The Derivative - Seeking (VIX) Certainty with Certeza's Brett Nelson

Episode Date: July 23, 2020

In a #ThrowbackThursday of sorts, we’re bringing you an episode recorded pre-pandemic where we hit the road and traveled to Utah to interview the brain behind Certeza Asset Management, Founder and CIO – Brett Nelson. Brett is another guest deserving of the moniker VIXpert – having been trading the VIX since it first entered the game, literally trading VIX back when there were a few dozen contracts a day changing hands. We’ll be covering everything VIX (along with non-VIX topics) including: skiing in Salt Lake, pure volatility futures, being a math nerd, the left and right tail, 19 y/o quant financing, the Spanish pronunciation of Certeza, trading the VIX since inception, term structure, gaming the VIX, proprietary algos, and the best resorts in Utah. Follow along with Brett on LinkedIn and check out the Certeza website to learn more. 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. Chapters: 00:00 - 1:37 = Intro 01:38 - 17:20 = Background 17:26 - 30:18 = Genesis of Certeza 30:26 - 44:42 = The Strategy 44:49 - 58:18 = Term Structure 58:25 - 1:08:36 = Research/Strategy 1:08:44 - 1:15:40 = Favorites 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. Another uniqueness of VIX is that I've followed a lot of markets in my career, and with near certainty, you can count on the fact that when more and more institutional capital flows into an instrument, it becomes increasingly efficient, harder to extract alpha. VIX doesn't have that characteristic so far. As institutional capital flows into it, it becomes either equivalently inefficient or more inefficient over time. Welcome podcast listeners to The Derivative by RCM Alternatives. I'm your host, Jeff Malek, and we're doing a rogue game for this episode, sitting down with the CIO and founder of Certezza Asset Management, Brett Nelson, in his home state of Utah. Welcome, Brett.

Great to be here. Thanks. Certezza is a quantitative trading firm managing over $80 million with multiple programs specializing in the volatility space, and specifically volatility arbitrage, where they use sophisticated algorithms to trade the VIX term structure, more on that in a bit, and identify opportunities to generate absolute returns. So that's a lot to unpack, but first let's start with the fun stuff. It's dumping snow

here in Salt Lake today. Do you enjoy this world-class Utah snow? Absolutely. I was born and raised in Utah, so I started skiing at a young age, and it's kind of like walking here, but we have numerous world-class ski resorts within an hour and a half of the house, so I can take advantage whenever I want. And you're a little north of Salt Lake. Where are you at? Yeah, we're about 90 miles north of Salt Lake in a mountain town. A lot of hedge fund guys up there? Not a lot of hedge fund guys. And so what's your favorite mountains? Do you get down here to the big resorts or you stay up there?

Yeah, we do both. We obviously have a family season pass to the local resorts up there, so we can go up for half days or weekends. And then we come down to Park City and Salt Lake Resorts. I'd probably say my favorite, if the snow is good, Brighton is amazing. Snowbird is also great if you don't get blown off the mountain. But if the snow is great, then Snow Basin up in the Ogden area that was kind of revamped for the Winter Olympics, that's a fantastic resort. And how was that? Were you a part of the Winter Olympics? I attended the Winter Olympics. I didn didn't participate i wasn't i wasn't

a competitor didn't participate on the staff but i attended uh what was that like for the for all of utah and for salt lake it was great um it turned out really nice and was probably one of the better hosted events that i've seen in as far as winter olympics the uh salt lakes downtown and just the surrounding areas is probably the best venue worldwide, I think, for that type of event. Did it leave you guys terribly in debt? Like a lot of these other places have these big issues after, right? No, I've actually been, I've heard multiple reports that says that Park City specifically has been one of the few places that's actually been able to monetize all the improvements and continue. it became kind of the world training training ground for future olympic athletes that's great when chicago was in the running for the

whatever next summer one i was a big no hard no it's like i was like it's going to be five years of construction followed by two weeks of the best times of our life, excellent. And then 50 years of debt trying to climb out from under it. Yeah, I was actually, I lived in South Korea in the year leading up to when the World Cup was coming there and I saw the lengths that they were going to to get the stadiums ready for the World Cup and just the massive amount of debt that they had to go into. And I was hoping when, you know,

you hope that when events come here that you don't see the same type of debt p they had to go into. And, and I was hoping when, you know, you, you hope that when events come here that you don't see the same type of debt piling up. Yeah. So let's get into that. You were living in South Korea? Yeah. I lived in South Korea for a couple of years. In Seoul or what part? No, a little South of there. I moved around, moved around a bit, but a place called Taejun. When, what, what were you doing? Uh, I was actually a missionary for a couple years. I did a service mission. And so let's, you went, or I wanted to go back to the, so you love the skiing, love the winter.

You like the summer even better? Or what's the summers like? I would say now that I'm a little bit older, the summers are better. I used to love the winters more when I skied just about every day. But now I would say boating, most people don't realize about Utah. It's not just about the snow skiing. It's kind of an outdoorsman's paradise year round. So between downhill mountain biking and boat sports during the summer, that kind of occupies more of my time for sure. And you're not boating on the Salt Lake?

No, definitely not. We have a lot of, we're a kind of a desert climate, so we have a lot of reservoirs. And so you can kind of pick your spot. And what's your favorite water sport? I'd say probably kiteboarding or wakeboarding, either way. I was back in ancient times growing up in Florida, we would do wakeboarding, but it was behind a little Boston Whaler with an actual surfboard. So there were no straps or anything. We just would somehow get up, hang onto the rope, and be sort of doing it on a surfboard. Wake surfing has kind of taken over the wake world anyway.

I think about 90% demographic now amongst the wake sports now is wake surfing. And that's when that boat's just putting up the big wake without a rope surfing it? Yeah, I mean, with the better boats putting up the big wake without a rope surfing it? Yeah, I mean, with the better boats, you can do it without a rope. But you can do it with a rope and get more aggressive if you want to. That always looks dumb to me because the boat's in Wisconsin up at the lakes there, and they're going so slow, and they're pitched. I'm like, it doesn't look like any fun for the people on the boat.

It's more of a social event than an actual sporting event. At that point, you can just sit and listen to the music and have a conversation and you can actually talk to the rider while they're riding, which is different than other wake sports. I like it. Hand them a beer. Yeah. And so born and raised in Utah, then went to college in Utah also. Yeah. Went to college in Utah, Utah State University, Huntsman School of Business. The Aggies? Yeah, the Aggies. I think I've owned them in a basketball pool or two over the years. That's a good bet. This year, they're actually quite strong in basketball too. Yeah, they'll make it in the tourney? I think they will, although they're not the best in the

conference. San Diego State's quite good this year, so we'll see. Oh, that's that same conference? Yeah, we'll see how that plays out. They hadn't lost a game, right? They hadn't until recently, and then they kind of lost that. I think it was UNLV, I think, beat them. And so Huntsman School of Business, that's the former presidential candidate? Ambassador?

