolled off. So a little bit different than just natural drawdown. But even saw it, you know, September of this year, it was only a less than 5% move in the S&P 500.

But vol came in hard during the 5%, you know, down move in markets. So, you know, we obviously, this is embedded within our strategy. This is why we're saying we're short vega, you know, 9 out of 10 times is we do think this is mispriced and we think we know why. And we actually think that it does contract during the down movement. But as always, when there's too many folks doing the same thing and the event that they're all supposed to unwind, it happens and they all go to unwind at the same time might affect the pricing of that. And let's talk about the flip side of that. Right? People say, oh, there's not enough institutional vault selling right now for there to be a big crash. Right? There's not enough people who will puke and start buying their way out of those short options. Where do you guys see us on the short institutional vol selling curve? If we say like early 18 was the top, perhaps, or tell me the history of it, if you know.

You want to go, Devin or me? Yeah, I mean, it's not. I'll let Zed do most of the talking here. But the answer is the biggest players in this space come from retail and private banks, and they are undeterred. So for the most part, this exposure is still out there, kind of very close to maximum levels. And if you think about how a private bank works, they go out and they go out and sign up hundreds of clients or thousands of clients for these strategies individually, right? That's a completely different dynamic than if you are managing a short vol allocation

at a pension fund or any type of commingled vehicle where there's a portfolio manager and a much more prescient agency problem associated with that manager, right? So like, yeah, they might get some redemptions, but essentially each account has signed up to the risks individually. So that's very – the short vol trade is very, very, very durable at this point. And, you know, we believe continues to create this, you know, this pressure on the front end, you know, to the point that we can use it and monetize it. And it would take a really, really significant move to shake people out of that in our view. Yeah, and I think it's actually different rather than just getting, you know, having losses on a large drawdown. I actually don't think is the function that causes folks to not jump back into the short vol trade afterwards.

It's as simple as yields going up, right? It's the main driver of a lot of this is just, we'll call it full and full yield replacement type strategy. And so, you know, if credit is only, you know, IG credit's only paying two and a half percent and high yield, you know, sub five and real returns negative, everybody's hunting for yield, which means everybody's going to sell options and they're just going to embed them in a bunch of different products that don't say options, but they're selling options. Now, you know, we get, we get tens to, you know, 6%, maybe they slow that down.

They have other choices to go ahead and find yield, but in this, you know, low yielding environment, it's, it's, it's fully there and probably accelerating, you know, beyond where it's been. And we just need to look to the folks in Asia, for example. It's a persistent option selling world for 20 years, and it doesn't matter what the market does. They're always there because they have to find distributable returns of mid-single digits,

and there's no other choice. I want to get your thoughts on some different vol strategies. We've had some fun in some of Chicago's finer establishments talking through these. Let's start with what we've already covered and you can just do a line on it. So the Taleb style, deep out of the money option, put buying. I think you've covered it. Give us just a last one liner on it. Yeah, going to be tough for that to work

in this fall regime. I mean, as we just talked about, fall doesn't necessarily go up when the market goes down 10% anymore, right? It was certainly not for the first time. I mean, way more simple. Huge monetization problem. Huge moment. The sombrero trade as Jason Buck and I like to call it, which kind of short the belly, long the wings. What are your thoughts on that trade? You guys have a little bit of that

concept in your stuff, right? Well, that version of how you describe it is the ultimate marketer's dream, which means it could ever make money, right? It's the old, hey, it produces 2% a month and limited risk of, I don't know, just pick 2%. And people and their brains instantly go, 2 times 12, 24 with a max risk of two, this sounds amazing, except for, you know, market slowly moves down a significant amount in December, 2018. And those strategies lose 16%. Your risk wasn't too. So, you know, anything that's really, really easy to sell, it's probably has some issues. Right. That's been working for most of the last few years, right? Cause if you have the sharp, sharp kickbacks, it works. If not, right, or if vol goes, it has to really go, which is what we've seen. Touched on this a little bit, but the JP

