The Derivative - The World of Equity Hedging, Part II with Jason Buck

Episode Date: July 13, 2023

Jason Buck is back in this follow-up, Part II episode rehashing all the goings on at Global EQD '23, and he's continuing the conversation on equity market hedging, not to mention interest rate, currency, and more hedging – plus volatility markets and investment strategies with host Jeff Malec.  Jason and Jeff discuss what was discussed, including the influence of Fed policy, abnormally low volatility in equities, cross-asset volatility, and the relationship between skew and put options. Tune in to discover the risks associated with high-frequency trading (HFT) firms in the zero-day-to-expiration market and gain insights into balance and risk management.  Explore supply and demand dynamics, black swan events, and the perspective of market makers. Gain valuable knowledge on the interplay between institutional and retail traders, the importance of diversification in building portfolios, and the comparison between systematic and discretionary approaches to investing — SEND IT! Chapters: 00:00-01:31=Intro 01:32-10:07= Leaders in Vol – Monetizing Vol, Skew vs puts & commodity Vol can’t be suppressed 10:08-26:00= The volume of ODTE options & when retail flow becomes toxic 26:01-32:55= Complexity, probability & path dependency: Building a resilient portfolio 32:56-48:43= Systematic vs discretionary, the importance of dispersion 48:44-58:54= Fixed income factors and a panel too short In case you missed it: Check out Part I of this EQD Breakdown here! Follow along on Twitter with Jason ⁠@jasoncbuck ⁠and ⁠@MutinyFunds⁠ for all updates and also check out the website ⁠mutinyfund.com⁠ for more information. Don't forget to subscribe to ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠The Derivative⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠, follow us on Twitter at ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠@rcmAlts⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ and our host Jeff at ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠@AttainCap2⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠, or ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠LinkedIn⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ , and ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠Facebook⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠, and ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠sign-up for our blog digest⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. Disclaimer: This podcast is provided for informational purposes only and should not be relied upon as legal, business, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations, nor reference past or potential profits. And listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. For more information, visit ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠www.rcmalternatives.com/disclaimer

Welcome to the Derivative by RCM Alternatives, where we dive into what makes alternative investments go, analyze the strategies of unique hedge fund managers, and chat with interesting guests from across the investment world. Hello there. Hope you all had a nice Fourth of July holiday and are ready to get back into the swing of things. Speaking of fireworks, trend-following royalty Jerry Parker threw up some fireworks of his own today, announcing a new ETF he's working on, trading over 300 markets via trend-following.

So we're going to try and get him on next week to talk through what that looks like. Go subscribe today so you don't miss it. On to this episode, we're dusting off the second part of our EQD conference breakdown with Jason Buck for today's pod. Jason and I talked through what was talked through on all things equity hedging, interest rate hedging, institutional trading, and more. Send it. This episode is brought to you by RCM and its Guide to Trend following white paper. How do they do it?

Why do they do it? When does it work? When doesn't it? Guide to Trend is a great complement with managers, performance, and more. Go to rcmalts.com slashts white papers to check it out and now back to the show so the last this was tough because i wanted to say like that lt panel was my favorite one but then our guys cory was good on that panel and then this panel is typically my favorite with some all-stars here um so this was leaders in volatility and talking about monetizing dislocations globally so it was uh natalie reed of sebo

which i still call cboe i'll get around to it eventually when you guys changed it uh and that's will bartlett ceo of parallax robbie knopp uh head of s&p options trading at optiver vishnu of volar capital management who used to be at Citadel, and Chase Mueller, I'm not sure, head of Global Macro at One River Asset Management. So a couple billions of dollars there on stage, and actually the people who actually make the decisions for those billions of dollars. I'll leave that be. But yeah, give me your quick thoughts on this panel

this was the same crew last year i believe right you might have fairly close you had um you had uh it wasn't robbie from october you had the uh ceo i can't can't recall his name right now and wasn't vishnu it was ben eifert oh yeah chase was on the panel or not yeah i think it might have been this but ben i have I couldn't say Chase. I have a few pages of actually anecdotes that we can kind of go through. And right away, actually, they started with a poll on this one. What is the biggest risk the audience felt was in volatility markets or that could affect volatility? It was Fed policy was the.

Yeah. And then Vishnu came right out and goes, OK, I'm going to stop hedging that since these polls are obviously typically wrong. Yeah, exactly. So Chase jumped right in because I think second on that was like debt ceiling and default. And he said markets are looking through the risks and they don't seem to be concerned about default as they're looking at even cross asset volatility is everybody's like, let's just get this Alvore thing and keep it moving. But Vishnu came back with, you know, you have to look at cross asset vol for some asymmetric hedges. And so, you know, you're taking basis risk when you're looking cross asset vol. But, you know, we work with some managers that do that and everything is because sometimes, you know sometimes maybe you can't find the cheapest asymmetry in equity vol, so you have to use a little bit of cross-asset vol to find those. But there's risk there, but if you spread your bets, it might be a decent idea. Will came right out with saying that 2022 was an aberration in low vol for equities.

I thought it was interesting to call it an aberration for 2022. And so he was saying is the equities turn. So it was almost like flip. I like how Will tends to flip things around. It is all we heard about in 2022 is equity vol is suppressed and rates vol is taking off. And then so almost like we were saying earlier, so everybody's kind of jumping on rates vol or looking for that cross asset ball and uh will was kind of like

maybe it's mean version like he felt like equity ball had been suppressed in 22 um maybe moving into second half of 23 do we see you know equity ball picking back up is it is is it equity balls turn to yeah that was his line which was funny? Like they're kindergartners getting a turn. I think it might be equity vols turn. Robbie had some interesting stuff talking about, obviously he has a very unique view working at Optiver, at the market maker and options. And why SKU was poor in 2022 was like we talked about earlier, like reduced exposure by real money institutions.

