The Derivative - VIX in the 30s, talking market shocks and VIX spikes with Brian Stutland of Equity Armor

Episode Date: February 24, 2022

With news of Russia invading Ukraine, it was as scary, market-wise, as it’s been since March of 2020 with global stock indices selling off rapidly overnight to send the Nasdaq into bear market territory, SP into correction, and the Nikkei to 15-month low. As the craziness ensued, VIX spiked up to 34 – so we got VIX expert Brian Stutland to come out of his foxhole to provide a unique overview of what is happening in the volatility world this morning and explain why he is so into providing some armor to stock portfolios via the VOL space. Brian's expansive knowledge of volatility comes from his days as a market maker/trader on the Chicago Board Options Exchange (CBOE). In this episode, he shares his insightful perspective on various topics like: What makes the VIX so hard to benchmark, why it isn't tradeable, and how to make it tradeable Where he stands on the newer wave of traders and programs focusing on gamma flows and modeling dealer positioning What he envisions for the rest of the year...is another recession in store? Plus, Brian gives his hottest take on why the Fed needs to take action and not let inflation continue Chapters: 00:00-01:40 = Intro 01:41-10:29 = What a morning! VIX to highest level in a year 10:30-25:39 = Trading VIX Options in the Pits 25:40-37:47 = Replicating the VIX, Does Gamma matter? 37:48-48:45 = Rebalancing the Markets Pops & Drops 48:46-52:35 = Where does Vol go from here? 52:36-01:00:04 = Hottest Take Follow Brian on Twitter @BrianStutland and visit https://www.equityarmorinvestments.com/ to learn more. Don't forget to subscribe to The Derivative, and follow us on Twitter at @rcmAlts and our host Jeff at @AttainCap2, or LinkedIn , and Facebook, and sign-up for our blog digest. Disclaimer: This podcast is provided for informational purposes only and should not be relied upon as legal, business, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations, nor reference past or potential profits. And listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. For more information, visit www.rcmalternatives.com/disclaimer

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, Dark Days here with our Vol Spike topic for this episode, caused by news that Russia was in fact invading Ukraine. We talk financial markets and strategies on here, but should remember that there's real people in real danger out there. So our hearts go out to all those in the path of war and the human tragedy that will unfold over the next several weeks or months. It's not going to be easy. For today's

pod with VIX shooting up to its highest levels in a year, we phoned a VIX friend, so to speak, getting Brian Stutland, CIO of Equity Armor Investments, to join us on short notice. Brian used to be a market maker in the VIX option pits and now runs Equity Armor Strategies, which use their EA Vol index to essentially replicate the VIX. We cover what this morning was like in comparison to 2020 and 2008, why is the VIX an imperfect benchmark for Vol, and what the rest of the year may have in store for the VIX? Send it. This episode is brought to you by RCM's professional team of advisors that help investors research and access hundreds of professional managers in this space. Check out everything RCM does at www.rcmalts.com.

Make sure to check out our newly updated VIX and volatility white paper, as well as the trend-following white paper we put out last week. Just click the Education tab and then White Papers. Okay, back to the show. All right. Hello, everyone. What a day to have a VIX specialist on. We're recording this around 11 a.m. Thursday, February 24th. U.S. markets were down about 2%. European markets down 4% to 5%. The NEAT guy was at a 15-month low. And our old friend, the VIX, was up in the 30 handle

all this morning. Brian and I were going to record actually at 9 a.m and the market was so crazy we pushed back to 11 a.m here so we've rallied back uh a bit i think nasdaq went positive now it seems to be turning over again so quite a day brian thanks for coming out of the foxhole for a bit to chat with us yeah it's been what quite a, quite a night, quite the last few days for sure for the markets here. I was playing paddle tennis, which listeners outside Chicago might not know, but in the northern part of Chicago here, that's a big deal. But last night, a guy actually left the paddle hut because he's checking his phone. He's like said something about margin call and ran out the door. I'm like, OK, this is happening.

So yeah, so tell us, we've got NASDAQ entering a bear market down more than 20%, S&P in a correction down more than 10%. So let's just start, explain what you're seeing in the vol space generally and option prices locally and anything you got? Yeah, well, certainly, you know, it all really started when the Fed started talking about pulling back liquidity, essentially, right, that they were going to stop buying bond purchases, the market basically anticipating rate hikes. And then obviously, the news on Russia and whatnot, you know, invading Ukraine is, you know, glorified the level of volatility in the marketplace. And so I think what we saw is once the liquidity started to realize maybe it's got to pull back a little bit, all this volatility

crept in. And you talked about the NASDAQ entering a bear market down 20%. Well, when interest rates start moving higher, at least on the back end of the curve, historically, that's not been great for the NASDAQ because those top names, what I like to call if you're a right wing political person, MAGA, Microsoft, Apple, Google, Amazon, if you're a right wing political person, MAGA, Microsoft, Apple, Google, Amazon. If you're left wing, you can add a Tesla in there and make it MAGA. But those stocks really lead the NASDAQ and they do very well when they can borrow for cheap, so when they can borrow cheap and either buy back stock or acquire other companies that have been fallen in value, it's great for them. So

a rising interest rate environment is not, that's led to a lot of volatility. They make up a big component, not just at the NASDAQ, but the S&P 500. So certainly that has been the reason for all the volatility in this marketplace is really coming from those large cap value names and the growth sector in general, having a very tough time. And what were you saying this morning in particular in terms of where option spreads blowing out, where VIX was what, hit 34? So it wasn't like March 2020. We weren't going into the 60s, 70s, 80s. But give us just a little behind the scenes look of what the actual plumbing was looking like. Yeah, well, I mean, I think when we looked at March 2020, you know, we were seeing four or 5% moves in the stock market, close to close, you know, then all the level of intraday volatility to go with it. Now, we're not quite seeing that level,