Actually, it's his dad. His dad was the founder of Huntsman Chemical. And then John Huntsman Jr. went on to run for president. Where I was just hearing, at Deer Valley, the Huntsman property up there, and supposedly they're

finally going to sell it. I think it was 80 acres or something right there in prime real estate, and they're going to put a couple lots out. Deer Valley is fantastic. I mean, as far as getting a place, if you're going for a second home and you want a place to stay near Park City, then Deer Valley is fantastic. And if you've got a couple extra million to throw around.

If you've got some extra money. So let's get into how did you go from growing up in Utah, Utah State, to getting into the hedge fund world. I can jump back a little bit to give some way back history of myself. Growing up in middle school and high school, I was actually a math nerd the entire time. I tried to be a closet math nerd, but I participated in mathematics competitions nationally and things of that sort. We joke about it because my parents actually used to tell me, you know, don't tell anybody you're in math competitions because it's really not cool and you won't be with the cool kids. And we joke about how times have changed because my impression

now is that nerdy things and smart things are cool and i might have fit in better if i was born a couple decades later but um a hundred percent yeah today you the right you got the zuckerbergs and yeah it's it's kind of a cool thing yeah yeah to be you know glee and and math and all that kind of stuff is cool now when it kind of it definitely kind of wasn't when i was growing up but i was myself on a math team in high school uh mu alpha theta team m-a-t-h nice clever but it was a four-man team and I was easily the fourth best the best guy on there got a perfect score on his math sat so we would just let him run with it I was a football player and I my job was kind of to intimidate the other teams. That's nice. We had one outstanding person too. He ended up being a stats professor at a university out east. So you're doing these math competitions and you had an aptitude for it.

Yeah. And I didn't really know at the time, I didn't know what quant finance was, but I knew that I was into math and mathematical modeling. And I started to have interest in the financial markets late in my teen years. And this just kind of happened to coincide with, if you remember the mid-90s, suddenly we had groups, Interactive Brokers and Scott Trade and others were offering direct trading online platforms. And so I suddenly had access to the financial markets. And I kind of parlayed my interest in mathematics into what I would later learn was called quant finance. And specifically, I entered into the options world very quickly and started doing more sophisticated mathematical modeling via derivatives and so was it

a stocks at first individual stock yeah individual equities and you know spiders index things like that I feel like that's such a natural transgression for people not transgression transition transition thank you for people though I'm trading stocks I understand it like, this risk doesn't seem to work out. Let me learn about options. Oh, let me learn about futures next. And you just go down the derivative chain to get to the most efficient vehicle. Yeah. And specifically with equities,

if you're getting into equities in a more sophisticated sense, you know, there's always those who do a good job of tape reading and things like that that can trade, you know, e-mini contracts or something. Do they still have tapes? Yeah. If you want to call it reading the tape anymore, right? Reading the digital tape. But, uh, the problem is if you want to get into sophisticated mathematical modeling, it usually takes a larger amounts of capital. And so one of the, one of the things is when you're, when you're a teenage boy and looking to get into the the financial markets you're saying where can i do sophisticated

modeling without being too capital intensive and options really is that place yeah and so i got into options and i found out and you know being in utah i'm not surrounded by wall street right so i didn't have a lot of access to mentors locally. I spent so much time. It's unfathomable, unfathomable how much time I spent on, uh, you know, public forums and quant forums and trading groups. And this is like pre Twitter, pre Twitter, you know, pre social media in general, but we did have, you know, online forums and boards, AOL chat, chat rooms. Um, and I, I found out in the public forum space that I was putting on far more complex and sophisticated positions in options than most were, you know, there was, there was always your,

you know, covered call guys and your vertical spread traders and things like that and your premium sellers. But I was doing multi-leg hedged positions and realizing that as I traded more and more, I was hedging out delta, I was hedging out theta, I was hedging out just about everything except for finding alpha in vega. And vega, for those not familiar, the volatility component of options. And what I eventually did was located on those public forums, a group of about five or six other volatility focused traders. And we kind of split off and formed our own private group online that would focus in on volatility arbitrage and

forecasting vol. And where were these guys or girls or whatever across the world? Across the nation mostly. There was a professor out of Georgetown was one of them and a couple of guys from some prop groups in Chicago and then a couple of just individuals like me that were mathematically minded traders. And so you're doing this all with your own money? Yeah, and I didn't come from money. So I was entrepreneurial from a young age.

So I had scraped together what would be considered not a lot of money by trading standards, but a lot to a, you know, to a young college student. Okay. So you're like 19 years old doing this? Yeah, 19 years old up through, you know, 2021, getting into the early 2000s now of, you know, being able to approach the markets in a completely different mindset now that the online world had kind of taken over and, and really there were no limits on what you could do. You didn't have to, you didn't have to go to a prop group. You didn't have to go to an investment bank or, or something to learn how to trade. Do you ever, uh, wish you had gone to one of those? Like you think as much as you learned, maybe you would have learned even

a little more or learned it faster you would have learned even a little more or learned it faster or something? There's a little bit of a give and take. I mean, having a mentor would have been nice as long as they're of the proper caliber. But when I talk to people now, usually my approach to the markets and my mindset is so much more unique and different

that I wonder if I almost would have gotten pushed in kind of the wrong direction for what I was trying to do. It would have shaped you into group think. Yeah, group think and specifically equity, buy-sell trading and things like that that I wouldn't have wanted to get into. And so did you then go get a real job or you just went straight from that young trading into running your own firm? No, I always wanted to trade. I always wanted to run my own firm. I wanted to specifically,

what I had in my mind was I was going to start my own hedge fund, not knowing the direction I wanted it to go at the time. And how did you even know hedge fund? Did you have some idols or some heroes that you wanted to emulate or just, um, I mean, rent tech, Jim Simons has always been kind of like the gold standard for me as far as where do I want to be? Cause he's kind of, you know, but even back then he was pretty unknown.

He was pretty unknown. But by the time I was in college, I knew who he was, you know, he's, he's been very successful at staying under the radar for considering how successful he's been, but extremely. So even did you read the book that just came out the uh not the most recent one no i'm starting it soon but uh everyone says like there there's really nothing in there like the

guy couldn't get much access and he's kind of talking around the whole story but i've seen the articles that kind of tease about it a little bit but i mean it's set it's so well guarded i've done enough research on my own to know you know with the with the various public information that's come out to see how how does it compare to other things out there but to answer your question i did uh i did end up working for a fortune 500 company a fortune 100 company actually for a while in an r&d capacity but uh who was that a dupont chemical yeah dupont company so i did that for a while um and i actually used to uh i don't know if i should tell the story but i would doing uh yard work as a summer job in

vero beach florida and one of our accounts was the uhPont heir. Huge property, tons of money. It would take us like four hours to mow the grass and do all this stuff. And the old DuPont lady would hide Coke cans like out on the grounds. And if you didn't find it, she'd fire you. Oh, man. But it was a small town. There were only like four groups. So she'd just cycle through the four groups because she'd keep –

oh, you didn't find that? You're fired. So who knows god she rest in peace she's probably long gone by now yeah and so where how did the certeza name come about i always want to say certeza certeza a lot of people say certeza actually but But it's certeza. Yeah. For those familiar with Spanish, Portuguese, you know, Latin base in general, certeza is mostly how they say it, depending. Italy says it a little bit different, but the concept there is the word is certainty. And obviously from the root there, the Latin root cert. But really it's more of an ironical usage for us because we're statistical in nature. And the one thing, if you ever talk to a statistician, the one thing you realize is that they will never state anything with certainty.