Everything was like scheduled macro data, right? everybody's just waiting for like cpi prints so those really kind of like just like one day vol and then he brought up um you know which was one of the other main themes is that structured product flow um and how structured product flow can kind of reduce uh especially skew with people you, rushing for any sort of hedges. And he said, you know, ball was, you know, you know, supply of ball was on down ticks was just fine. What they said is, oh, is how you've had a bit of reversal coming into 23 here where, you know,

skew got crushed in 22 and we saw the return of realized ball or just long gamma positions where he's saying in 23, we're seeing realized ball come down and implied skews start to go back up um but at the same time he said still short skews trades have been profitable this year so it's a little bit of a mixed bag there um but that was interesting kind of his perspectives and i think i asked you during the panel of like they use skew probably in a the correct professional way and my brain is not the correct professional way but right they were using SKU kind of interchangeably with puts in my opinion right so when they were saying like SKU

worked selling SKU this year worked they're basically saying like buying puts last year did not work selling them this year has worked was there anything more to that specifically you say like out of the money puts right like that's where you're going to see the SKw the most is more in your out-of-the-money, deep out-of-the-money puts. As we know, those people that were just buying deep out-of-the-money puts as protection got crushed in 22.

But then we're seeing a little bit of skew come back. So it's a bit of a trade-off, right? If you're buying those deep out-of-the-money puts, you're getting crushed on skew coming in. But then as skew picks up, you're making a little bit of money on those, but it might just get crushed back again. You know, you don't know if this is actually when you're going to get your payout or you're just getting kind of lulled into like a teeter-totter or a whipsaw when you're buying that kind of out of the money SKU. And then these guys got into the zero DTE a little bit as well, but mainly saying they're kind of on the fence they didn't have a strong opinion one way or the other yeah i have uh notes on that before i get there let me just skew ideas is like vishnu pointed out also that that paradox that you know skew is higher in bull

markets so as we're as we're rushing out of bull markets you tend to get a little more feet where people buy a little bit more protection right where you're saying like we were talking about that uh telegraph 2022 you know drawdown or recession or whatever you want to call it is like you actually have skew coming in and it seems counterintuitive um but he's seeing institutions you know implement a lot more call spreads these days um he said you can make money uh long skew and a grind up uh it's just a little bit more difficult. What's interesting, Chase brought up that he feels that VIX looks relatively cheap compared to rates fall. So that one's quite the basis trade that you'd be looking at.

And I've seen a lot of people starting to buy calls on VIX. But as we saw, implied didn't do as well in 22 that people expected it to do so who knows like maybe will said it's maybe it's vix turn as well i don't know yeah that seemed weird to you that he's the pro quoting vix right seemed like a retail-y thing kind of the same um yeah and you still have some pros and i mean you've had like rougher that was like um you know they'll they'll take their shots on vix calls you know in the past that's where they've been 50 cents so you know, they'll take their shots on VIX calls. You know, in the past, that's where they've been 50 cents. So, you know, it just depends on how large you are. And I think Ruffer is almost 30 billion-ish.

So that gives you an idea. But it's also, that's not fair to say 30 billion-ish because, you know, they have some, you know, tail risk and long ball positions. And they usually use upwards of three different trades. And so VIX calls might be a small position in that, you know, relatively the overall size. One,

another one of the ones that before we get to zero DTE is that Will said that a commodity ball looks attractive because the Fed can't suppress it. Yeah. I had that as well. And so I think people have been talking about commodity ball for a while. And I think even Will has been talking, he was talking about commodity ball last year, but I thought that was an interesting anecdote they threw

in there at the end because the Fed can't suppress it. So that was an interesting way to think about commodity ball. So getting to zero DTE that you brought up. Real quick on commodity ball, that's like the mother of all basis risk, right? Like, okay. Yeah. Right. Like, I don't

even know where to start with that. Like copper, one of those like oil, I guess, but yeah, I think in this sense, like, I don't think Will's worried about basis risk. So we started talking about like VIX calls and everything. We talk about basis risk, but I think, uh, Will and Parallax is just, they run cross asset ball books and they're not really hedging against S&P, so they're not worried about the basis risk. They're just trying to make money in commodity vol. So on the zero DTE front, Ravi was talking about that the liquidity allows for cheaper transaction costs. And he finds that HFT firms are starting to enter the space of zero DTE. And they're

selling spreads based on backtests, which is always a pause for concern. And it's that idea too, is like, if you look at any sort of longer term systematic backtest, everybody's gonna tell you like 85% plus of options expire worthless. So should sell options i mean but they don't get into well what's the price you're paying what's your tender etc but if you take that to the extreme well if i can sell options on a daily basis i'm just compounding more effectively you know or quicker over long term so i think that's what we see a lot of um but also say is is doing the spreads? ETFs? Robbie said that I think maybe the HFT firms that he was coming in were the ones.

HFT, high frequency trading firms. But he sees very balanced risk, which was kind of a theme we kind of heard throughout the few days. He said that you see more trading balanced risk, but then they're raising the risk limits. He felt that you see more trading balance risks, but then they're raising the risk limits.

So he felt that it was fairly benign and fairly contained in a balanced market. And he said he had an interesting way to look at balance, right? He said it's balanced with volume, with liquidity. And I'm going to forget the third thing. Like, what's his name? Don't ever hold your fingers up. But they don't just look at it like, okay, the order book's balanced. They're looking at it.

