The Derivative - Vol Arb, Rates Vol, Dispersion, & Risk Premium. Part II with Noel Smith

Episode Date: May 19, 2022

We're back for part two with Noel Smith – where we dig into the types of options and volatility strategies, he employs for his Convex AM hedge fund.  For the background on why he’s worth listening to on that front, listen to Part 1 about marketing making on the CBOE floor, Getco, and more here: https://youtu.be/XCeN56HgT68 Noel’s deep options expertise has led Convex AM to a four pillars approach to volatility trading: Vol Arb, Dispersion, Risk Premium, and Bond Vol Arb. In this episode, you will learn ideas and best practices from a lifetime of professional trading and how the Convex AM team bundles these four pillars to offer them to outside investors. Noel also takes a deeper dive into the current macro environment we're in and how it impacts his trading (or should we say how he lets it affect his trading), option and market maker gamma hedging, what exactly is Bond Vol Arb, how to trade it and why it is in a portfolio, and more! Plus, we couldn't close out this two-part segment without a little fun. We ask Noel to play two truths and a lie. So, stay tuned to find out if Noel has done better in real estate or options trading, if he is actively working with Columbia University in their AI department developing their derivative model, and/or if he was the only market maker in the world on a few stocks. SEND IT. Chapters: 00:00-01:51 = Intro 01:52-05:25 = Constructing a Volatility Trading Program & Driving Your Own Car 05:26-16:52 = The 4 Pillars of Convex AM, providing real Alpha in Vol Arb 16:53-38:28 = The importance of Dispersion & Risk Premium 38:29-49:57 = What is Bond Vol Arb? / Term Structures & the Move Index 49:58-58:12 = Macro thoughts: Flow & Liquidity 58:13-01:08:01 = Two Truths & a Lie Follow along with Noel on Twitter @NoelConvex and for more information check out convexam.com Don't forget to subscribe to The Derivative, and follow us on Twitter @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. Welcome to another week of May, everyone, where we continue to ask, how far down will the market go this week? Why hasn't vol picked up much? And where and when will the bottom be? Who knows, but we'll keep bringing you a bottomless handle of hedge fund hot takes here.

We've got Anthony Zhang from Vinovest for National Wine Day next week, then Charlie Magiera, Chief Strategist at Blockchain.com to open up in June. For today's episode, we're reaching back two weeks ago where we had such a good time with Convex Am's Noel Smith, talking about the glory days of the trading floor. Make sure you go check out part one that we split the real talk about trading options and vol in today's market into this part two episode. In today's episode, we touch on where vol could be headed the rest of the year, what rate vol arbitrage looks like, and how Noel implements his four-pillar vol trading approach, send it.

This episode is brought to you by RCMs of VIX and Volatility Specialists and Smanaged Futures Group. We've been helping investors access volatility traders like Knoll, Jim Carson, Chris Cole, and Mutiny Funds for years and can help you make sense of how and when volatility makes sense as an asset class. Check out the newly updated VIX and volatility white paper at rcmalternative.com under the education slash white papers menu. And now back to the show. All right, part two. So we're going to dig into the strategy a little bit. I want to talk through that. But as a primer for that, I want to talk through part one, we talked about trading your own money, having others trade your own money. So tell me some of the biggest difference between you trading your own money, two, having money traded for you, and three, now trading other people's money. Also a very good question. They're all pretty different. So from a marketing standpoint, third millennium trading was very successful. We made a

lot of money over many years and anybody with a brain would want to have participated in those profits. But here's the difference. The volatility of that P&L would probably be something that a lot of people would be very frightened by. Using specific examples, Enron, I wrote to zero. 9-11, September 11th, 2001, we lost a lot of money and that was a crazy time. And there was other instances where, who knows? I don't even know that we had a positive Sharpe ratio for any chunk of time. So if you're going to evaluate our performance by that metric, you probably would have not made a decision. But the way the P&L worked out, you would have been fooled not to. So when you're trading your own money, when you're driving your own car, you drive it differently. And then when

things are really crazy, say you're in a police chase or something, you're going to drive it more vigorously. When someone else is trading your own money, it's way worse. And you have to really find people that have a different moral set. Because when guys that are not moral get down, they kind of have a YOLO attitude. They said, okay, well, I'm either going to get fired or I'm going to make a billion dollars. And it's not on my end. So I had to learn that the hard way. I backed guys that ended up in a debit position and then they just piled on risk and they ended up getting fired. I don't think anybody ended up making a lot of money out of luck. The old hair spread, we used to call it.