definitely high levels of volatility, but not quite those moves. And that probably warrants a pretty lower VIX, not the 60 or 70 VIX or 80 VIX we saw in March 2020. The market moving 2% or so, it is very volatile. It's tough to be an investor in this market, but it is also warranting a VIX somewhere in the 30s, not the 60s or 70s. And compare, contrast one more time with Lehman, crash, 2008 lows. Compare and contrast that one as well. Sure. I mean, I actually would say

this is somewhat comparable to the 2008. You know, 2008, we saw high levels of volatility, but it was a consistent market down, down, down with a couple of gaps in place, right? When Lehman collapsed, I remember that day very clearly. The VIX popped extremely hard on that day you know there was panic but then once the sort of panic settled in you got into this normalized

volatility level not where normal in terms of like it's fun to be in the market but normal in the sense that you know you've got that range of two or three percent daily moves up or down and that sort of became the norm and that that's where the VIX sort of settled in back then as well. Obviously, once we sort of got through the clearance of October of 2008, that brought high levels of volatility. But December and then January 2009, February 2009, it was more of that normalized move of 2% or 3% that we're kind of seeing today. And I think that's fairly comparison, which hopefully means the tail end of a bear market

as it did in 2008 heading into 2009. Yeah, it seems a little similar, right? At that point, they let Lehman fail. At this point, they're kind of letting Ukraine be taken. So it seems like a similar thing. People are like, hold on, you're actually going to let one of these go. Yeah. A little wake up call for people. And that I think is why you're seeing the pop in the mix today that you weren't maybe seeing like a week or two ago, because now people are waking up realizing, are you actually, you're really just going to let Ukraine go? This

link you mentioned, are you really going to let Lehman go under? So that's what I think we're going to see today. We're going to probably see some higher levels of volatility due to that. The same way we saw Lehman, you know, September, October, we're probably kind of in that timeframe comparably versus the December, January, February timeframe of 09, where we then saw the bottom. We're not, I don't think we're quite there yet. And then you were saying, you think it's a little bullish, actually, what was that comment of like the 08 comparison? Well, I think when you said the 08 comparison, basically, you saw the VIX actually start going down and the market was going down.

The VIX going down because the levels of moves in the market were not as great. We kind of settled into a 2% daily range for the market, although that was elevated in terms it was not increasing in volatility. And so whether you're increasing or decreasing in volatility is more of the key to be looking at. Right now, we're seeing the ball pop. We may get a little bit more shakeout in this market. It may not be over yet. So until we start to see the volatility levels come down, the VIX come down, the daily moves come down, you may see a bear market kind of continue. Robert Leonardus And what does that look for you,

like into the 20s or back into the teens all the way? Or you're saying just into the 20s and the VIX would be fine? David Sherman Well, I think the S&P has got to get over some key levels here, 4,200 intraday on a close to close basis. I'd like to see it close above 4,320. I think if we do that, then you may see the VIX start to come off and get into the low 20s. But with the Fed sort of in play, decreasing liquidity in the market, the normal VIX could be back to where it should be, which is around 20.

So the days of low-teen VIX, I think, are gone for a little while until the Fed indicates that they're going to stop raising rates. Until that happens, the upper teens to 20 is probably an area where now the VIX, market participants say risk is now back on again. You can get into the market. So that's probably where the VIX goes if we break some of these higher levels in the S&P. But until then, this feels like a bear market right now. And give us the, not to put you on the spot with the math, but give us the math on a VIX, right? A VIX of 32. Yeah. Like what does that mean in terms of daily moves in turn of weekly moves versus a VIX at 22, say, or 30 and 20? Sure. Yeah. The way I like to look at it is for every 16 handle move in the VIX that represents 1% daily moves in the market most of the time.

So a 32, double that. So that's 2% daily moves. So when you're looking at, is the VIX cheap or not, you have to say to yourself, well, is the market moving 2% a day? If it is, then the VIX is not cheap, right? Because 32 is representing that 2% move most of the time. Got it. That's an easy, easy one to use. And then halfway would be one and a half percent and so on and so forth. Exactly. Yeah. It's symmetrical all the way up. 48 VIX would be a 3% move. Which is crazy to think of when it's in like the 80s and it's representing what, like a 6% daily move or something. Yeah. And that's what we saw in March 2020,

right? I mean, that was, that was just levels of insanity. anymore like a six percent daily move or something yeah and that's what we saw in march 2020 right i mean that was that was just levels of insanity i just want to backtrack a bit and dive into your personal background give us a little bit how you got into the biz where you've been touch on that michael jordan last shot is that jordan last shot versus utah behind you that that certainly is it's one of one of my favorites so that's a guy you know like he kept that follow-through right yeah right have you ever read about that he said like he knew he was tired he could feel his legs were tired so he wanted to really exaggerate the follow-through to make sure he got it to the basket right yeah

that was i mean that the reason i love that shot was just representative of when you know it came to crunch time for jordan he was willing to step it up and he knocked down the shot when you had to i mean that's what made him the greatest right it's just when you needed it you got it from him i heard a great actually i heard a great argument to end the LeBron versus Jordan debate. It was like, there's one NBA defensive player of the year, two NBA titles. It had basically the difference between them. And they said, if that was a player, right?

If the difference between their records was just a single player, it'd be a first ballot lock Hall of Famer. And that's the difference between their records was just a single player it'd be a first ballot lock hall of famer and that's the gap between the two so yeah yeah we'll move off our jordan fandom so yeah give us a little background you were down in the pits at one point right yeah um you know grew up in chicago uh went to this chicago board of objects exchange pits right after college in 97 after uh finishing a degree in chemical engineering and a master's in biomedical engineering from Michigan. And went down in the pits, traded for some pretty big specialist units down on the floor, eventually formed my own broker dealer, went off in my own pit and went into the VIX option pit right when they listed options. There was maybe like