He said they did a deep dive, did this research, went across volume, liquidity, and whatever the third one is, and saw no disruptions there. And then I think you might have misnoted that because I had the note of him saying, ever since the zero DTs have come out, they haven't had to adjust their risk limits once. So basically saying as a market maker, if you're scared about all this stuff, we haven't had to like have a special meeting or had like, Oh my God,

the risk is all out of control one time. Basically saying like everyone calm the hell down. Like this is just normal operation for us as a market maker. It's a new toy. It's a new tool, but the balance is there. And that was the key, right? Everyone's worried of like, oh, if this thing gets out of control, which is always weird to think about, right? Because everyone that's bought is sold and

vice versa. But I think they mean the balance. If everyone bought them and just the market maker on the other side, right? And then the market pins at that thing and the market maker has to cover that so it could cause this liquidity cascade. TM, Corey Hofstein. But he's saying, no, it's balanced. We're seeing client flow on both sides of the order book, of buyers and sellers, so they're not nervous about it at all. Yeah, it's a good way to point out

that the balance risk is more like the gamma effects of the market makers trying to lay off their risk. And thank you. That was a function of my notes. So I couldn't read my own notes. So it has said trading more, and then I see raised risk limits. But then after you said that, I realized I wrote haven't, but I couldn't. I was like, is that honest? What is that? So yeah, like you said, they're trading more, but they haven't raised their risk limits. So that was, yeah, that was a key point. And like, so so as you know i i'm having a really hard time reading my notes but yeah so like robbie you know being co-head of smp options training at optiver as like a market like i would

uh he would have the most interesting things i would think to say and the most expertise and like zero dte options but then the the second order effect of that is like what is he saying on stage versus what is he saying on stage versus what they're saying privately? So that's the only caveat I'll give to it. But like, if I want to hear from anybody about zero DTE, I want to hear from like Optiver. Right, not the person like creating a gamma model

based off publicly available data and whatnot. Like, here's what's happening. There's a huge gamma squeeze going to happen. Like, no, this guy's living it every day. Probably many multitudes of capital personally at risk right as well as the firms at risk so yeah i agree with you 100 of like that's i would trust his opinion above all else um but then the other guy i think they all basically said like yeah we trade it but no one was like it's the best thing ever we're making tons of money we're doing zero dte it was just kind of like yeah it's a new tool in the toolbox right do you get a different

feeling um yeah for the most part and i'm just trying to think i'm looking at some of the other notes from like will and chasen i love you know will's not afraid to uh step in and push back or be contrarian but he was saying like he's like basically everything's gotten shorter term you know all life and trading gets shorter and shorter term you know whether we you know watch used to watch two-hour movies to watching 20-second tiktoks like so he was just kind of saying everything's shorter term he's and they use it as a tactical compliment to other things they're doing like you're saying they're they're like barely using them um he said the implied volatility looks cheap to the realized volatility on event spreads. But he was also

saying, this is what I thought was interesting, he said he felt the transaction costs were high relative to the vol exposure that you get. So where Robbie thought that the liquidity allowed for cheaper transaction costs, I think Optiver is going to have a very different perspective than Will's going to have

kind of from market maker to buy side kind of. And so it was interesting that he felt their transaction costs were too high. That's why they weren't using them, but more as a compliment. And he said it actually surprised him how successful it was. So he had an honest admonition there that like he didn't think that zero DTE was going to get the volume that it has or grown over the last year. And so he said he's been generally surprised by that. Chase was saying that like he, this, that I shouldn't write this down because it's like confirmation bias for me, but he says it's not cannibalizing the one to three month trades. So you didn't see, you know, vol has been, I mean, sorry, volume has been coming down in like the one to three month trades and volume has been rising in the zero DTE, but he's saying they're not related. The volume in the zero DTE has nothing to do with the volume in the one to three months. Which is, yeah, everyone else is saying like, so it's just purely coincidental that it's in inverse lines, right? Which seems weird, but you would know.

Well, it also starts with though too, it's like, do you think? Which seems weird, but you would know. Well, it also starts with though too, it's like, do you think who creates the volume, buyers or sellers, right? And so for me, the zero DTEs is just people wanting to sell zero DTEs. And so, and we've always, everybody's been saying it's like retail buyers, et cetera. But like, is that really true?

I'm not so certain. Like who creates the supply and demand? Sometimes it can be inverse. And shout out to uh chris city all ambrose they wrote a paper about the zero dt if you want to go look it up and that's what their research have found as well is it's more um institutions or hedge fund selling and not necessarily retail trying to punt on a uh basically you know a directional play on a daily basis um and then i had the note but i can't read my numbers there of his example right of the or maybe i just wrote an example to help me think about it of that the vols expensive right was basically like if you're paying

right chase was thinking like you pay only two percent spread or whatever the number is maybe it was 50 bps or something. But Will's thinking like, okay, I paid 50 bps, but I'm really only realizing 1%. I'm getting 2 to 1. If I have a three-month option, I pay 50 bps, basically the same spread, and I can get 15% realized. Then I'm like 30 to 1. So that's where his mind was of like okay but you're kind of expensive for the realize you're going to get in that day like how far is one day going to go is the ultimate question yeah mind me the uh arguments i used to have with you about like the

tick size for vix contracts yeah even sm even s&p did somebody else doesn't matter sizes for s&p too like at one point i think maybe it's in my notes for later yeah um will also said that you know a black swan event can and will spike fall but he's like nothing on the radar because i think somebody had a question about black swans and like you're like we're both like tautologically like you know they're like tell us what black swans come it's like you can't that's why it's a black swan um so what robbie said though is the black swan especially Right. So what Robbie said, though, is the black swan, especially for zero DTE, that that was a lot of rumors going around the event was the proposal for intraday margin could exacerbate balls with rolling margin calls.

So that's the other reason why we've seen the rise in zero DTE is it's a it's a function regulations. It's like you don't have to post that much margin for these intraday options trades. And that's why people have been really pulling them off in size and why you see that volume increase. But if they were to move to intraday margin requirements or raising those, that's when you could just see, like you're saying, it's just a cascade of margin calls. That would be a systemic risk to the zero DTE space. But is that a cascading risk to the systemic financial system is a whole different ball of wax or topic of discussion. And then that didn't even make much sense to me because if you're

out each day, there shouldn't be margin calls, right? You just put on the margin every day. So you just wouldn't put it on the next day. Yeah. It's just, but if you're intraday, if we had a movement and they got margin called and the buffer, at least on the market makers, right, you could have a cascade of like bankruptcies, basically. I was taking it to mean there's this like 30 billion in zero DTE volume that has a margin associated with it, which is true intraday, but not true day over day. Right, correct.