Because there's no such thing as statistical certainty, right? And so what it is, is this ironical thing that we have where it's the carrot dangling out in front of us, this concept can we get closer and closer to the idea of statistical certainty, knowing that we're never going to be able to say, we know for certain that this trade or this concept is going to be.

Right, the law was saying like, well, I'm pretty certain about that. But 99.9%. I was here though, but there I'm pretty certain about that. But 99.9%. I was here though. But there's a greater than 0% chance that there's a different outcome. Sure. Cover themselves. So you left DuPont and started Certezza.

I actually started it concurrently. And really what had happened was the evolution of that kind of academic vol group that I was in. What I noticed was we were taking the same approach to vol, and for those who know, modeling volatility is one of the more difficult concepts mathematically, modeling variance and volatility, and it stands to reason. It's not too difficult in the stock world to say I have some type of sense of what stock movement is going to be in the short term or in the intermediate term with fundamental basis and everything. But to say then another derivative of that and to take it and say I not only want to know what the direction of the stock market is going to be, but I also want to know what the volatility or the variance of that movement is going to be. It's much more difficult.

And in a certain time frame. Yeah, and within the time frame. We always talk about volatility is synthetic time and vice versa. So, you know, volatility has a direct relationship with time passing. I would say it's 3D chess on an ocean with sharks with lasers on their heads. Yes, yes. That's a good, that's a map description chess on an ocean with sharks with lasers on their heads. Yes, yes. That's a good, that's an apt description, I would say.

So what ended up happening was the landscape really changed for me in 2004 because the CBOE announced that VIX futures were coming online. And up until then, every vol trader out there was using options because that's where volatility trading was. And you couldn't trade. The VIX was just an index. Yeah, the VIX was an index. And the VIX still isn't tradable, but the derivatives are.

And that vol group that I was participating in, we were some of the very first to ever trade. We traded VIX from inception. And so it was a weird world then because there wasn't consistent listing traded VIX from inception. And so it was a, it was a weird world then because there wasn't consistent listing of VIX contracts and there would make, there might be five to 20 contracts per day traded. You know, the daily volume was nothing. And it really was myself and these other traders trading against each other for bragging rights and see who could kind of

guess model volatility better at the time because there was no mathematical foundation for it. They were completely new. And or you could have just done the game theory approach and know what those other four guys were doing. Yeah, it really was maybe more of a game theory mindset. But by the end of 2006, really, more institutions had come into the market for VIX futures and the CBOE had to introduce the options as well. And it wasn't that I was really interested in the options because I had really kind of gravitated away from the options world in favor of more efficient execution and futures.

But what really happened was that the options in VIX attracted a lot more attention and the daily volumes in the VIX futures became much higher and deeper. And by about the end of 2006 we had an actual consistent volatility curve, the term structure that we always refer to in VIX. And that obviously then changed the world for me because I could now model VIX mathematically. And then did you have your family then said, okay, I'm going to take this leap. I'm going to quit my day job. I did it concurrently for a while because this is still 2006 and I maintained a professional contract.

The nice thing was that it wasn't taking up crazy amounts of my time. I was really more of a research and development capacity where I would do projects and inventions and things like that for them. And so I was able to do both. Did you invent anything cool? I actually invented a couple of things kind of cool, a couple of things that people actually use now. You're not allowed to tell me. You're not allowed to kill me. I can tell you. My name's on a few patents out there if somebody would want to search for them so I invented mostly what I was working in was brand protection and

Authentication so ways to prevent counterfeiters from being able to beat products So to redo a chemical so for example in the world of Everything from Nike shoes to cell phone batteries everything you can think of really counterfeiting is a problem right and and I specialized in developing new technologies that would prevent counterfeiters from being able to beat them so ways to tell you as a consumer that the product is real. Cool. So then Certezza's launched, you quit. So Certezza is launched.

I'd finished my models. And what had really happened was, interestingly enough, that group of vol traders I was working with, I found them all leaning toward what we now call the short vol trade or the premium selling trade, the risk premium trade. And I found myself on the other side of that trade over and over and over again. And the reason for that is I didn't ever debate them on the fact that it was a positive expectancy trade because it was. And it still is, I believe, for the most part. The problem was the tail events. And the tail

events for VIX are absolutely insane you know vix most people think that vix topped out at you know 89 in in the 2008 2009 crash um actually those for those of us who have back calculated it further back than 1990 in the 1987 crash it went to at least 150 wow and so if you're considering being a short vol trader, knowing that 150 also is not the ceiling, you could go to 200, 250, there's not really a ceiling for it. And so I always looked at that and said, you know, I would talk to, to my, to my colleagues there, I call them colleagues, I guess I would talk to them and say, and they would always have the same response. Well, when it starts to happen, we'll get out of the way yeah and my response was so you feel like you can buy insurance on a burning house

right and and what happens when it happens on a sunday yeah and the gaps i mean we all remember for example the the august 2015 move where you know we closed the market on friday VIX was in low 20s, you know, and it opened, I believe, the first print was 53. And gaps like that don't happen in other instruments. And we always joke, you know, everyone talks about the February 2018 VIX meltdown. And we always kind of... VIXmageddon, as we call it. Yeah, they call it VIXmageddon. They say, you know, nobody really saw that coming.

I'm saying, well, a lot of us saw it coming. It should have happened in August of 2015. VIX went from low 20s to 53 on the opening print. The only thing different was that it kind of calmed down by the end of the day. And so it was supposed to have happened then. And remind, what was the catalyst in that? That was a China economic meltdown oh yeah so the the more recent one you know it was the most recent one

until the one that we're kind of currently in so but anyway the the the point there was i found myself in the long ball trade more often than not and so i went about trying to figure out how to build a model that could um kind of take advantage of both. Could I take advantage of the positive expectancy of the short vol trade, but find a way to not be exposed to the tail and be long vol biased overall? That was always the question. And I finished my model by about mid-2010 and went live with it in July of 2010. And that was kind of the genesis of Certezza. And I kind of have an issue with that, the short vol is a positive expectancy trade.

Like over a long enough timeline? Yes, over the entirety of history. Yeah, right. Selling vol is what we all kind of know in the markets is that humans are willing to pay an excessively high premium for insurance. And that's what the short ball or the risk premium trade is. It carries a premium.

And over time, it's not unlike the insurance industry in that the same thing happens with insurance companies. And law of large numbers says that it's a positive expectancy trade. Except instead of millions of patients and you're not going to have all of them get sick at the same time except for coronavirus that we're in right now. But it's like you have one patient that could get deathly ill tomorrow. Yes, and so insurance companies work on the concept of expectancy the same way we do.