five of us trading in there. It was quite quiet. Goldman Sachs, Barclays, SockGen were the very big institutional players in there, whether they wanted to protect themselves against the housing crisis. When you think about the movie, the big short and Goldman being so involved in that, you know, I look back and say, you know, there was a reason why they were fixed by Goldman was buying upside calls in the VIX, right? Anyway, so I traded around that and just learned a lot about how VIX moves, how VIX futures move, and how volatility moves relative to the market. And eventually we formed a registered investment advisory sort of to, you know, turn our market, you know, making strategies that we developed into market taking business and capacity that we're portfolio managers on a couple

of funds now and offering all that VIX trading and knowledge to the marketplace and the public. And so take me back to some, so what was that 2010 through 2015 in the VIX pit? No, 2006, right when they listed options, The Futures came on in 2005 and they listed VIX options in 2006. And I was there from the start. Okay. And so you were there, like we were just talking about heat of the moment. Yeah, heat of the moment, right. What was that like in the pit days? Insane? Crazy? Yeah. I mean, wild swings for sure. I, you know, it definitely helped in 2007, 2008, you know, the bid ask spreads were a little wider. If you're a market maker, you kind of enjoy that being able to, because you're basically making a little bit of edge in the market,

trying to get in and out and manage your book and risk. So the wider the spreads are, if you can buy on the bid of the spread sell on the ask, you know, it definitely helps. So, I mean, we had some great, great moments back then. And actually our firm became one of the higher level volume traders in the CBOE electronically. We were one of the top volume trading firms there. So, so yeah, so, so certainly that was, you know, exciting times for us. Obviously, 2008 hit, you know, we were able to manage it, have a ton of success. I don't even post returns from those two years because they were insane for us. crash crash crash 2010 was probably the most craziest moment when the market out of nowhere dropped five or six percent and vix you know moved from like 30 to 40 in a matter of like seconds um

but but certainly a lot of a lot of times we see a lot of volatility it seems like you know even though the standard deviation moves are called three standard deviation moves they seem to be happening you know once or you or, you know, once every other year, once a year, almost. Right. So it just seems like all the high frequency and everything that else that goes on in this marketplace is making and driving this level of volatility. And when you were down there doing the VIX, did you, could you feel that steady increase in the volume and the interest and the institutional participation? Like what did that feel like in real time? Yeah, I mean, we went from like five guys trading in the pit,

you know, a lot of orders coming in. How does the VIX future move? And I mean, I remember one order, a guy bought a call spread, you know, a customer bought a call spread and like literally five minutes later, he sold it back out for like two and a half cent loser because he didn't really know what he was doing.

But basically the pit grew from like the five over six of us standing in there to you know a pretty sizable pit now when you go to the chicago board options exchange the only two open outcry pits left really are the s&p 500 options and fix options um so volume really grew the number of guys trading and women trading it uh grew so um you know it it uh became more liquid um and more actively used for market participants to use a better way of hedging themselves rather than just using a put option contract and could you feel two things one who was that guy 50 cent yeah that would just keep coming in and buying um so one what was that like was that you you guys knew who he was i think it's come out since right it was like a london yeah yeah um yeah you knew it i mean you know it just wasn't him doing that

obviously he had his 50 cent program or whatever, but other market participants, you know, similarly, you know, what they wanted to do was own the upside call in the VIX because on days like today, you get this asymmetric pop, you know, out of nowhere that surprises people. And then all of a sudden, all those call options that you bought in the VIX, you know, playing the VIX to the upside explode in value. So lots of traders played that. And as a market maker, my job was obviously to sell them that call, but then also trade around that and manage my book so that I wasn't caught off sides by that ball pop. And so you'd sell the option, then you're kind of like all these gamma flows now. So then you would delta hedge that and you

were trying to be, what was your strategy in terms of market-making? You were always neutral? Yeah, I was pretty neutral as a market maker. The way I would sort of play it was trying to leg into butterflies all over the place because that's usually the most neutral option strategy. If you're somebody that is more knowledgeable about options, and I talk about this in the higher level parts of the book that I wrote on option trading, but the butterfly is usually the most market neutral kind of play. And so as a market maker, you would try and sort of leg in and out into those flies. So if you sold one strike, you were buying something around it, whether it was the same month or a later month

and try and stay neutral. We did for actually a little bit of time have a couple guys market making in the S&P and sort of trading S&P versus VIX for a little while as well to sort of play those two option areas since the S&P 500 options are built to calculate the VIX. Yeah. And then the second one, just what was it like? Could you feel the institutional interest, the retail interest in being short vol, right? And kind of, did you feel that playing out with the ETFs coming online and all of that? Yeah. I mean, you could see that when the short volume or short interest increased to try

and play VIX to the short side, whether it was selling a call on the upside or shorting VXX, for example, the ETN tracking the front two-month futures contracts. When the ball popped in, you could feel those guys just have to rip out of their positions. I know a handful of firms that literally blew out on having those positions on and not managing that risk. So, I mean, people say being short VIX futures is the greatest trade until it's not. And then they go up 100% and you're done.

So it's a difficult trade to manage, but you could see the players come in and the level of panic it created when we got these ballparks. Love it. And then, so like you said, left the floor, started Equity Armor. So you guys run some managed accounts. You run some programs and sub-advice on some mutual funds. And the main takeaway that I have from it is, right, Equity Armor, you're trying to protect the equity portion of the portfolio. So talk a little bit about the main idea there of what you're trying to accomplish. Yeah. I mean, our handful of strategies, the core issue there in play is using the VIX, using VIX futures to provide a hedge for any

long equity exposure or long beta, I like to say, to the market. So if somebody is dialed in in some way or form with correlation to the S&P 500 and being invested in stocks, what we like to do is we like to use VIX with that. And there's a handful of reasons we do that. One, we know that over time, we believe stocks go higher. If you look all the way back to the Great Depression, 1929, the market is higher, right? At the same time, the VIX kind of acts as like a heartbeat. Yeah, it spikes, but it kind of comes back down. You can't exercise forever.