And then if the regulations come in and take that away, that margin goes away. We're saying as it would be applied intraday yes it would exacerbate and cause which would be we wouldn't put it beyond our government but right which would be dumb like hey we're going to try and make this safer and we're going to add basically circuit breakers that make it worse yeah and so you're right there's countervailing forces right going in the next day it you know you just don't put it on the trades but everybody gets wiped out in that day so that's the kind of the issue there um and then chase just pointed out there's mainly been massive isolated ball events throughout the

last like year and a half it's like more like one day kind of events so we've seen those spikes and balls but then it just mean reverting just as quickly yeah and i wrote down contagion were they going into contagion like until we see right those isolated events haven't bled into right they were in bond ball they didn't bleed in equity ball they were in like the ruble in the beginning of the year it didn't bleed into equity so the mat and i think it was vishnu bringing like, yeah. Am I on the wrong panel there? But yeah, the... Yeah, that's fine. Yeah, right.

He was bringing up like until you're not going to see a big blowout and vol really spike until there's multi-asset contagion. Correct. And then what makes that happen is the billion dollar question. So once again, though, too, we're always trying to decipher, you know, on zero DTE, how much is like retail non-toxic flow versus like toxic professional flow is, is Robbie pointed out, this is what I love too, is like, he said so much, so much of it trades electronically. It's hard to decipher these days between retail and institutional. And I thought that was a great point

because like you said, everybody's selling, you know, their products for how to decipher between retail and institutional and gamma positions of market makers but then you don't know what's in dark but like there's just so much unknowns there that i thought that was a great pointing out that with the electronic trades and then not only you and i've talked about this many times is not only the electronic trades but then electronic algo execution trades for like hiding with icebergs etc it's like it's hard to know if that you know 50 lot trade is you know or five lot trades retail or if that's institution just trunching into the trade and then we talk after the event or somewhere in there like it's funny to think of right retail

flow is usually non-toxic in the market maker world right they don't want to get in front they don't want to see an order get in front front of it. And then it's some institutional player that can come 10x the size over it and cause them a big loss. So it's in their benefit to know who's retail, who's institutional, so they don't get in front

of the wrong person. You had an interesting point with these zero DTE that when does retail's non-toxic flow become toxic? This was even in meme stocks and they were tying in meme stock a little bit stuff is there well like it builds this momentum and then the non-toxic flow becomes

toxic flow because they're moving on the same direction at the same time yeah as soon as they as soon as they in an aggregate and in correlated nature moving the same direction at the same time that's like nuclear toxic or something like it's just a whole other level it goes from non-toxic to just like get the hell out of the way and shut down just flip sign immediately like and then i asked the question at the end i was gonna tee you up i was gonna see you up but like i was just saying for like um like vishnu was saying like uh like going back to what you're saying about this anyways he sees that cross asset correlation is where we could see a potential like black swan is like once again if we see yields down stock down potential world um you know like back in march that that can be an issue um so then that what sorry but isn't that interesting you two panels

are like if we see yields down where they say yields down stocks down yields up stocks down no he's i think i think vision is saying like rates down like yields down stocks down yields up stocks down no he's i think i think vision is saying like rates down like yields down stocks down okay i was coming from the same point like we just had um bonds down stocks down so if everyone's like oh that would be a big black swan thing if we then like we just had it how could it be unexpected everybody's position for that's what i'm saying everybody's position for the previous like he's saying going back to the previous like few years ago like our last few decades where everybody's positioned the opposite now i think it was what vision was trying to say because of that cross asset correlation flipping again um so then it was question time so you got

in uh a great question so i'll tee you up for that one that was uh you're showing your uh your big brain memory from from last year with will uh you're gonna tell them what my handle was in the question app yeah oh what's up with the moss wasn't that your question there were some butterflies slash moths that were uh plaguing vegas two or three of them full bloom yeah in the wind uh place but yeah my question was like last year and they kind of misconstrued it so we will get to clear it up here that's why you have a podcast um so last year there was a lot of talk about dispersion doing great dispersion doing great this year zero talk of dispersion uh and a lot of talk about how gamma had done great last year that was the part they missed right and so

my question was like hey last year we were talking about dispersion doing great nobody was talking about the gamma trade which is like at the money don't rely on a vega pop rely on it uh approaching your strikes so question was simply like last year we're talking dispersion no one talking vega this year we're talking or gamma this year we're talking gamma no one's talking dispersion what's what's next you're going to be what are we going to be talking about next year that we didn't talk about this year um so they misconstrued the question and thought i said gamma is working this year and they're saying no it's not working so far this year uh the past few months hasn't seen gamma working at all but will jump back in and took jumped on his sword and said like yeah i called

last year that dispersion was going to blow up. Way too much money in it. Way too much excitement about it. And that correlations are going to unwind and it's going to be a pain trade across a lot of firms. Didn't happen. I'm going to double down. He's like, it's still a big risk.

I still see it having problems. He said they're still involved in it. They still trade it. But he sees a big risk in that still see it having problems. He said they're still involved in it. They still trade it, but he sees a big risk in that dispersion trade as well. Perfect. That's the end of day one. Day two started off with Tom Lee.

Keynote, forecast or forge, building resiliency in a risky world so it's tom lee cio of parametric um talented public speaker i like to style um kept this all engaged and a lot of we could go way deep on this but we're gonna keep it high level but you know everything you're always talking about, complexity, emergent behaviors, had some interesting stuff on probability versus confidence. And an option needs to know not just the probability, but also the confidence and how the confidence brings in the second order. The first order of uncertainty is just the probability. The certainty brings in the second order of probability, which is the

range of probabilities. Like, okay, here's the probability, but what's the probability that this thing actually happens way over here? So the range of probabilities. And he was kind of bringing that back to build a resilient portfolio. You need to think about the range of possibilities, which you would call paths, right? And think about those range of probabilities, the path dependency, and build a resilient portfolio that can exist and not get blown out and think about those range probabilities the path dependency and build a resilient portfolio that can exist and not get blown out in each of those range of possibilities um so his how do you build a resilient portfolio diverse liquid attentive to cost cautious of complexity which was sort of interesting but then he went with like like a core satellite approach

like everyone knows that thing. So he lost me a little bit there of like, you had all this great stuff. And then he went with a simplistic example. So, and then the other interesting thing, and then I'll let you go in here is he had this pyramid of basically investment products at the top was pure alpha,