Yep. The old hair, you book a one-way ticket. So I didn't really like having other people trade my money as much as I did. Almost all of the profitability that came from the third millennium came from the desk that we ran from upstairs. Of the overall arching. Yeah. Yes. So if you took all of our traders, I would say you could probably kept 80% of them. And all of them were smart guys. All of them came from good schools and whatever, had some kind of a pedigree. But not all of them made money and it was frustrating. I remember guys that were debit, they'd come in late and leave early. To me, I was just like, what? What are you doing? Yeah. You've got millions of dollars of my money. Why are you here after the bell?

Table stakes, man. Right. And why are you leaving early? What are you doing? It's like millions of dollars in my money. Why are you here after the bell? Table stakes, man. Right. And why are you leaving early? What are you doing? He's like, well, I got to go to my dog's bar mitzvah. I'm like, what are you talking about? You're in the hole. His dog's bar mitzvah? Just all these cockamamie stories. And I didn't really like being the police, the dad of everybody. And the guys that took their job seriously, they were much easier to deal with because they were a known quantity and you could reasonably predict what they would do. When I was trading, the idea that I wouldn't be there by the open

and I would stay after close was just like, it was absurd. Of course you would. It was just like common sense. And some guys- Preston Pyshko These guys were millennials before they were millennials. Yes. And I was always surprised at how lazy, otherwise very smart people could be. So let's dig into the strategy. You got it on the screen behind you there. Convex AM, Convex Asset Management, name of the firm, four pillars to the approach, volatility trading. So take us through the four pillars, then we'll dig in on each. So for anybody that watched the previous segment, it gives context that's pretty relevant.

What the point of the firm is, is to take the best ideas and best practices from a lifetime of professional trading and put them in a bundle and offer it to outside investors. It is the ideas that we feel are the most repeatable, scalable, and something that we can do. We're not competing with Getco or Susquehanna or Optiver on these trades. We are competing with other hedge funds that are trying to figure out which way Tesla is going to go tomorrow, which is a tough thing in my opinion. So the point of the trades are to work in concert so as to provide real alpha. And they do that. So going down the trades, as you mentioned, there's four real pillars. In no particular order, there's a vol-arb trade, there's a bond

vol-arb trade, a bond term structure volatility trade, there's a dispersion trade, and there's a volatility harvesting trade. And they all do different things at different times in different vol regimes. And the reason they work together and separate is because they don't really have much to do with each other or necessarily the marketplace. If VIX goes to five, that's fine. If VIX goes to 500, that's fine. It can work either way. So we don't really have a big opinion on market goes up, we make money, market goes down, we lose money. It's just not like that. And in fairness, some people think that market goes down, we make money. Also not true.

We can, but it depends on the vol path. And if the market goes down, we make money if our puts go up. If they don't, we don't. Right. So not fair to say you're a long vol program, but you're not a short vol program either. You're just a vol, a neutral vol program. So we're long vol in the sense that, yeah, if you look at the book and it's full spectrum of prices, which is zero and infinity, right? We're definitely long vol. So we don't have any ability to have a spectacular blowout because we have long volatility in warehouse. But it doesn't mean that those strikes get violated and those puts make money.

Because even in 2022, the market has basically been going down, not crashing. And it's been very frustrating from a volatility standpoint. And then every now and then it'll crash up. So it's almost like the reverse of a normal thing. Typically you go up and crash down. Now it's been going down, crash up, crash up. So our puts haven't generated the move that we otherwise would have wanted to. And so part of my brain after our first section was you only took four things away from all that time? So there's way more trades. So to your point, maybe back to the cattle story, it's not that cattle is a bad trade. Cattle can be an awesome trade. And you can have a 10 sharp with cattle. And the thing of it is, the cattle guy can only feed him and maybe a couple other dudes and that's about it. If someone says, okay, I think

your cattle trade is amazing. Here's a billion dollars. You can't do anything with it. It's not usable. So scalability is a big part of it. We want to be able to take a billion dollars. You can't do anything with it. It's not usable. So scalability is a big part of it. We want to be able to take a billion dollars if it's offered to us. So maybe not a billion, but you get my point. More than a couple million. More than a couple million. So the points of the trade- More than a couple hundred million. Yeah. So the idea is that it is repeatable, scalable, and in best practices. So that's why we picked the trades that we did because they have enough room so that if we're doing them, we're not interfering with the marketplace and we're not injuring our own prices and violating our own models.