That heartbeat comes back to normal. So VIX sort of returns to this mean, right? So if I own something that is mean and not going to generate any returns, and I own something that's moving higher, well, now I have two pretty good things. The thing is, is this mean reversion going to give me protection when the market goes down? And the answer on a daily basis typically is yes. The VIX pops when the market goes down. And so if I get this daily hedge embedded where I have two sort of securities that are balancing each other, But then over a long period of time,

I have one that I'm owning that's going higher. And the other one that I'm owning, that's going to return back to its meat. I can play that seesaw action and benefit from that. And so embedded in that is the whole concept. I'm basically using the VIX as a cash machine. When it pops, I can take that, put it back into the equities that are going to generally trend higher. Yeah, exactly. It's like, it's like, you know, a farmer, you know, you're, you're going to, you're going to sort of plant your crop, plant your seeds. When it becomes, when it comes due, when the corn, you know, is ripe, you're going to pick the corn, right. And eventually the corn is going to go away. You're going to have to replant again next year. So we do the same thing when the ball pops, we're selling out of that volatility pop and buying equities at a lower price. And talk a little bit, right, that

structurally that makes sense. The devil's in the details, right? Because the VIX futures have a constant bleed. They're always reverting to the cash fix price. You can't trade the cash fix. So talk a little bit about that dynamic of like, how can you trade the VIX profitably when it seems very hard to actually hold it as a long holding? Yeah, it is tough to hold as a long holding. I mean, we see the VIX drift lower here and whether how you hold those futures or how you traded the VIX really depends on how well you did. You know, the key is, is we developed a methodology in order to start to limit some of the decay of a contango market. And by the word

contango, I mean, example, the oil markets, when the oil, let's say spot price is at 100, oil futures traders, whether it's storage costs or whatever, the future out month is trading at a higher price than the spot price. So that happens a lot of the time in VIX, where the VIX future out months are trading at a higher price than the VIX. So what happens is if the VIX does nothing, the VIX futures have to come down and settle down into that cash price. And so that's called decay. And so managing that decay aspect of the VIX futures is the key part. And the actively traded part that where we use some methodology and tricks sort of to be able to hold long VIX

futures, hold that long VIX futures synthetically to play all this mean reversion back and forth in volatility. But that's right. And a lot of people thought, oh, I'll just buy VXX. I'll buy one of these ETFs to have that long exposure. They're rebalancing, right? They're down 98% or whatever over the history. So that's the kind of the trick of like, okay, if I just bought and hold VXX is based on the calendar. Every day it's going to roll from the front month and it's going to buy a little bit of the second month VIX future. That's what the VXX is tracking. It's owning the front two month futures contracts. It has no idea where the spot price is or where other future contracts are trading. It's like this systematic program based on a calendar that's owning VIX futures, whereas we are looking at the shape of the futures curve on how to own it, how to hold it.

It's very similar to a treasury trader. You want to own two-year notes or 10-year notes or 30-year notes or the euro dollar traders that trade the shorter term yield curve, so to speak, there's a yield curve to be traded in the VIX and that's how we manage. And you're gaming for the cheapest part of that curve, essentially, right? Exactly. Yeah. Yeah. Which it seemed by definition would always be further out, no? But close to buy, right? If it's in contang, you think it's always closer by, but then you always having to do the continuous role. Right. So it's not just measuring, owning the further out, it's how many contracts do you own to replicate the front month contract, right? So our methodology, our EA vol

index, which is disseminated by the Chicago Board of Options Exchange, actually, they have our calculation, right? And so they take our calculation on how we hold these VIX futures, and they publish the returns of holding these futures. And so it's an actively managed position on how many contracts to hold and where to move along the curve. It takes a little bit of sophistication to do. Let's dive in a little bit to all the problems with the VIX as a measure of volatility, right? Like I did a thread, we'll put it in the show notes back in January of like a lot of long ball programs struggled in January, even though VIX was a quote unquote 40%, um, because fixed strike ball

was actually came in a little bit. So talk to us a little bit about those dynamics of like why the VIX isn't always a great measure of what's actually happening underneath the hood in terms of the ball surface. Yeah. I mean, so I think what's interesting about the VIX calculation is it measures S&P option contracts, the amount of the money puts in calls. And so it's just an index calculation. What's really embedded in there are two components. One, realized movement, the actual movement in the market? And two, what do traders expect 30 days from now, what the VIX should look like, or what volatility should look like 30 days from now? So it gets a little tricky. Some of the vol traders that like to be long vol,

when you're buying S&P options to do that, you're having to really manage those two issues, right? Did I get the realized movement correct? And our future expectations of volatility, can I get that one correct as well? And so that makes it a little bit more difficult. And like you said, a lot of the long ball firms had maybe some trouble with where the straddle was priced. The reason being was options on the downside were accurately pricing the level of volatility that the market would be at when we got down there. So when the market would move down, those option prices were priced right for the level of movement you would then see in the market. And so it's these two dynamic components realized actual movement and what people expect. Whereas when you're trading VIX futures

and we're doing it in our model, we're just trading expectations of where the VIX goes. And the VIX has, like we talked about, negative correlation to the market, meaning when the market goes down, the VIX will travel along that S&P 500 option curve and go up in value. So it's very difficult for times to see the VIX go down and market go down.

It happens a handful of times per year, but not very often. And so now we're sort of removing these two components and we're only trading one thing, volatility, and we can just manage that better and we can rebalance, harvest the crop when we need to, and rebalance with stocks accurately versus some other vol trading groups. And so would you say, right, people say VIX isn't tradable, would you agree with that or not agree with that? Yeah, I don't think it is really tradable, right? It's the calculation and measurement of what these premiums are in the S&P. And because it doesn't factor in time decay or future implied volatility, what's going to happen in the future,

it's just that snapshot moment in time. It's not tradable in that sense. So it makes it difficult for traders to play it. And sometimes trading straddles or strangles to get long volatility doesn't always work out the way you want it to happen for those reasons. And it's a floating band on the market, right? So if we go down 5%, the VIX kind of resets to those options and it's ignoring the options that were bought at that previous level. And talk to us a little bit. I've got into it on Twitter here too, of like,

what are your thoughts on quoting VIX in percent gain? Don't do it. Well, you know, it is important actually. And it's really a key measure. We look for, when we're trading our strategies, when we're trading VIX versus along equities, we actually are looking at what's the percent change of VIX relative to the percent change of the S&P 500. I think that's something to keep an eye on. When that ratio drops to two or three to one, it usually indicates a level of comfort that we're at a level where option traders are willing to sell puts in the market and get long in the market is what I find. When we see the VIX move, let's say up 8% for a 1% down move in the market, that 8 to 1 ratio is very high.