right? That gets charged two and 20. Next was hedge funds that are basically still 1 to 2 a little bit less management fee but still 1 to 2 to 20 uh then alternative beta which gets down into your 50 bps to 100 bps then indexable alts which get down to like 10 bps and then market beta which we know like spy which is down less than 5 bps and then market beta, which we know like SPY, which is down less than five bps. So it's kind of this interesting as you, that products and strategies kind of move down this pyramid. So 20 years ago, we might've thought a simplistic carry strategy was alpha and kind of now you can get that as a alternative beta. So it's moved down that thing. And then even 50 years ago, we would have thought

owning all 500 stocks in the S&P was maybe some alpha, maybe indexable. So that's moved way down the chain. Yeah. And he basically was saying to protect against moving down that chain, managers add complexity and they add all this stuff and you have to be careful of, is that complexity just to protect their turf and not move down the pyramid or is it actually to provide resiliency? Man, unfortunately, I was in a coffee meeting this morning, that morning, I would have enjoyed that talk, it sounds like. But what has been interesting to me is it was also a side theme throughout this where it's always the conversations about alpha and beta.

And these conversations like fascinate me. a side theme throughout this or it's always the conversations about alpha and beta and you know these these conversations like fascinate me and in part of the the rub i think i always see between people um i think corey talks about this often as well it's like the idea is alpha is unexplained beta but most traders or managers have to have an explanation for their alpha so like they kind of preclude each other in a way it's like or most people don't want to like take the rentax style alpha if it's unexplainable because they want to have an explainable uh strategy and thesis to their investors yet we're saying alpha is just beta that hasn't been explained yet so it's just an interesting like it's like uh what's the uh you'll know the term but like once you notice it it's gone basically so once you

once you explain your alpha it becomes beta yeah yeah and then he had an interesting with managed futures he had an interesting thing of like an example of adding complexities like to protect their turf a lot of trend followers managed futures added complexity maybe they added some long only they added equity tilt they added things. That resulted in a lot of tracking error versus the fictitious managed futures beta. And he brought up, which you've talked about, ad nauseum of like, okay, this dispersion between every year, the top, the CTA index, the top guy to the bottom guy is like, he quoted, I think seven percent uh dispersion we've seen even larger than that my pushback on that would be hey if you know what's going on underneath the hood this one's an energy trader this one's a short-term quant trader this one's a long-term trend follower that it's not as easy to just say they added complexity that's why there's dispersion to me it's like they're doing massively different strategy types and they're just poorly

categorized and lumped into the same category but you even see that in the stock trend index similar dispersion so it is there but that i yeah i just kind of argue back with that of like is that adding complexity for the sake of protecting their turf or are they adding complexity to to be the best they can be. Who knows? Even if they're doing this, as you've seen over those decades too, even if they're doing relatively similar things,

the divergence can still be wide, right? Just different lookbacks, different trading time horizons, breakouts versus crossovers. How do you define a breakout? All those things matter over the longer term. And then one of the questions by someone someone i think whose handle was mothman in the uh question was how do you think about whether added complexity is worth it or not so he didn't quite have the time or thing to get into that but he's kind of saying comes back to understanding what it's doing, understanding,

is it complex for complexity's sake? Or is it complex to the average person? Or is it complex to you? Which was interesting, right? He's like, okay, one man's complex is like, oh, option scary, which we actually heard on some of these other panels. But right, if option scary is complex, well, hey, I understand these options inside out. This isn't complex to me. Therefore, I don't think adding options overlay or something to a portfolio is adding complexity for the sake of complexity. Yeah, if I go pop the hood on my car, it's going to be incredibly complex to me. Even if it was an old car that somebody could figure out pretty easily how to work that mechanical system, I'm going to be a complete moron and that's going to be overly complex to me.

That is a great example and apropos to me because i would be in the same boat of like what this looks like the uh engine block um to me like a microwave is nothing but magic to me so i mean again it works what a great invention what do you think is more important for society the microwave or the refrigeration oh i was definitely refrigeration i was even i thought you might go ac because that's like what changed you know yeah any sort of equatorial country or the south but same technology right so the right ability to cool the air instead of the food um next panel was you done with that you got any other thoughts on forecast or forge but yeah I thought you'd like that because that read a different way of thinking what you

call path dependency and covering all paths is resilience right creating a resilient portfolio yeah unfortunately I was at a coffee meeting and I was making plans to meet up with Jem in Istanbul so unfortunately I missed that one next panel options block liquidity how institutions will benefit from the technology of tomorrow um this was super in the weeds super inside inside baseball, right? You had head of Citadel Securities, was it?

Yeah, so it's like, is this a panel when the moderator, Jason Rolke at Citadel Securities, and then when the panelist is Dave Silber at Citadel Securities, and then you have Rob Wilkis from Waratah Advisor. So yeah, it was very in the weeds about, you know, trading options block and liquidity and everything. So I just had some anecdotes and then you can add to it. But it was interesting,

actually, Jason, the moderator actually was even jumping in more than any other moderator because I was a smaller panel. But he was saying he thinks that institutions follow retail traders and options. And I was like, that's, that was a hot tip that he didn't necessarily expand on. But he also thought that, like I said, these are more anecdotal, but that dispersion is down to like two weeks. So they're seeing the dispersion really take effect over a shorter time horizon than, or I guess depending on who you are and your time horizon might be shorter or longer. But he really pointed out that two-week mark.

But what do you mean there? Not the dispersion we were talking about with a dispersion trade of the... What do you mean on the two weeks? I thought he was talking about dispersion trade on that, more like the two weeks is where you're seeing the most dispersion between index and single name. Oh, he could, yeah. One of the other things, almost like he pointed out too, is that he feels like there's

extra liquidity in single name options compared to their underlying asset. So that would be almost a Jem Carson, like tail wagging the dog. So he had like those counterintuitive things where like institutions are following retail and that the options are more liquid than the underlying reference asset that they're overlaying. So that was a, and then this was just pure anecdote, but he's like daily volume at the OCC is quote unquote astronomical. Astronomical.