And the problem with the markets really is that there there's a little bit of a false sense of security in this concept of traditional diversification and so we all think that there's more diversification in the market than there actually is until we see things line up and the first real evidence of that was the 2008 meltdown when everything correlated suddenly. And just backing up, and we'll get more into the strategy in a minute, but what happened to those five peers from the group? Are they still around?

Do you still talk to them? I don't talk to them anymore because I kind of went a separate way. Really, with the advent of Certeza, it became a situation where I was no longer willing to share modeling freely with them. And a couple, the most successful one of them also wasn't. And we talked a little bit and said, you know, we're not, we're actually at a point now where we're not really willing to openly share with each other. And so this really isn't going to do us a whole lot of good anymore. And so we kind of went our own ways. I do remember I, I'd caught up with one of them. He was, he was one of the individuals. And I remember he, he was out of Chicago. He had built a quite small account, less than $100,000

account into 10 million over the course of, you know, from 2006, up to up to 2010, which is wildly successful for an independent trader. And through the 07-08? Yeah, and you have to realize that for VIX, 07 and 08 and 09 for that matter, was very, very profitable. There was so much inefficiency in the market that it was crazy for those of us who knew the market. But if you remember the flash crash of May 2010, they were all on the short vol trade during that crash. And I remember

talking to that specific individual and he said, I'll never forget it. He said, my vision just went blurry because his 10 million account had turned into 4 million in 10 minutes. And 100K to 10 million to four. Yeah. And those types of things really drive at home when you're already someone who says, I prefer the long vol bias trade. I just need to figure out how to make it positive expectancy. The flip side of that would be turn 100K into 4 million. Yes, be on the other side of that. The problem with the crisis alpha trade really is that being a negative expectancy trade over time,

you have to figure out how to overcome that and you'll see these crisis alpha funds that will just bleed for four years at a time. And that's not the biggest problem because if that was the only problem, then it would be manageable by saying I'm serving my function if VIX goes from 18 to 70 and I perform the hedge function, then I've done my job, right? But the problem is that VIX is very much lightning in a bottle at that point. And if it's printing 45, is that where you capture profits?

Or is it going to go to 70? And if you took it at 45, you're not performing your function. Most often what happens is VIX will go to 50 and then immediately back down to 20 in a blink. And so how do you really capture that? And that's been the biggest problem for crisis all the time. Okay. You're listening to The Derivative and we're back with Brett Nelson of Certeza, not Certeza, Certeza Asset Management, getting ready to dive into the strategy a little bit more.

So Brett, give me the elevator pitch on what Sir Tezza does, and we're on the first floor. We're going up to 10, so go. Sure. First statement would be that we don't trade any options, pure volatility futures. We arbitrage the VIX curve. We do not arbitrage the difference between implied and realized vol like most do.

The best description is that we figured out an optimal way to capture the virtues of what most people would call the role yield trade in VIX in that, you know, what would otherwise be considered a short vol trade, but in a way that doesn't leave us exposed to the vol spikes, because we've been able to use VIX convexity to not only hedge itself but to become the return driver in the vix spike events so we end up collecting that roll yield that everybody wants so much in vix under normal conditions but being long ball biased day in and day out so we catch the spike as well so not necessarily long ball i think a lot of vix

managers that we talked to they're like okay i'm a long ball play and think a lot of VIX managers that we talk to, they're like, okay, I'm a long ball play and I'm limiting the bleed, or I'm a short ball guy that's either ignorant of the spikes or has a plan of, well, I'll get out when it comes. So you're sort of opportunistically moving back and forth between those two? Yes, but more specifically we found that there are structural inefficiencies within VIX itself as an instrument that allow us to capture that roll yield without having to choose do we want to be short or long vol. VIX has certain virtues that don't exist anywhere else in the global marketplace, and we can exploit those to say we can actually be long vol biased almost all the time if if not all the time then almost 90 percent of the time and and even being long ball biased we can still capture that roll yield so we're not just

minimizing the bleed we're actually overcoming it producing you know absolute return during those which is that's hard for people to have both those thoughts in their head, right? Of like, it seems impossible that, okay, I'm doing both of these counter things at the same time. Yeah. And if it wasn't for the unique characteristics of VIX, I don't think it would be possible. Can you touch on those unique characteristics a little bit without giving away the secret sauce? Sure. There's general ones that everyone knows. For example, VIX is a statistician's dream, is what I would say for someone like me. It is non-trending, where nearly all other assets trend over time. Statisticians don't like that. We have to actually perform little tricky maneuvers

to get rid of the trending nature of an asset, asset. So VIX is non-trending. Being non-trending, it's also the most highly mean reverting instrument in the world. So let's go back to non-trending. I think we did an event at the CBOE once and you were getting in on this. You were saying it's mathematically impossible for it to trend. It can't trend over time. If it trended, it trends in more of a flat manner. It's not to say that it doesn't have what we call volatility clustering,

because it certainly does, and the market does in general. But do you mean it can't trend higher? It doesn't trend higher or lower over long periods of time. For example, the equity markets, they have an obvious trend. They trend with productivity increase and inflation. And every other oil, corn, wheat, cattle, they all do that. But VIX doesn't because VIX is a mathematical formula and variance over time does not trend indefinitely. It can't mathematically.

And if it can't trend, I don't have to manipulate it mathematically. And the other thing is that if it's not trending, it's also reverting by definition. And so when you talk to people who are in the equity markets and they say we trade some type of mean reversion strategy, what they're trying to do is capture a reversion back to a trending mean line, right? And we all know that specifically for individual equities,

they can go bankrupt, they can go to zero. So a trend isn't really a great assumption. And even in the broader indexes, the trend is very loose. So a mean reversion to that trend is going to be loose. But for VIX, it's not very loose. VIX, if VIX goes to 90, there's a virtual certainty that within a very short period of time it's going to be back below 50 below 40 you know for that matter maybe below 20 and there's math in there too right because if a vix at 90 is telling what that there's 90 annualized volatility over the next 30

days yeah consider what that means in the bottom of the market of 2009, VIX is printing 89.5, whatever it was there. Consider what a plus or minus 90% move in the market actually means. Does that mean, for example, that certain market participants had it in their head that an S&P at 100 points was a possibility? Right, and it's saying that volatility is 90%, right? Yeah, the variance, the annualized volatility, it's a forward 30-day that's an annualized, but basically it's just saying that this year

there could be a plus or minus 90% move in S&P, which you're looking at and you're saying, that's one standard deviation, by the way, at and you're saying that's one standard deviation, by the way, not two or three, that's one standard deviation. So that's a crazy thought to think of how bad everyone thought it could get. And so on a weekly basis, not to put you on the spot, if you can do that math quickly, but what does that mean on a weekly basis that it was moved? For sake of argument, we'll say like 20%. Yeah, I mean, you're talking about reciprocal roots there in order to annualize it.