So those things I do like to watch and totally ignore the price of both the S&P and the price of the VIX and just look at the percent change relative to each other. Some of the people are saying you can't, if right, a VIX of 20 means there's 20% volatility, a VIX of 40 means there's 40% volatility. It didn't increase 100%, even though technically, right, it's only 20% more volatility, not 100%. I can see both sides, but it's an interesting debate. So where do you stand? We'll go to another Twitter commentary. Where do you stand on gamma flows and that that's all that really matters? And if you can model where the market makers are and you were a market maker and where they have to do their delta hedging, you can glean some information on where the market's going to make a stand or break through. Yeah.

I mean, through time, traders have looked at open interest. They've looked at volume. They've looked just at that. Where are people short gamma and long gamma? Because obviously as a market maker, if you're short gamma, you're having to sell the market as it's going down, which is then forcing the market lower. If you're a long gamma trader, it means that when the market's down, you're actually buying the market and trying to push it back up. So getting that sense of feel of flow of that actually is important. A lot of times you can kind of sense that as we get towards like these big strikes in the market. Let's say, for example, S&P, let's say it got

down to 4,000. That seems to be like a key big strike level for a trader there. So certainly I do like to watch that. It takes a little bit higher level of sophistication. If you're a trader, you're going to go through those levels of iteration to try and figure that out. If you're a general investor, it's probably a little bit too detailed to try and determine where the gamma is and all that kind of stuff. And you mentioned before the 4,200 level, why does that have significance, if at all? Or just it's had significance, so it remains significant? Yeah. I mean, I think 4,200 on the S&P was a low kind of where we saw at the end of January.

We saw that market kind of touched down near there actually just before Russia attacked last night. And if you go back even further in 2021, that was sort of a level that it bounced off of as well. So that seemed to be a support in the market where market participants were willing to buy the market. And I think last night when we saw it crack that level, it was a real indication that maybe the buyers are getting a little bit weaker in hand here. And so that level now becomes a very key, important level, whether the market can rally through that and probably push the market significantly higher, or it's going to trade back up to there. And all those buyers are like, hey, I got to get out of this thing now. And then it's going to flush lower. So it's an important level. On the close to close, I like to look at that too,

was 43.20 was a level on a closing basis. And the S&P is something to watch as well as a sort of support resistance line. And then I want to circle back on the NASDAQ that we touched on briefly. There's been tons of carnage sort of under the hood there. I think the index finally caught up a little bit being down 20%, but right. A lot of those art names are down 60, 70, 80%. A lot of those IPOs down more than 50%. So just two things that one, have you seen a lot of demand of investors of like, hey, help me hedge this other part of the portfolio, these single names or these higher tech names, not just the index. And two, well, we'll start there. Yeah. Well, I mean, I think with the single names, some of these growth names that have seen wild swings, the thing is, is in a raising interest rate environment, some of those names become more difficult to own. The level of volatility increases there. And so they tend to lose a little bit of the correlation

to VIX, meaning they perform a lot worse. I mean, there's nothing worse than owning an asset class that you're trying to own. And like I talked about, we expect stocks to go up over a long period of time. You're owning something that actually is departing from the broader based stock market and performing worse. Those are names, if you want to use levels of hedging and volatility against some of those names, we encourage people to try and look for the best to breed in the market. And right now, we've been buying stuff where, think of it as things you need, not what you want. And all those want stocks are just getting hit because they're getting hit without any sort of correlation to

volatility. And it becomes a little bit difficult to hedge those kinds of names. And doesn't CBOE have a NASDAQ fix, but it doesn't trade at all? Yeah. The shares are just the index. There's two other, they have a NASDAQ mix. Also, the NASDAQ publishes a Vol-Q, which is their version of NASDAQ volatility levels as well. But again, those aren't really tradable. They tried to, you know, little success to get volume going in those contracts.

And so now people just kind of use it as a measurement and indication of where what the NASDAQ is doing, where it's at. And actually, we own the VIX in one of our strategies and we trade. We own the NASDAQ, I should say, as stocks, and we trade that against the VIX. And we just kind of measure up the beta of the NASDAQ versus the S&P to sort of be able to manage that and hedge it. Right. So I guess you're saying I can still just use the VIX and I can use twice as much because the NASDAQ's 2X the beta of the S&P or something like that. Yeah, exactly. Exactly. There's a rough correlation to that. Now, obviously, the last couple of months, you talked about some of these growth names. That's obviously pushing the NASDAQ down a little bit further than you'd want to see it, which makes it a little bit more difficult to hedge, even if you're at that 2x level or whatever. But yeah, just measuring up the beta exposure.