Yeah. So I had jotted down that the options execution is basically just catching up with the rest of the market of what we've had for years and years in single name securities and even in futures. So block orders on the screen, algo execution. And the Citadel guy was kind of saying like institutions sometimes still have to call. They have to wait for an auction to get made. They have to wait to see what both sides that are and the advances are going to be.

That all happens immediately i think he was even saying like a bloomberg plug-in that could be possible where you're seeing your auction inside of bloomberg um there's a little bloomberg hating there of like hey we all right we know we all use it we know we all hate having to pay the price um and then they dropped this little nugget unintentionally i think but that citadel securities has compounded volume at a growth rate of 80 a year since 2020 and that 70 of the volume is done electronically through them 70 um so yeah moving towards option auction automation and that was it less clicks less friction right

there was kind of interesting like bringing it back to retail and amazon and they're just trying to get to less clicks oh yeah and then i had the same thing retails the tail wagging the dog institutions following retail in if retail causes the liquidity to increase so i had that if right they're following it in if when retail comes in the liquidity increases so it's kind of coming back to that like non-toxic turning toxic right so if they're seeing it kind of concentrated movement they're now switching sides and they'll follow it in uh and then he also said the large increase in leaps volume, especially in rates. Yeah, I mean, I think you'd see longer out rates in general

than you would see in any sort of equity. Yeah, because your liabilities are going to be longer. Yeah. Moving on, we had equity and systematic strategies in the new regime. I think we'll both politely say this was one of the least interesting ones to us. Is that polite enough? actually does matter. You know, we think sometimes the host is like inconsequential, but maybe driving the direction and arc of a conversation and tying things together might be, and I'm not saying this was the case in this scenario, but I was, it was just making me think about some of the panels that were kind of just more, you know, people just whipping back and forth anecdotes and no real follow through or conversation. Yeah. And I think it was kind of

set up to, it was a of mis- set up too. Some of them were just doing long only, some were doing income strategies and equities, so it was kind of big, simplistic, I don't want to use that in the wrong word, but quantitative models that are doing not advanced

option whatnot or whatnot, but how many securities to own and which securities to own. They did get into a little bit of like back testing yeah that was the only interesting part that i had some notes on yeah and one of them said back testing they don't mind the shorter back test and that a human is needed to judge the length and the approach to back testing yeah that was uh linus at um blackrock was talking about how human sensibility has to see the parts that the back test doesn't make sense, right? Or that was outside the parameters of the back test. And then related to that is like, you know, we've talked about this many times before, like systematic is about, and I think this was from Sharon, she was saying systematic is about creating a low-cost automation of emotional fundamentals. So when everybody goes, are you systematic or discretionary? It's like, well, every systematic rule had discretionary emotions embedded in it.

Right. And so you and I have talked about that many times. Yeah, automating what a good fundamental manager would do at scale and at cost. Right. And then Beryl followed that up basically, too. yeah what automating what a good fundamental manager would do at scale and at cost right and then barrel followed that up basically too is yeah we're we're rules based at newberger burman but um but in the inputs can be emotional and i thought that was another interesting way of putting is like you can have emotional battles about the inputs but then it's all rules based

once you get those in there um and then they're also an interesting point that their models look at the current market signals and not historical so i took that to mean they're not saying hey every time the market's down six and a half percent it rallies x percent and that's what our model's working off it's just when x indicators above y indicator we're getting into those i think it was more fundamental than that of like if the price to earning is x we're getting in and then i'll i won't name names here but i had this someone up there said they take some liberties in adjusting the models based on the macro environment and i just wrote down wtf so it's like what that's like to me quant 101 i'm like no you don't adjust the models based on what's going on. Because how do you know, right?

You just picked up the paper or you listen to a podcast and you're like, oh my God, this SVB stuff is terrible. Sell everything. Take some liberties. I wonder how much that is part of the zeitgeist though, because I think about how many of our potential clients ask us that similar question. And so maybe that's what they're using as a narrative for their clients is that they're attenuating their rules based to the macro overlay.

They're smarter by half. They're just throwing that in there, even though they don't do it. Yeah. I don't know. I just, that's my, uh, my dubious questioning of that, but like, that's I, cause I just hear that more and more often these days. So it just, I don't know if that's kind of in the ether. Um, and then, uh, Linus also said they use options as a smart money indicator.

So I thought that was kind of interesting, but most of this stuff was very, whether it was BlackRock Systematic or Vanguard, it wasn't as interesting. Yeah. So moving on, we had the next one was. This one should be good a combination approach to building a diversifying strategy portfolio with roberto croci jim's brother just joking um newton joe elminger powis for joe grant and ryan lobdo so i had stepped out here so i'm gonna let you and flew home thank you and why i said it was interesting too is because uh obviously grant jafarian uh famous chicago trading family that you know well uh ryan uh lobdell works at makita uh with my buddy jason josefiak um especially on their rms strategies

their risk mitigation strategies um and then powis works at uh Group, but I think he's in a separate division from Roxton. But I was like, yeah, when Powis is on there, it's always interesting. So I have a lot of anecdotes. But, you know, basically, Grant was like talking about how trend following has evolved a lot over the last decade, mostly how managers have moved much more towards long term, like six months plus, with the addition of carry and beta. So as you're saying, as managed features evolves and people want to add carry and beta to provide better return streams, but the actual trend piece has moved much more longer term signals

like six months plus. Do you think you've seen the same thing in the last decade? I mean, especially during that lull of the 2010s yeah definitely if you wanted to survive was go longer term add add beta yeah and and or carry much to a detriment in some cases like okay are you going to perform in a 22 when that happens which most of them did so i think that's what's lost in that conversation like oh you're adding these dangerous pieces You're adding this dispersion from the true trend following right But there's nothing to say they can't turn those pieces off or like when trend comes fully back like they can be dynamic and switch Around but that I can use the macro environment as an open. Yes