So you say if something had, for example, it's not linear. Let's say a normal VIX of 15. That's an annualized number. That means a monthly vol of about three-ish or so. It's like a reciprocal of the 12th root for example but so yeah and so in that 90 you're basically people are saying the market's going to go bust it's going to zero basically it's saying that this month alone we you know we could be seeing a 50 move you know 40 move so it's it's very very dramatic and even this last week you know as

as vix nearly hit 50 last friday a couple days ago um vix nearly hits 50 and to think about what that means in the market is actually a pretty staggering thought that means that this month the move you know could be 20 plus or minus and one standard deviation and the the danger of all that math though from the short ball side right is that the old line of the markets can stay irrational longer than you can stay solvent absolutely yep so yeah it makes no sense to be at 90 but it like you said earlier it could go to 150 go to 150 and it has and then you're you're broke you're bust yeah so right you can't just put a post out there of every time it goes above 30 or 40 or 50 to say, oh, this is, it's going to mean revert in a hurry, I'm going to go short.

But the nice thing that that brings us to is one of the other virtues of VIX is that not only does it not trend and it mean reverts, but it's also single-tailed, which is very unique in the marketplace. Most things are two-tailed by definition. mean reverts, but it's also single tailed, which is very unique in the marketplace. Most, most things are, are two tailed by definition. That's not to say that, that, you know, a stock can go below zero because it can't, but most stocks, for example, are, you know, say they're at $50, $100, $200 in any normal single standard deviations down one, two, three standard deviations. It's pretty well double tailed and somewhat symmetrical. Maybe log-normally distributed, but nonetheless somewhat symmetrical.

And VIX doesn't have that characteristic in that it's very strange. The mean for VIX or the mode, as we like to say, the mode for VIX is actually very, very close to the mathematical floor. So VIX can't really go below nine for any extended period of time mathematically. It's just, you'd have to think about what that means. If VIX were to print five for an extended period of time, that means that the broader world of investors thinks that there's going to be over the next year, there's going to be plus or minus 5% move in the markets. And how is that any type of predictable? It would almost be like if all the companies got nationalized or something

and they said, hey, by definition, by law, no company's stock can move more than 0.5%. Sure, and if VIX, if there's an actual assumption that realized volatility is going to be down in the single digit, the low single digits, you might as well just be in fixed income there because what type of risk premium is associated with equities at that point? Because everyone's in equities for the risk premium. It's like we've become muni bonds at that point.

Yeah, really. And so when you're saying there's single tail, you're saying there's just the fat which one? The fat right tail. The fat right tail versus... There is no left tail. So VIX can go all the way up to 100, 200, whatever. And the nice thing about that is, and you think in the context of our model,

so we've positioned ourselves so that we're not vulnerable to the right tail but there is no left tail so if you can position yourself so you're so you profit or are at least neutral on the right tail and then you can gain the benefits of its mean reversion characteristics toward the left tail that doesn't exist that's actually kind of a nice trade i like that and that's the whole concept behind most successful hedge funds, right? Of like, I have an asymmetrical risk reward. I've identified. Asymmetrical reward. Yeah. I just was thinking of Tesla stock in the past couple of months

has had a hugely left and right tail. Yeah. Right? It jumped from whatever, 400 to 975, and then back down to 620 or something. And how do you really build a model around something like that? That's always been my question because obviously to protect against a certain direction, most things actually don't have enough of a characteristic we call convexity.

And if you don't have convexity and it's not controllable, then really it costs you too much to hedge your absolute risk. Or even to speculate, right? Like I think the naive investor would say, oh, well, I can buy a straddle on Tesla and I know it's going to go huge one way or the other, but there's a cost to that. But yeah, what most people don't realize about the options market, and you've got to realize that's my background. I extensively mathematically studied options for a long time.

And what most people don't realize is that if you don't actually have some type of edge in options, the options are priced in such a way that a straddle in either direction, whether it's a short straddle or a long, is statistically priced correctly. The assumption is it's efficient. So it's very strange to make this comment that, well, as long as it moves one direction or the other, what you're actually saying with a straddle is, as long as it moves one direction or the other to a greater magnitude

than what the market is already predicting, because that's already priced in. That last part is what everyone leaves out, right? Yeah. Yeah, I've always said that. You get some people like, oh, well, we believe vol is cheap or vol is expensive. Well, isn't it? It is what it is. It's priced as it's priced. Yeah, vol is almost always slightly overpriced. And that's why the short vol trade is statistically positive.

Relative to what? Overpriced to... Relative to what? Overpriced to... Relative to realized. So the typical vol arb trade is implied going to maintain its overpricing relative to realized. And it historically does have that until events like the current one with a surprise virus, viral epidemic or something like that. Pandemic. Pandemic, yeah, which the who is refusing to call a pandemic um the the concept there is you have to have some type of edge an edge is is is statistical it's not it's not an abstract nebulous concept it's not like oh my edge is my ability to outthink other people no right edge is a mathematical number a trader should people. Edge is a mathematical number.

A trader should know what it is by number. Is it 10%? Is it 5%? Is it 100%? Right, which is alpha. Edge is expectancy. Yeah, alpha and expectancy. So that's the thing is if you don't have a mathematical edge in options, then it's already priced in. But that seems counter, not to belabor the point too much, counter to the concept of it's overpriced. If it's already priced in, it can't be overpriced.

There's a recognition that humans are willing to overpay for insurance. And so that's what's understood about at least at the money or near to the money options is that people are overpaying the premium on options generally. And so in a perfect world, if they weren't overpaying for that, the put prices would be much lower or not much lower, slightly lower to match up with what the actual realized volatility over the next 30 days, year, whatever turns out to be.

And it's obvious in the put volatility smile, the skew that everyone always talks about, these things are pretty well known. And so to get in there and say, okay, I somehow have an edge in predicting, you know, implied volatility behavior within options or something like that, you better be certain that you do. Otherwise, not enough to say that people overpay for insurance is my edge. Yeah. And so the the option selling market out there is huge. And it was huge going into the VIX, as you call it VIXmageddon going into February 2018. It's a massive market because everyone,

you know, intuitively knows that people overpay for that. But you have to realize what kind of risk you take on what event risk you take on to be on the side that takespay for that. But you have to realize what kind of risk you take on, what event risk you take on to be on the side that takes advantage of that. And let's talk a little bit. So you mentioned term structure, and that's a big part of your model. So just give us the quick definition of what the term structure is and how you guys view it. Yeah, it's interesting that we call it a term structure in VIX. Some might actually say that VIX is the only futures product out there that doesn't have a true term structure, but that's kind of the nomenclature used in the market. Why is that? Because it's not...

Well, I can describe it a little bit. But to establish what a term structure is first, okay, a curve that you would see in any any type of commodity, whether it's, you know, a physical commodity, like cattle, oil, for example, or a financial futures contract, you know, we have the bond futures and things like that. The term structure is essentially month to month, you've got a listing of contracts, say, we're in, we're in February February right now or March now, but the front month contract would be March and then April, May, June. And it forms a curve because all of them obviously are not going to be the same price. And in most commodities, they have a condition called normal backwardation, which basically means that the nearer months are priced at a higher premium than the further months.