If you can get something highly correlated to the S&P, even though it might have a different beta, then you can use VIX to hedge. Right. And I guess these days it's even more highly correlated than normal with a lot of those big names becoming part of the S&P, right? Yeah, for sure. And then come back to that interest rate thoughts on, right. Does it make sense to me of tech stocks have a lot of interest rate exposure, right? They don't need a lot of capital. They don't have, right. It's not a airline that has to buy and lease planes and whatnot. So

go back to that theory on why tech stocks have that interest rate exposure. Well, they do, but they don't, right? So the thing is, is that when you look at some of the big names that I talked about, Microsoft, Apple, Google, Amazon, not only are they in a great position to buy back stock of their own, and certainly when interest rates are lower, they're able to do that cheaper, right? If the market's down and interest rates go down, they can borrow cheaper, they can buy back stock, they can push the market back higher doing that. The other key component here is when it gets cheaper for them to borrow out longer term, then a lot of these other high flyer names,

Microsoft, Apple, Google, Amazon, they're almost private equity firms, right? They can get in and acquire. They almost want to see a sell-off, right? They want to see interest rates go lower and a sell-off because now they can acquire companies at a cheaper rate and build up their portfolio of growth returns through acquisition. And so in a sense, everybody then is tied to valuations off of that. And there's where that interest rate trickle down effect. Um, you know, we, we have a, a newsletter on, on, you know, calling it sort of the butterfly effect or the ripple effect. When, when you drop a bowling ball in a pool in the deep end and the

wave moves, it eventually makes its way to the shallow end. It might not be as big, but it'll make it there. So there is a domino ripple effect that occurs even with interest rates to big cap tech and then down to the more growth, smaller cap names. So you've at first traded options at CBOE and then moved into the VIX, right? That's right. Yep. Do you ever feel like there's a better, like how do you manage that dichotomy between the options and the VIX? Like in theory, sometimes you could go into the option market and get better, right? The SPX options and get better value, so to speak, than buying the VIX futures.

So do you play that game and look for the relative value there, or are you just focused on the VIX future? No, we do do that, you know, under unusual circumstances, as we're seeing in the markets over the last few days, there is opportunity that presents itself to do that, to make that switch. You know, when I talked about, oh, you know, owning straddles or puts or strangles is sometimes difficult. Well, sometimes it's not. And it's just a matter of finding the right balance of seeing realized volatility occur. When you get a pickup and realize volatility, sometimes the S&P can present itself as a nice place to sort of hedge yourself out and play volatility in that sense. But if volatility becomes muted, then it becomes more difficult to use that. And the VIX becomes a better place to trade. And then how do you view in the blended product, right? That has the beta plus the VIX exposure. Does that have a, is it 50 Delta or 80 Delta or what?

Do you have a Delta target on that? Yeah. I mean, so in that sense, you know, our beta strategy, we trade NASDAQ and S&P futures, mostly a lean towards S&P 500 futures to be long the market. And we trade our EA vol methodology, the index that you see on the SIBO, we're buying fixed futures against that. And we're trying to keep the notional value of the two balanced out at the ratios. And we talked about percent changes moves in the VIX versus a percent change in the S&P, looking to balance that accurately so that it provides a hedge should the market move lower. But it doesn't have a set.

That's why I was going from the VIX futures back into the options, right? So if you're buying those straddles and whatnot, you're going to have some delta component. But you're saying, no, it's just to try and even out the, if I lose 10% here, I want to be gaining 10% here? No, I mean, in that type of strategy, we actually have a long market bias. We actually offer that strategy as a more efficient way to be long the S&P. I mean, you could buy the SPY and pay the five or 10 basis points management fee and just be long the market.

What we think is there's a more efficient way to do that. So we want to be long the market. We want to provide market-like returns at 20% less risk. And the reason we're able to do that is we actually dial up, instead of 100% long the market, we're actually longer the market, more like 130% long the market. But then we're holding VIX component to hedge out the 130. And what we find is that we actually participate almost in line with the market going up, maybe a little bit better. And we reduced drawdowns by 20% or so. So now we've created a dynamic that's a more interesting way to be long the S&P 500 than just blindly buying it and riding the roller coaster. Love it. And then so does that aim is to reduce volatility as well as drawdown

or just drawdown? The aim is really to reduce drawdown, right? So if we can create this asymmetric return where my beta to the downside is a 0.8 beta to the downside, but a one beta to the upside, I mean, that's the home run, right? That's where you get, you know, all the geeks out there, you know,

the Sharpe ratio, the Kalamar ratio, all those ratios, whatever, start looking really good when you can change the beta profile. Whereas if you're owning the S&P, you're one beta to the downside, you're one beta to the upside. That's it. You're right in the market. But if we can give you the same one beta to the upside, but only a 0.8 beta on the downside, that's a more efficient way to be long in the market. And in theory, you're risking the one beta in order to remove it on the downside, right?

So you might have a 0.9 to a 0.8 or something. Exactly. That's the trade-off of the risking to the upside beta. Exactly. And so what we want to do is give people, you know, if I'm someone that normally was in a portfolio and I like, you know, I'm a little bit more conservative, let's say, and I want to be 80% low on the market and 20% bonds, okay, because I only want 80% of the risk of the downside, right? And I want the bonds to protect me. Well, basically, our beta strategy gives you that level

of risk to the downside. But now I'm actually giving you 100% of the upside. If you look at what we've done over the last couple of years in that strategy, right? So I'm risking the same to make more is really what it comes down to in terms of how to devise a plan to invest in that kind of strategy. So that's important because if you're talking to an investor, hey, I'm trying to get equity-like returns with less risk, or here we're saying we're going to get equity-like risk with more return. Right. So that, you know, that really depends, you know, that's just a matter of going from like 1x to 2x or beta strategy, right? You know, the 1x strategy is give somebody, you know, a 80-20 risk profile that normally is in that lifestyle category,

but give them 100% of the upside, right? Is where you kind of start with. So we're always giving you a higher level of upside versus the same amount of risk you're willing to take on the downside. And talk through a little bit, right? Like we're making it sound pretty simple, right? Like, oh, I'll just go do this on my own.

I'll buy SPY. I open a futures account. I trade the VIX against it. Yeah. Like talk through why it's harder than it seems. One main thing is the rebalancing hack that occurs, right? Because when the VIX goes from 20 to 35 and back to 20, did you on a daily basis take advantage of that to harvest the crop, right?

So that I can put it back into the market. That's a very key component, especially when we're seeing wild swings like we see on days like today or last couple of weeks, right? So the harvesting of the crop component is very key because the VIX that you're owning, remember, it's a mean reverting product. It's gonna go back to not return anything for you. So you gotta take advantage of these daily moves

versus the long-term outlet. And that's the main thing that makes it difficult. The second thing is just how do you buy VIX and not become a VXX and see it decay away 98% to the downside over a long period of time. That's the other part that needs a little bit of massaging as well. And so you've opened up a little nugget there. So every day you're harvesting that or not necessarily, right? That worries me because now if it went from 25 and it goes to 80 and I got out of 25, didn't I leave a lot on the table or how do you do that?