Morgan hedged equity, buffered notes, all the collar stuff, just your overall thoughts on how those are all structured. If you want 0.7 beta for 20x fees go for it yeah i mean and a lot of taxes right i mean just just you know the problem with this whole there's two big problems with this entire camp of products which is um first getting in and out of them is a tax event, right? And it seems like, you know, I mean, it's unsurprising. A lot of the folks in the product management world here, like, came from institutional thinking. And so, like, this just, like, doesn't get on the radar. But, like, the answer, the second problem is that the risks are very dynamic depending on spot, right? So to the average advisor buying one of these buffered products, I just refuse to believe that they actually understand the risk that they're

taking. I believe that they understand that there's a collar in there and that three days before those options expire, they know what the profile is, but they don't know what the risk is on any other day. And so the people who make these products respond by creating more series of them, which only makes the tax problem worse. So there's no squaring the circle of path-dependent risk and really bad tax profile in the buffered product space, no matter the wrapper, right? Whether it's a structured note you buy from a bank or an ETF or ETM, whatever it is, right? There's no squaring that circle of difficult to no risk if you're not a professional and in very difficult tax situation to enter and exit. This is why we exist, right? What you prefer is to actually put the options

that make sense directly in your account and not disturb your asset allocation. Right. What was I reading? The hedged equity program, the calls are almost at the money now, right? So they buy all the puts then they had to sell the calls to fund the puts and it's it was like 10 out of the money now five eight percent now five and it just keeps coming down it's like what there's no upside and you're collaring you know you're taking the first 10 of loss doesn't make a lot of sense implied versus realized vol-arm type strategies. Yeah. I mean, so here it's difficult to paint with a huge lead wand brush. I mean, there's people that,

there are professionals that really know what they're doing. Okay. And there are good products out there. If, if you are, if you can go and invest in, you know, what I would call the top tier of hedge funds in the space with people that have real pedigrees and really know what they're doing. But there's not many of them. And we are talking about writing real hedge fund allocation checks. I think that what disturbs me a little bit is that there's a tier right below that where there's a lot of magician cant hand-waving going on about relative value and options world in the VIX. And for the most part, outside of a handful of people that I think really know how to run a hedge fund in a relative value of all strategy, you know, it's, it's kind of scary. I mean, really, right? Like, so, you know, there's a, there's a big, big dispersion

of quality here. And I, I, I do think that there is good stuff. And I think that it's, they're mostly asset, excuse me, absolute return strategies that, you know, that belong on the alpha side of your portfolio, not the risk mitigating side of the portfolio. And I do think that there's a lot of landmines you can step on, depending on the manager that we're talking about. Which is because, per your view, there's no signal there in realized versus implied. It just is what it is for whatever period. I think that the sophistication required to really understand the flows of where those dislocations come from. I mean, there's a bit of this in what we do in the specific security selection and understanding how much edge we actually have to work with when we select the options that we do for the risk mitigating strategy. But there's a relatively high level

of sophistication that you have to have in order to assess these things, to size them correctly, and then to do the risk management. And based on almost all of the commentary I hear, I don't believe there's a ton of people with those skills. So there's good stuff here, but you got to be careful. The key word to be careful is anybody that's pitching something in this category that focuses on the word yield. If you hear the word yield, run. Right. We're generating a yield by selling high implied versus realizing as devin said it's an absolute return type of allocation yield is the easiest means to sell just selling the concept

of selling options uh and we touched on it earlier but the and you just touch on it now but pure flow traders all that matters is gamma and delta hedging and where the market makers are at um thoughts on on that type of strategy yeah i mean at any reasonable size i don't even think that's a thing right i mean i think outside of that no i don't i don't think there's people out there defining the net positioning. I mean, just give me a break, right? Like, you know, I think that if you're close enough to the flow, if you are a large automated market maker, you do have some information. You do have, they're the only real people in the market able to take advantage of, you know, let's call it

extremely, extremely temporal, you know, sub minute to small number of minute type dislocations. I do think that's a thing. But I also, I mean, I should also say, I think that there are talented prop traders that have strategies that they can't make bigger than 10 to $40 million, right? Like, I think there's that too, and that's successful because it's small. But if we're talking about product that you're going to go out and buy, I'm highly skeptical that there are independent folks that can divine the net positioning of dealers

and somehow profit from that. Well, but that is a little counter to like JP Morgan hedged equity and their size and you know their strikes and you know, in theory, where the hedging needs to be. Yeah. Okay. But great. Like, so, so like you, you identified a half to six handle dislocation of the S&P. What do you want to do with that?

What do you want to bring up, Jeff? This December 31st, JP Morgan waited literally until the 31st to roll the entire hedge equity product. Obviously, those are all deep in the money calls.

Essentially, on that roll, they're buying 10 plus billion deltas. They're all going to do it in one print. Everybody in the world knew it was coming and we're going to be able to take advantage of it and move the market zero.

Zero. You're like, everyone on vacation. It should be the perfect setup. Nothing. It's a fun story. Why is that? Are they crossing it with someone who has $10 billion to sell? Or is it just the market's that deep and liquid?