So it's a downsloping curve with some type of concavity. In VIX, it's actually opposite that. We have a natural contango, which means that the near months are typically cheaper and they get more expensive as you go back. That makes a lot of sense because in VIX, the further back months are pricing in a greater uncertainty. And uncertainty means means you know a greater potential for higher prices in the future so so the further back contracts are going to be you know retaining some type of a premium relative to the more certain near-term contracts right and

the whole concept being i have a better of idea what's going to happen tomorrow yeah versus next week versus next month versus next year like predicting the weather you know i can predict the weather really well tomorrow somewhat next week but my concept of what's going to happen on a day-to-day basis in the weather three four or five months from now it's pretty much all the same so you'll see it kind of flatten out toward the back end of the curve because uncertainty in the markets is the same way they're they're kind of similar once you get back there that far um the reason i say it doesn't actually have a true term structure is that it comes back to this concept of what makes VIX unique in the marketplace. One of the other characteristics,

we call it a virtue. Some people might call it an annoyance, but VIX actually doesn't have a physical. It's the only thing that doesn't. All other commodities and financial products, for example, have a physical. You can buy corn, you can buy cattle, you can buy fuel products like oil or gasoline. And because you can buy the physical, or you can somehow replicate the synthetic physical, as soon as you can do that, you can arbitrage it. So if a futures contract, you know, given, you know, cost of carry and things like that, and then the risk free rate of borrowing, once you can factor those things in, you can actually come up and say, okay, as long as I know the physical price, I can arbitrage. And if the futures contract wanders off of fair value by very far, then the market is very good at pushing it back to fair value. VIX is unique in that there is no physical. And more importantly, you can't replicate the

synthetic physical. So there is no cost effective way to go out there and buy a representative number of all of the different options used to construct what the VIX number is. It would just, it would, it would eliminate your edge and trying to do that simply by trying to buy that many contracts. Although, and we can get into this in a bit, weren't there some rumors and things that people were doing just that and kind of gaming the VIX close by jumping into the right strikes and pushing the VIX calculation? So that's the whole thing is because it doesn't have a physical,

you can, a large order flow could technically push the direction of it. Because what ends up happening, and in this manipulation you talk about that's been mentioned, is that without a physical, the front month contract actually doesn't have something to pin to. So in a normal market, you would say the front month contract has to equal the cash price or the spot price at expiration. But with VIX, it has something, you know, a weird thing called the special opening quotation, which basically is a number that ends up settling out as being what's proposed as being the VIX price at settlement. But no one knows what that's actually going to be. And specifically, the VIX spot number stops printing prior to the expiration.

And so what ends up happening is, let's say that VIX, the last printed price was 12 going into expiration, and an hour later you find out that the special opening quotation was what, 13? Or 11.25? Is that even somewhat close enough to actually arbitrage because you're you're quite a ways off and so there had been some speculation of manipulation on that to say that you can actually try and push the direction of that off so that that soq that we call it is much further off of what the last spot print was and to do that you'd be buying what is it it's on the oh it's 100 yeah the the spot vix takes in a wide

cross-section of near the money options prices and and then the special opening quotation then has to the reason they call it the special opening quotation is it considers the opening price um from the following day for those options and so so it's really, it would, it's basically come down, a lot of people have tried to kind of create something that sort of mimics the behavior of what a physical replication would be. But the point there is that because you can't replicate the synthetic, there is no actual fair value for a VIX contract. So what we've done is we've gone through and said, we know really well what a probabilistic range of possible fair values might be and where within that range the current value sits.

And so... You make me think of like this oil trade back in the day, right? If these huge Glencore's and big commodity firms, if they own the futures, they've got a tanker with oil and if it's off the fair value, they just keep it in the tanker, right? Or if it's like, oh value they just keep it in the tanker mm-hmm right or if it's like oh we can keep it in the tanker for a dollar a barrel but the curve is in backwardation it's cheaper for me you know there's trades all around that physical like you're saying that don't exist in the VIX because there's no physical right I have no other side of

the trade yeah interesting and so quickly would your models work at all on something other than the VIX or they're VIX specific? They were built for VIX. We have used them in a different program across 20 different commodity markets and they work quite well there. Those other markets admittedly don't have the virtues that VIX has. So one of our other programs... And they do have term structure. They do have term structure. But at its core, our model is a statistical model. So any time that there's a statistical inefficiency within a term structure,

we can find it and we can exploit it. They're just greater inefficiencies and more commonly occurring in VIX than any other market. And so to boil it all down the strategy is essentially saying the the term structure per our model the curve per our model should be x the fair value or in as a statistician you're saying it should be it's got a 89 probability that this is what it should be yeah picture in your mind if we said this specific contract has a possible range of values from x to y right and right is right now is that like so specific of 11 75 to 11 82 in the vix yeah so if you say if you say the range is a three standard deviation range, right? So three sigma range, plus or minus. And we're saying it is, you know, say to your point, 11.75 up to 13.25.

And the current price is, let's say, 12. Where does that put us in relation to where the median or the mode value for that? Got it. It's usually a mode value. But what ends up happening is that that range is not symmetrical in distribution and so we can look in there and say because it's so far out on its extremes of where it probabilistically should be we know that it has a high tendency to revert toward its probabilistic probabilistic fair value. Probabilistic mode. Yeah, so we look at that and we say,

okay, we can exploit that by taking a position directionally in that one contract, but the problem is a shift in the curve could completely overwhelm that inefficiency. So we almost always, virtually always go through and find a nearby contract that we can anchor it to because we want to ensure that a curve shift in and of itself is not going to overwhelm our inefficiency. We just want the relative value shift of that contract.

And so that would look like, you said, we're in the March. I've identified the inefficiency in the March. It's a buy for us. Yes, if I want to buy March, then I'm going to sell April against it. As the hedge. As more of an anchor than anything. Yes, if I want to buy March and then I'm going to sell April against it to anchor it. As more of an anchor than anything. We want to eliminate curve behavior, overall curve behavior or market behavior directionally, and we want to exploit the inefficiency caused in that one contract relative to all the others.

Which comes back to your options experience of like I'm trying to hedge out all that delta and everything and just be looking at the Vega. Really, that's what it is. And what you realize in VIX is that, to mention another, kind of another uniqueness of VIX is that I've followed a lot of markets in my career. And with near certainty, you can count on the fact that when more and more institutional capital flows into an instrument, it becomes increasingly efficient, harder to extract alpha.

VIX doesn't have that characteristic so far. As institutional capital flows into it, it becomes either equivalently inefficient or more inefficient over time. Really? And to get into that a little, and we're talking all these exchange-traded products? Exchange-traded products certainly help with that. Because that's more retail flow. Because they're blind, they're indiscriminate. But I'm talking about literally the capital flows caused by the largest equity funds out there, the really big, long equity funds.

But that are outright playing in the VIX space? They can be outright playing in the VIX space or they can just be employing models like put buying, put protection. Okay, that are driving VIX. Which drives VIX, yeah. So what ends up happening is that as institutional capital flows in, it causes the individual contracts to to kind of move throughout this range this probabilistic range that we talked about and the more they move throughout that

range the more opportunity there is for someone like us to come in and exploit the inefficiency just for that contract so we don't really have to take a view on the direction of vix or something like that we can take a view on the relative value of that contract relative to the rest of the curve. And so would you warn friends and family away from those VIX products? I would warn most people away from VIX ETFs. I think that they serve very little purpose for the average investor. They're good if you want to bet on the VIX going up tomorrow. Sure. Most of them are long VIX products, right?