Yeah. I mean, the thing with Vicks is it's really tricky. I always say you never know when the merry-go-round is going to stop, when it's going to stop spinning. So at some point you have to do some harvesting. The key component in the harvesting though, is that as it's going up and your price averaging out of the VIX and buying the market, yes, maybe it starts to go against you, but we're keeping that percent relative to each other. So in other words, let's just say I have a hundred dollars, I'm long $90 of the market and $10 worth of VIX, right? That ratio,

we kind of maintain so that the market keeps going. We're not blasting out of all our VIX. I don't think anybody ever wants to do that because like I said, you don't know where the merry-go-round is going to stop in volatility, right? Whether it's March, 2020, and you go to 80? Or is it, you know, 2018, February, it goes to 45-ish, 48 and comes back down. But it's maintaining that, you know, nine to one ratio of the two, let's call it, with each other. That is the key component in the daily rebalance. And so then by definition, you'll never perfectly rebalance, right? On every move to 25 and back to 15, you're going to miss some and then you're never going to have everything on all the way up to 80 either.

Right. Yeah. So I mean, there is a little bit of science to that, whether you let some of that run a little bit or not. The key thing is if you can sort of maintain the relationship, like I said, that nine to one, eight to one relationship or so with the two, then you're going to have the daily hedge on. And then doing some of the rebalancing of the weights back to that norm allows you to sort of take advantage of the pops and drops of volatility. And by time, the VIX has sort of made that round trip up and down. As long as you've averaged out of the VIX and averaged back in, typically what you find is after that time, you're actually up. A great example was 2020. We're selling out of the VIX a little bit as it's going up. Our EA vol, if you looked at it, was about unchanged on the

entire year of 2020. The markets were up. S& like 13 but we were actually our strategy was actually up more right so the only reason we were up more was because we captured and harvested all that volatility back up and down um and you know capture three to five percent or whatever a year on rebalancing the mean trading you know you're you're adding, you're adding alpha. What is, have you done those, that research? I'm sure. What does that look like in terms of daily rebalancing versus monthly versus quarterly versus annually, right? Annual would make no sense at all for the fix because I didn't get totally revert and you missed the whole thing. But at the same time,

if it reverts in the market came back, maybe no, right. Yeah. I mean, we, we, you know, we looked at daily, we looked at monthly, we looked at annual, and sometimes it works, sometimes it doesn't. What we found really is somewhere in between a daily and a monthly is really where you want to be at. And if you really want to be tight, the daily is probably the best way to go. But you could leave some level of room to rebalance, you know, on trader feel. I kind of feel like in some degree, I mean, we kind of stick to that daily rebalance, but there are moments in time where as a trader, I've found that I have a pretty good field of X and, you know, I can maybe let it go or not go. Sometimes I've rebalanced it three or

four times in the middle of the day in 2020. I couldn't stop trading over this last month or whatever. I haven't been able to stop. I've rebalanced a couple of times in intraday because of the wild swings of the market. So it really depends on market conditions, how you're going to play that, that rebalance. Got it. And so that makes it less systematic and more just, Hey, it's the goal is to capture that and redeploy it versus the goal is, like you said, with the ETFs or with the it's just time based and I'm doing this and that leads to problems. Exactly. Exactly. There has to be pull back a little bit if you, you know, if you want to as well, and manage that structure, and not be on this set it, forget it kind of thing. So where do we go from here? We talked a little bit about rate hikes. We talked about looking and feeling a little bit like 2008.

You know, say this week hadn't happened and the whole Russia thing hadn't happened. And just talking about the Fed, what do you think for the rest of the year? Well, it's kind of interesting because I think we've been in such a dynamic over time where, you know, we wanted the Fed to rescue us and lower interest rates to save the market. The thing is, is throughout that period of time, we were in a flat to deflationary, let's call it, kind of world where inflation wasn't a factor. Now it's quite the opposite, right? We have this inflation pressure. I actually think the market wants the Fed to hike rates 50 basis points. I

think if the Fed came out today and said, we're hiking rates 50 bps, I think the market would actually go up. The opposite would almost happen. When we were trading in the floor, we'd always say, don't fight the Fed. And we would say that because if they lowered interest rates, you wanted to get along in the market. But that was in a non-inflationary environment. We had a whole boom of technology keeping inflation lower. Now we're not in an inflationary environment. And so I think if the Fed actually raises rates, the market might actually like that. And what about with volatility?

So if they keep rising rates, the market likes it. Does that dampen vol? Where do you see you mentioned before? You kind of see it settling in in the 20s for the rest of the year? I do think it dampens vol. I mean, I don't want to see the yield curve invert, you know, so if the yield curve is kind of meaning the interest rates of the two year versus the 10 year, that can sort of kind of stay maintained. I'm okay with that. But as you've noticed, the more that the Fed does nothing, the flatter that yield curve has been going. Right. And so typically when that has inverted, that's been an indication of a recession coming.

And so I actually think when they hike the rates, the yield curve, I think, will maintain itself. The back end actually might go higher, which is not great if you're a bond investor. But sorry, if you're a commodity investor, sorry about that. But I think commodities will get hit hard. They'll hike rates. And I think the market will rally off of that because it's asking for it. I think that's what the level of volatility in this market is all about. And I think you might see the VIX come off and back down to that 20 level. Yeah, it was super weird this morning to see red stocks, bright red and energies, everything else risk on was bright green. Yeah. It was quite a difference from usual of like stocks are down, oils down,

grains are down, everything's down. It's a risk off play. Yeah. Although it was actually kind of interesting this morning when you looked at big names out there, the big oil names, energy was actually down when the market was down. Not as much as the market, but it was down, which was to me kind of strange. Maybe people are kind of sensing that oil $100, okay, it's maybe gone far enough. Yeah, I think we'll start to see real world effects with that. And I think I probably lost a bet somewhere in the last five years that we'll never to see real world effects with that. And I think I probably lost a bet somewhere in the last five years that we'll never see $100 oil again. Well, I can tell you this.