It just ate it up? Why is that? It's a mix of the desk that they're working with has the appropriate time to prepare to some extent, along with just it's not a big enough dollar amount to move things. And if JP Morgan hedge equity product isn't moving, you know, S&P 500 futures, there's not much else out there that can. Right. It's fun. It's fun for people that use Twitter, but it's not an actual event for making money. Right. Because what is it? 18 billion or something into what's the total market cap?

$5 trillion or something? We'll finish up. Watch your hottest take. We're talking Chamath style, foot in your mouth sound bites. If you have any refugees to insult or anything um but no something market related your niche niche related nobody else is talking about something everyone is talking about but wrong or as i told you guys in the email something like tom brady sucks or the beatles are overrated which is i'll take it off the beatles are overrated. Yes, nice.

This isn't going to be as hot as no leg day, Chalmuth. But I think my hot take is that Congress is going to greatly reduce the Fed's tools over the next three years. And I think the reason for that is, in theory, everybody likes what the Fed has done if you're a congressional representative because it's all kicking the can down the road, which normally is good for you to win your next election.

But the difference here is inflation and inflation has trickled into everyday conversation. And they're going to be strung up by Congress because they got to point a finger at somebody that's not them. And the best way to eventually execute that is to create a congressional committee to review the Fed's tools and reduce their flexibility in using those tools. So I would say that's my quote-unquote. So that means like no more buying junk bond ETFs? I think the path they will go is, yes, what their total amount they're allotted to buy. So that would be my hot take is the Fed will actually have reduced influence over the next three years in all of our lives because Congress is going to take a lot of their powers away because they got to point at somebody. I do like that. That is a good one because

everyone else is saying like, no, they're just going to keep expanding, expanding powers and buying outright stocks. They're going to own half of Apple's market cap, yada, yada, yada. I love it. All right, Devin. Yeah. I mean, I'd go back to kind of my opening comments about the founding of the firm. I think a lot of the derivative managers face just as getting it wrong in that tax matters. You can't bring your institutional thinking into the family office and retail world. it and make the investments to be able to manage derivative overlays in an unfunded multi-custodial environment. It's really tough and you got to make the investment in order to do it. But once you've swallowed that pill, the opportunity set for the manager is huge, for the investor is huge. And if you use these tools correctly, you actually do stand to get the full benefits of derivative investing rather than kind of

small chunks that the manager is essentially able to offer to you. I love it. And I got to do a shout out and just ask you one question about you're a semi-pro shooter, correct? You do competitions i am yes uh what what does that look like you're shooting clays or discs or the little targets like in the biathlon in the olympics uh yeah so um my particular version of the game is not uh is not an olympic sport uh in the olympics that if you're used to seeing things like bunker trap and international steep those are what we call fixed field games where the targets are the same every time uh and the discipline that i concentrate on called sporting clays uh and fit and then there's some related sporting clays disciplines we're looking

at the targets for the first time um right before you shoot them so uh you know ranges are like let's call it 10 to 60 yards uh usually in pairs and kind of any trajectory and speed that people can get to come out of a machine. And the complexity is super high because you've got to be able to look at it, select a technique, make a plan, and then game that's exciting and I've been successful with. What are the top guys doing? 80%, 90% hit rate? Scores are far less standard due to the variable difficulty of the game. Even as complex as the game has become, people are very, very good. So, you know, it used to be in the sporting clays 15 years ago that you could win the nationals with, you know, a low nineties type score. You know, now we're

talking about needing just out of 300 targets, you probably can miss eight whoa so yeah so we're talking we're talking really high 90s averages uh to be able to win consistently um at a regional and national level it's uh it's very very competitive uh and ideally there's no money in it either. So after you spend your life getting good at this, you don't really win anything. You get a little pat on the back, maybe a plaque. It's entirely about mental discipline and focus and being able to control yourself well enough to execute. That's one of my favorite winter Olympic events, that biathlon, where they're breathing hard to slow it down, hit those targets.

And Zed baby on baby number two, is it on the way? Baby number two. Baby number two on the way. Good luck with that. I tell all expecting parents, it's a lot of fun. 40% of the time. That's right. And as to go full circle, it's the end of the Zeds. So first one's the daughter and the second one's also a girl. So it's ending at four.

Well, you never know. Zed five. Number three. Is there a feminine Zed? I don't... I don't necessarily think it's a masculine name either. Feminine derivative? We have to work on that. Zedina.

Alright guys, thanks. Next time we gotta do this in person in Chicago. Devin, you gotta come in. But we'll talk to you soon. All right, guys. Thanks. Next time we got to do this in person in Chicago. Devin, you got to come in. But we'll talk to you soon. Good luck with everything. And thanks for being here. You bet. Thanks, John.

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