They can take some liberties Joe as an opening to it anyway. They can take some liberties. Joe had an interesting point about the Wimbledon trade. I don't know how much you know about that one. The insurance? Yeah, the tennis tournament, how they were basically paying

$2 million a year for pandemic insurance. A lot of people were like, that's stupid. That's a negative line item, all that stuff. But it was based on their CapEx growth. So that was an interesting,

almost like we were saying with whether knowing if flow is toxic or non-toxic is like, you don't know if somebody's hedging their book, but it was based on their CapEx growth. So that was an interesting, like almost like we were saying with, you know, whether knowing if flow is toxic or non-toxic is like, you don't know if somebody's hedging their book, if it's a directional play, you know, what they have in dark pools. Well, now if you're talking about actual businesses and having to have CapEx growth, you don't know that like the hedging

creates a lower cost of capital. So Wimbledon had decided to be a preeminent tournament moving forward. They had to put tens of millions of dollars and quite frankly, hundreds of millions of dollars over a decade into building out their facilities, you know, restaffing all of those sorts of things. So if that are strawberries. Yeah, like all those things are like more champagne and strawberries. So no one likes bleed, but still like it saved their bacon, right? They were able to survive and surviving is the only success. But it was interesting how much that hedge was not necessarily predicting a pandemic, was more like hedging their CapEx spending. So I think that's always an interesting way to think about things where, you know, in options world, you know, everybody can get what they want because you don't realize that, you know, real economic, you know, hedgers, especially whether it's managed futures and options, might be

hedging their exposure to commodity versus refined product versus cost of capital. So you really don't know kind of what's at play there. And Grant was talking about, too, that strategies that offer genuine diversification need dispersion um no there is there is no benchmark and it needs to be uh timing oriented no passive no passive no benchmark and you need dispersion for the genuine diversification that managed futures can provide so he must be jotting down when tom lee was using that as a bad example like oh I'll show you a dispersion. And then Roberto asked, I think, why do you need active?

Why not QIS? QIS, Quantitative Investment Strategies, are basically systematic passive factor investing. So Joe's response with that is, everyone has thousands of bespoke indices. The rules-based doesn't adapt to a changing market so going back to the idea of like a macro overlay or like you're saying even if managed features had on you know carry and other beta trades that they can switch you know the more trend trades or just or just adjust kind of like a uh like a dimmer switch you know how much exposure

they have um what was interesting too like we're talking about that dispersion with managed future trend trend players is like ryan pointed out that um trend directionally correlates but pnl dispersion can be large and so it's best to use ensembles for clients just mic i'll just mic drop that one couldn't couldn't couldn't agree more oh this is where the tick came in. So even Grant brought up that the tick size for E-minis, that $12.50 makes it difficult for the execution costs, right? You have to innovate on the execution cost side. And so he was pointing out that like the HFT and other front-running traders make their execution costs so much higher for trend followers than they have been historically.

So part of a CTA or trend following firm these days has to have a division that's really working on their execution costs and making sure that they can have better execution costs. So that's that bit of that Red Queen principle that we find where everybody's like, well, I can use a trend index, I can do trend at home, all that stuff. But as we know, the firms that are working hardest is actually on the reduction of the transaction cost side and worrying about disguising their orders for the HFT firms. And that's like a big fund problem, right? If you have $3 billion of your huge trend follower, but point taken. And then interesting, I think Qis used to be called risk premium right have we

gotten rid of the risk premium name and now it's qis you saw that popping up too and the factors and yeah it's just all like everything has just a new acronym and everything which you know i i always joke with the guys at makita about their rms their risk mitigation strategies is like the new new version of tail tail risk or long ball yeah um ball or managed futures or commodity. Once again, managed futures, commodity trend followers, CTAs, you know, pick your poison. And then obviously Ryan's, you know, with their RMS strategies, person after my own heart, he said, you need to size the allocation to like managed futures or trend to the payoff you need. Like a 1% allocation doesn't do anything.

And so, yeah, Makita is, you know, advising trillions of dollars. And so when they're talking to large institutions about their allocation size to trend following, you can imagine when they're having those conversations, they're like 1 to 4%. They're like, you know, what's the point? You're actually not doing anything. But that's usually a lot of the conversations they are having. I'll throw out a shameless plug for our guide to trend following white paper that has a whole couple of pages in there on that, which was based on a great work by Welton a bit ago. By a bit, I mean maybe 15 years ago. But it was basically showing, okay, if you expect

6% annual return, whatever, and you want to get to 10, it was just simple math, right? Of like, you're expecting six out of your 60-40 portfolio. You want to get to 10% a year to meet your pension liability. What does this allocation of these alts have to return? And it was showing like at 5% allocation, it has to do 78%. So it was just like, I feel like that's a better way to frame it. I'm like, okay, you're into it. You like the diversification.

What do you think this needs to return in order to do what you want it to do? And they'll be like, right where it's at of the 15%. Like, no, no, no. Then you need 25% exposure. So yeah, kudos to him for recognizing that. But I would love to ask him follow up of like, how many of your clients actually listen and do more than 5%? The next panel was on fixed income factors.

And my buddy, Roni Israelov from Endeavor, formerly of AQR, was on that panel. And so maybe I'll shorthand this. It's like recently, Roni's been making the podcast rounds and I highly recommend his, um, his episodes on resolve riffs and then Corey Hoffstein slurring with models. And Rony really breaks down like corporate bonds and, you know, short deferred dispersion trades. Like he, he, he views like, you know, why being corporate bonds when you're basically long treasury plus risk premium and short to put.