When I was in the pits during the Obama era, when he was coming in, what was it, 2008, just before we won the election, over the summer of 2008, oil was at like, what, $140 or whatever we had a bet in the pit you know uh call it trading places bet of a dollar that i'm like mark my word oil is going back below 80 and gonna stay down there for a long time and a few months later it happened nice the uh well it's hard to believe right two years ago we were at negative 40, negative 40 to 100. It's a good trade. We'll let you go here, but last bit, give us your hottest take. If you have one, something nobody else is talking about, something everyone's talking about,

but you're 180 degrees on the other side of it. Yeah. I mean, I think like I just mentioned before, I think when we need the Fed to take some action here, we can't let the inflation continue. It's opened up the door to places like Russia, who profits greatly off of owning gold, which they have off of owning grains, you know, they're the breadbasket of the world off of owning oil, places like that, when they see inflation, they smell, they smell, you know, their chance to go in for the kill, right? We need some of this inflation to back off. And like I said, I think if the Fed comes in and raises rates, I think the stock market is going to love it. And I think it

sort of stops the volatility bleed to some degree, as long as those rate hikes are somewhat systematic and people see them continually coming to get some of this inflation out, get some of this commodity pressure that's being created in the market, because it's becoming more and more difficult for companies to pass that buck on to the consumer. And so, you know, if it gets more difficult to do that, what does that mean? Profit margins get squeezed versus if rates are higher and we can sort of, you know, crap out the commodity markets, that might be a positive for the overall stock market.

I was like, yes, you can raise rates. Yes. Historically that's lowered those commodity prices, but at the same time, if the, the industries, the people, if everyone still needs those goods, right. So to me, I don't know how much you dampen that demand, unless we're saying the rising of rates just eliminates a lot of speculative demand. Yeah, I think it takes a speculative flavor out of it. Maybe it's not raised the Fed funds rate. Maybe it is just stop the bond purchasing what they're doing, but actually pulling back some of the money supply

as well. But there's all this speculation bubble that's occurring in those markets. You've got to pop that market. And I think if you do that, then you're going to see profit margins in companies go up. Right. But is that financial speculation, like futures traders like us? Or are we saying like, because the money is so cheap and they're buying, building new condo buildings in Miami and so right there, that whole knock on effect of.

Yeah. I mean, it's, it's made everything cheap to do all of that. Right. And so, you know, what people then have clamored towards is things that they need, right. Because, because there's this bubble that occurs and people pile into the trade and there's a lot of speculation, I believe in it right now on top of, I mean, yes, we increased the money supply dramatically in 2020, right? Some of that's got to come out of this market. The markets can't be at all time highs and you maintain that money supply in the marketplace. And so, you know,

what was real and what was not, you know, there might be some levels of a little bit more volatility to go. But I think you'll get a big carpet shake out and the markets will move higher after we hike those rates and take some of the supply out. Love it. I let everyone know where they can find you and find all the good equity armor stuff. You guys redid your site like was that a year ago now so there's some cool content on there i know yeah yeah we uh we're always keeping it up to date uh you know our guys myself publishing media all the time uh i'm on nasdaq talk on cboe tv on uh some of the other channels out there some of my colleagues as well so lots of contact content that we we produce for people to just kind of see our insight on how we're trading the VIX and volatility. And it's important for people to follow along. So we're excited to have you. Got it. And what's the website again?

EquityArmorInvestments.com. And Armor is A-R-M-O-R. And when you go on there, by the way, we launched a book that I wrote about option trading. It actually goes over some of our times on the floor and compares how we use those times with teaching a lesson about option trading, very basic kind of stuff. But if you don't want to learn about option trading, some of the stories of the war stories on the trading floor are in there and you can pick up a free electronic copy of the book when you go to our website and sign up. So feel free to stop in there. Give us a teaser. What was one of those stories? Well, we talked, one of the funny ones is just, I traded a buyout, Dreyer's Ice Cream,

if you remember, was bought out by Nestle's and there was a whole big hubbub about ice cream, right? And one of the funny things was, was the buyout gonna happen? And was our government going to approve being taken over by a European company for ice cream supplies? So that was kind of a fun one. A US company?

Yeah, dryers are the US company and Nestle being the European company. And so a lot of activity on the call option side to the upside, whether the buyout was going to happen or not. And there were some lessons to be learned just about binary situations that occur, whether it's going to happen. It's either yes or no. There's no gray area. Value is going to slowly go up. And so that was kind of a fun one to trade under. The other funny thing that made it even funnier, you're trading ice cream and the pit was literally,

so the S&P 500 pit, real quick story, is built up on stairs, right? And it's a massive pit, hundreds of guys in the pit trading it really loud. The dryers ice cream option trading pit was literally underneath the staircase of the S&P. So you're like in this little like, you know, under the staircase as if you're like under the bleachers at your high school trading this like buyout thing that was quite active with all this noise going on that where dryers didn't matter what the S&P was doing, you know, dryers had its own deal. So that was probably like just a couple hundred million dollar market cap, right? Was it relatively small? Yeah. Was it part of the S&P? I guess.

You know, I want to say it was not part of the S&P at the time. I don't think I ever had dryers. Byers? What's that one? Briars. Yeah. No, dryers was like, it was the hard ice cream, you know, sold at stores. So it was, it was, it was a fun one to be at. You know, there was maybe five to 10 guys in the pit. It was very active and big, big, you know, broker dealer players that came in, came in there, which made it kind of fun to trade. But it was kind of a funny situation. Love it. All right. Go pick up the book. I'll read a copy and we'll talk to you soon. All right. Great. Thanks, Brian. read a copy and uh we'll talk to you soon all right great thanks brian thanks a lot thanks for having me 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

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