Long short-term VIX or medium-term VIX. And they're very indiscriminate, so they don't exploit the inefficiency in the curve. They just roll, and they have negative roll yield over time, certainly. And if I stated previously in this interview that the short vol trade is a positive expectancy trade, the long-vict CTF is then going to be negative expectancy by definition. And if you look at a chart of some of those, they're down 99% short vol.

Yeah, and that's going to be the case. Now, do they have some utility for the institution that has a specific tactical reason to use them? I would say yes. But unfortunately, most of what's been happening is that people have been piling, using them as a vehicle to pile more and more into the short vol trade.

Yeah. And that kind of can end up becoming a tail wags the dog scenario. You think that's partly what happened that Feb of 18? Yeah, and and unfortunately the short ball trade is back and bigger than ever since then is it larger it's larger yeah it's larger than it used to be fortunately enough some of the blown out etfs um first of all the ones that were really vulnerable did blow out and they're and they're gone now and the ones that stuck around

actually delevered by half and so svixy yeah yeah so the the likelihood of a liquidation event happening again is incredibly low if not non-existent um but that doesn't mean that that the blind short vix trade isn't you know creating inefficiency in the market it certainly is right so you're welcome in it's like hey these are the suckers that we're taking advantage of yeah and in fact the uh that blind short vix trade um caused unnatural distortion in the market leading up to this most recent crash so do you think a lot of those guys got blown out last week i i'm certain that they got hurt yeah whether they got blown out we'll see but they they definitely got hurt and and it might not be done yet let's change gears for a second and you've got all your proprietary algorithms it's a big part of what you do what's the uh give us some insight into how those are developed and

tested and whatnot. Yeah, I'm the primary driver of the research. research slash programming guys focus completely on research and ensuring that the model is optimally finding an efficiency within the VIX curve. The recognition of VIX is that it's still a young market in comparison to everything else. So when you consider, as a statistician, the more data, the better, right? And I would love it if VIX futures went back, you know, 50 or 60 years, but they don't. Right. It's only back to 04. 04. And it's really only usable since about October of 2006, when the curve actually got really established.

And so you consider what that means for us. Every month, every 12-month period is a dramatic increase in usable data. Right. So there's a constant effort to not only find opportunities within VIX, but also to take ideas that we had back in 2012 and 2013 that only had a handful of data points to support them and say as more occurrences pile up, is repeatability being established or were they just a consequence of certain market conditions? But are the algorithms firing off the individual trades?

Anything that's acceptable is. We do a pretty extensive analysis if uh it's uh the best way to describe it would be most people know what a monte carlo simulation looks like now um jumping out of the mathematician's world of being able to say i can do a monte carlo with some random walk scenario some some type of stochastics if i can get out of that world and say okay now i'm in a more discrete data sampling world that's more applicable to vix vIX doesn't resemble any type of a normal distribution or a log normal distribution like most other financial instruments do. So we discreetly sample and we realize that regime fits have to be a critical component. And so once we've done all

that, or in order to accomplish accomplish that task we have to do something that most people don't have to do and we take in these large amounts of data and we literally lay up monte carlo simulations on top of each other and end up with hundreds of thousands of simulations that capture the universe of what could happen in volatility and then and then we come in afterwards and say okay once you've recognized some type of um idea or say a an exploit an exploitative idea within the vix curve in an efficiently priced contract for example there's thousands or tens of thousands of ways you could trade that you know do you take an outright large position? Do you scale in, scale out? What points do you scale in, scale out?

We run this through an optimizer that actually takes those thousands of different methods and applies them to all of the hundreds of thousands of simulations that we've done and kind of gives us a statistical profile of what the best trade might look like. And kind of assigns a score? Yeah, you could call it a score. It's a representation of, we call it an expectancy profile. Okay. But, yeah.

And then, so if the expectancy profile is above such and such threshold, then the trade is triggered? The trade is good, yeah, and we can take that trade. And then that analysis is done every day to see whether the stats are deteriorating or improving for that trade. And that process is always ongoing? You're saying you want to be the wizard behind the curtain in your room,

coming up with models and let the rest of the guys run the shop? I would prefer to be the guy, yeah, the guy that's tucked away in a dark room and does research all day. That's my forte. I like it. And so let's finish up on the strategy

with just talking about risk a little bit. So the algos trigger that trade, says you've got this expectancy. Is the risk already built into that, or do you overlay some risk on it? Yeah, the really nice thing, and I wish the investment world would better embrace the concept of expectancy because they're all using it to some degree without even knowing it. But when I go to events that are surrounded by Wall Street professionals and I mention the word expectancy profile or expectancy ratios or multiples,

most people just don't know what I'm talking about. And I'm saying this is a key concept. We've invented things like Sharpe ratios and Sortino ratios and everything to try and create a simplified version of what an expectancy profile is. But when you understand what proper expectancy profiles look like, they include everything from probabilities of success or failure as well as magnitudes of success,

success and failure, everything that you would want to know about that trade, including things like value at risk metrics and value at risk on a daily or over time basis. All of that's included in expectancy profiles. I think people get worried or might be the wrong term, but if they say, okay, if it's a 99% expectancy that I should just be naked short the front month fix or something. Yeah. Right. They worry like what if the model shoots that out? I get it that it has a super high expectancy per your models, but it's kind of an implicit like I don't want to trust your models completely. And so I want some other safety

net or risk measure. Yeah. And that's part of what drove us to, to build the positions that we do is we want to be able to say, okay, we can come in and we can say that that role yield trade, for example, that, that everyone talks about that, that, uh, can tinkle role yield trade is positive expectancy by itself to, uh, you know, sometimes to a 99.9% level of confidence. But to your point, I don't want to just pile into that. I don't want to just trust the model. So the best way that we've found to come in is to actually use VIX convexity to hedge itself, which is another unique thing about VIX is it's convex and it can hedge itself.

So we can come in and say, I'm going to trust that model there, but I'm not going to trust it to the point that I don't actually have a hedge that not only acts as a hedge but also becomes the return driver in the big VIX event. And just to put a bow on convexity, it's just it pays out at an increasing rate. Yeah, so the acceleration, your hedge accelerates as it moves. It doesn't just perform like a linear hedging function. Hedges are a double edged sword usually they just become a wash like you put them on and yeah they they stopped your

downside but they also dramatically limited your upside when you've got convexity it's a different story because you can say for example i've built this position that would be for example something of a short ball position. But I put so much convexity on the back end that if VIX were to spike a little bit, move up a little bit, I might be neutral to that. But with enough convexity, if VIX goes to 30, 40, 50, your hedge accelerates. And then you don't even care about your roll yield trade anymore. You're just saying this convexity has, has produced a return driver. And that hedge by itself is now producing not only an absolute return, but a significant

absolute return. Right. Putting it back in the insurance terminology, right? It's like, if you have a life insurance policy, a normal non-convex, it just, you die, it pays out a million. Yeah. This would be like something like the faster you're dying, the more it pays out. The more it pays out, yeah. And so you're looking at it, and it's hard to even consider it a hedge anymore. It's a position in and of its own. Well, it's like the ideal type of thing, something that can not just hedge but pay out beyond the hedge.