And so Rony can go into all those details. And I highly recommend listening to any of the podcasts he's been on recently, um, because the stuff they're doing in endeavor is very interesting. And to your question earlier is like, they're building LDI ladders for retirees. And I think that's a really interesting differentiating factor for an RIA that nobody else is really doing. And he's just bringing all of that firepower that he, that he's built, uh, with AQR over the years and, it at Endeavor now. And it's really impressive what kind of using the technology and what they're building out there. And really quick, what do you mean by LDI ladder? So you're matching their, I have 200K spend in the next five years, then it's down to 125. So cool. We're going to get

to this income at those milestones. Right. you need when you have those income needs or for other people to be liability needs historically when you're an insurance company but for individuals yeah it's when you need those income and then tying your treasury ladder to the exact income you need so that way you're always just hitting it dead on for all those trunching out the years of your future life especially at today's rates that's what makes that even possible right yeah and then uh a little bit of you know fireworks are trying to you know before i had to catch my flight the last the last uh the last discussion because it wasn't panel a discussion i caught was does the rear rear mirror see the wall ahead with uh mike green from simplify and jim carson from kai volatility

great title and yeah great title. You know, I love a good Kierkegaardian reference, right? That we only understand life through the rear view mirror, except for we have to, we have to drive looking forward. So that's always the tough part about life. So there's a little bit like kind of anecdotes in here. The problem I think actually was, you know, with, with both these gentlemen, they're quite verbose. And I think they gave him like 30 minutes to talk. And so I think they were trying to jam a lot into 30 minutes. So it was kind of a little bit of back and forth.

And so basically the conversation is like, can markets price in a future event? And Jem's pointing out that we had the rise in zero DTE because Vega didn't work and the RV gamma has the realized vol and gamma has worked. But now he's saying the realized vol is dramatically compressed. So there's once again, touch on the zero DTE. Mike was pointing out that the least sensitivity of VIX to S&P moves is like is nobody cares about 30 day vol. And right. And so vix is priced on uh expected 30-day forward variance and he he had a slide i can't remember exactly what he had a good wording of it but it's basically like nobody cares about 30-day ball like kind of like a who gives a

shit um which is counter to the other banner where they're saying no these both those 30-day out and zero dt volume is separate and different. Yeah. And then what Jem and I have actually been talking about for a while now, him and I have been talking about this privately too as well. And I think he's been talking about publicly. He's like, you know, vol, like we were talking about earlier, it's moving to other asset classes and back.

But like we were talking about the historical lessons, right? Like vol gets compressed and then vol explodes and then everybody gets blown out. And then if they rush to buy those hedges, Vol compresses again. And so we just keep going through these cycles over and over and over again, right? Like post 2008, everybody wanted insurance, but that was a good time to be selling insurance, you know, and then until selling insurance does well, it compresses down. Then we have like pops like 2020 like it just keeps it keeps expanding and contracting and usually people are kind of on the wrong side but it's just like that really

historical references like you're saying you have 2017 you had all sellers and then february 2018 you had volume again it pops and then you reverse course again like it just keeps going back and forth the problem to me is the timing there right so like cool i know it's going to revert but if it's post 2020 and that echo remained around for a long time it's like yeah it took too long to revert and i got carried out on a body bag like so you can know it's going to cycle but if the one edge of the cycle takes too long well yeah you can what's the uh you can predict things but not the timing or whatever like you can say directional but not don't give a time frame yeah so you're talking about like you know 2020 everybody's talking about 2020, short of all sitting in equities,

and then currently we're set up for a vol expansion. So once again, that's... But once again, what is the timing? And Jem was just talking about with the debt ceiling and that anything under two years, the market is a voting machine. He feels that liquidity is slim in the tails. So maybe that's also why you could see that, that reversion of,

you know, buying, and this is not investment advice, you know, buying that skew, that deep out of the money skew, like if that liquidity is thin and people just go keep, keep rushing in there,

you know, out of potential, you know, low liquidity environment that you could see that, that deep out of the money tail, like pop again. It made me a little nervous overall that several people were like, Oh, it's getting to be a better environment for that several people were like oh it's getting to

be a better environment for that tail protection like if everyone's noticing it is it really going to be there well as you and i both know it's like it might be a better environment might be what we quote unquote cheaper but it could be cheaper for years yeah and get and get even cheaper than that right so that's the problem right but at least it's not the asymmetry is back at least but you might just still be bleeding out. But better to bleed out 2% a year than 6% a year. Yeah. Mike pointed out that everyone lacks conviction.

So they're just buying calls for upside instead of Delta one, which also might skew other people's metrics on like put call parity, et cetera, and whether the market is bullish or bearish. Which also comes back to Jem's overall thesis that people are moving whole hog into options yeah and jim said the recession isn't the biggest risk stagflation is so i thought that was interesting secular sticky inflation and we'd have like a middling economy um i don't know how much he's i don't think he's been talking about that too much lately so that was that was fairly new um mike said though he he pushed back much he's, I don't think he's been talking about that too much lately. So that was, that was fairly new. Mike said, though, he pushed back, said he's not worried about stagflation. But he is that we were shifting back to that local populism where we've been in a global capital world for decades, or as he likes to call it,

planet Palo Alto. And then he referenced once again that the zero DTE becomes a problem if it gets unbalanced. But everybody was talking about how balanced it's been. And then Mike asked that question again of if the OCC changes those intraday margin

is that a catalyst for that 0DT to blow up and they both kind of agreed that could be the potential catalyst but that was yeah it was a quick back and forth and it ended rather quickly they were trying to I think I didn't write the notes down they were trying to basically go through a lot of history of options trading back into the 80s and 90s. So that's what I'm saying. I think it got too compressed and a little bit jumbled and probably needed two hours for those two to have a good conversation.

They could have had their whole own day, right? Session panel three with Jim and Mike. Panel six. Yeah. And then after that one, I had to run to catch a flight. But then there was another, you know, talking about QIS again. There's a fireside chat, you know, about equity derivatives. And I really wish I would have got to sell the risk management portfolio

diversification in 2023. But once again, I had to catch a flight. I hear you. And you got to go catch a flight now. So ish. Awesome. This has been fun. Thank you. And you gotta go catch a flight now. So, ish. Awesome. This has been fun. Thank you. We'll see you again next year. No, thank you. I appreciate you.

That's it for the pod. Thanks to Jason. Thanks to RCM. Thanks to EQD for the great conference. And thanks to Jeff Berger for producing. We'll be back, hopefully, with Jerry Parker next week. Peace. You've been listening to The Derivative. Links from this episode will be in the episode description of this channel.

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