Yep. And so that's just at the back of everyone's mind is that VIX spike risk, but you're saying that's what we've covered. Yeah. And we, we were, we maintain a positioning that says we would prefer to assume that we're actually going to profit significantly from the VIX spike. But in the meantime, you know, it's the classic V bottom rally, you know, um, you're in a, you're in a recent one, you're in May of this last year, and the S&P sells off 7% rapidly, right? And you say, great, so I have a long vol bias,

and I profited from that. And then suddenly the market puts in a V-bottom rally of 9%, so it gains back the full 7%, plus another couple more goes to all time highs and vix goes back down to low teens and you're looking at that and saying okay if i properly constructed the position like i'm talking about i will have gained from the spike and then when there's a v bottom rally and vix goes all the way back down i will either be neutral or gain on the on the collapse of VIX as well.

And how do you handle what we touched on earlier, how do you monetize the spike? Because it's the whole, right, if I want to get out at 45 and it could go to 90, it could go to... So for us, we have preset profit targets in our model that are just sitting there. You will not see us chasing VIX to a 50 60 or 70 level okay um you'll be out we'll be out before that because what the acknowledgement is is given the mean reversion characteristic of vix if vix is at 40 or 50 and you're long vol you're in a dramatically negative

expectancy trade at that point yeah so yes it could go to 90 and you're going to be kicking yourself if you bailed on it and it does go to 90, but 99.99% of the time, it's not going to go to 90. It's going to go to 12. And it's not what you're offering investors, right? You're not saying like, I'm going to produce 90% when the VIX spikes. You're saying I'm giving you an absolute return. We're not giving them crisis alpha, and we're not giving them convexity in the purest sense. We use convexity within our model to produce stable, absolute returns over time. We'd like to finish off every pod going through some of your favorites,

some of the back to the personal side. So I think you already mentioned, but favorite Utah ski resort? Brighton with good snow. With bad snow, you stay home. With bad snow, I'll go to a local resort and get one or two runs in and then call it a day. And I didn't even ask you, you moved into telemarketing, or you just no downhill seems like

the longer people ski the more they'll go down that route yeah i i would if i could do telemarking it would be for one reason and i've recently wanted to climb a couple mountains and then and do the ski ascent skin up and then come down telemark style which would be nice but i don't have the skills for that yet if you decide to do that give me a call we'll do skin up and then come down telemark style, which would be nice, but I don't have the skills for that yet. If you decide to do that, give me a call. We'll do. Skin up with you. Maybe. I'll have to start working out.

Favorite investing book? Favorite author, Nassim Taleb. Either The Black Swan or Fooled by Randomness. Okay. Love it. But you had already kind of come to those conclusions before those books came out. Yeah, but I studied his books as some of the earliest that I studied. I tend to be someone who would rather put the personal research into something

rather than taking someone's word for it in a book. And I don't know, does Taleb do VIX? Options in general. Yeah, I know he does. As a derivation, just just you know he he has some great insight into the concept we were talking about earlier if you don't have an edge in options then it's already priced in and he covers that extensively so uh favorite math theorem or proof or concept uh stochastic differential equations um just in general. They're most applicable to what I do.

And I like to get past linear and into nonlinear equations. So when you realize what convexity and everything is, you realize you jump into nonlinear. Can you lay them and term that out for us real quick? Most people, for example example if they did something like a regression analysis which is basically just taking a whole bunch of what what might be random or somewhat non-random plots and then saying i'm going to draw a line through that that most represents you know the the trend or the value i think i did that in college statistics of

like yeah major league baseball salaries versus the player's age or something. Sure. Yeah. And so you do something like that and you get something of what they call a curve fit and it's really easy to do a linear regression, right? So most everybody does that. And most of what you see is that, but a lot, most behaviors in nature and in markets are more complex than just a simple linear relationship. So you get into something that's nonlinear. For example, we talk about convexity, something that actually accelerates or moves through time. And for example, in VIX, there's a concept of what we call volatility clustering.

Robert Engel won a Nobel Prize for discovering volatility clustering. And yet most people don't utilize that in their statistical modeling. And we do extensively because it's very real in VIX. Most people don't utilize that in their statistical modeling. And we do extensively because it's very real in VIX. Volatility does cluster and it's autoregressive. That just means like this past week of like there's none, there's none, and then it's a huge bout of volatility all of a sudden. So layman terms is calm produces calm and chaos produces chaos.

So if you were to look back over the history of the markets you'll notice these clustering periods where the markets are volatile for three years at a time and then they're very calm for three or four or five or six years at a time and you have to utilize that if you don't if you're ignoring that in your analysis how are you going to get a proper analytical perspective there was some interesting research back in like 09 of the song musical and art that people enjoyed it became like more calm when it was crazy in the markets they preferred calm stuff that's very vice versa yeah that's interesting so you look at these relationships and say things are a lot more complex and i like that the financial world is moving toward behavioral finance rather than, you know, we'd gone toward this quantitative realm of thought before that basically said everything was efficient

and everyone acts rationally. And now we're getting completely away from that. It can be modeled on a single VAR number. Yeah, it's so much more complex than that. So the concept of nonlinear equations comes in. And, yeah, so. Favorite Star Wars character? Oh, golly. So the concept of nonlinear equations comes in. Favorite Star Wars character? Oh, golly.

I mean, Yoda. Oh, nice. Can you do a Yoda? I don't want to hurt anyone's feelings on that one. All right. No worries. It's a hard one. You've got to practice it. Yeah.

Favorite, how many national parks you guys got here in Utah? A bunch. A bunch. What what's favorite one i go every year down to the lake powell area which is kind of part of the grand canyon um but i would say that bryce if i had to pick one out bryce bryce canyon's phenomenal i gotta i haven't had the kids out there yet so we'll'll put it on the list. I bought a book one time that was the top 10 places that National Geographic crews would choose to go to, having been there and photographed it. Bryce Canyon was number three, I think.

You'll have to share with me after we hang up here what the first two are. That's it. Again, thanks, Brett, for joining us. Thanks for the great Utah snow. And tell the people where they can find you, website, LinkedIn, Twitter, any of that. Yeah, our website is certezafunds.com. So that's C-E-R-T-E-Z-A, funds being plural, F-U-N-D-S,.com. And they can kind of find at least basic info on us on there.

And I've tried to put out some material in the past. I don't do a great job. I tend to be stuck researching a lot. I know. I'm pushing you to release more of that. So hopefully we can convince them at dinner after the pod to release more research. They start telling me I should tweet because my insights are somewhat relevant on the vol environment. So yeah, you can save one person from just buying a fix naively.

You'll have done your duty in the world. Great. All right. Thanks, Brent. Thank you. 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.