If I want to go out and buy S&P 500, the size in which I would do it is not going to move the S&P 500. If you want to do that same thing in Occidental Petroleum and you have even a $10 million position in Occidental Petroleum, you have to go out there and shop it and you have to go out there and do these things to participate so that you don't move the stock. And it's not that small of a name. That's kind of my point. There's only a handful of names where you can really go out there and get aggressive. And a lot of other second and third tier names, you can just outsize them pretty fast. I mean, I move the markets in almost every trade I do now. And I can't imagine if we had several orders of magnitude larger than what we do have. That always amazes me. Some of the prop shop guys

I talked to in there focused on just the largest names. I'm like, tell me about this. I think it was Krispy Kreme. This was years and years ago. It's like, nobody trades Krispy Kreme. What are you talking about? I'm like, why not? In my brain, it's less traded. There's more edge there. And he's like- So that's true. There's been a few times in my career where I've been the single person on the planet earth that's making markets and names. And when that's the case, it doesn't need to be all that big because I have literally all the dominion that there is to have. So when, you know, in these particular names at that particular time, you know, if you saw a market in these options, there was one person you would talk to about it, me. And so I could move the vols as much as I wanted to

either lose less or make more. What happens when you go on vacation? Nothing happens. The market's just- A hundred wide. I don't even remember because I don't think I ever did that because that doesn't last very long. Typically, if you're making a market and you're the only guy out there, it really only lasts a couple of weeks, maybe more, but not much more.

So let's go pillar by pillar. Volarm. So give a quick example of a Volarm trade. A quick example of a Volarm trade would be like GM Ford, right? So you think Ford volatility is cheap and you think GM volatility is high. And so you sell GM and you buy Ford and you hope that they both kind of compress to their mean, and then you make money on both sides. That's- Buy and sell the Deltas or their Vol? Their Vol. So say for instance, you think both are a 30 volatility, and Ford's a 30 volatility and GM is a 30 volatility. And you think their correlation is 0.9. I don't even know what it is. I don't care. And Ford volatility is trading 25 and GM volatility is trading 35.

So you buy 25s and you sell 35s and you hope they both go to 30. That's a basic vol arm. And then you sprinkle so many other ideas on top of that, but that's the core. Yeah. And in my world of mainly VIX and futures trades, do you have example of like in the VIX? Do you do any in the VIX itself? So the VIX is different because VIX is the derivative of the S&P 500, of course, right? So what you're doing is you're looking at vol and mass.

So I'm able to trade VIX because I trade mainly the big products and mainly the most macro stuff. So VIX and volatility of the major indices is mainly what I care about. So how that translates in the futures world instead of SPY, it's E-minis or Russell, same stuff. But VIX and the VIX term structure is very relevant to the overall stability of the marketplace. So I look at all that stuff and I have basically a matrix of different things that are derived from macro products and some secondary and tertiary products as well that try to give me an overall opinion. And then we look at that opinion in the VIX space and we can translate that sometimes not even in the then we look at that opinion in the VIX space and we can translate that sometimes not even in the VIX space, but sometimes in the VIX space. And typically we're not like long VIX or short VIX. If we're going to do something in the VIX,

it's usually going to be in options or via butterflies. Robert Leonardukes Then a lot of naive VIX vol arbitrators would just be like, if realized it's high or implied it's higher and realized we might buy the VIX, sell the S&P or buy, buy, right? Long, long, short, short. I don't know if there's a question there. In my experience, it's been a tough trade post COVID crash for Volarb. So why do you think that is and how do you approach it differently? I don't think Volarb has been a tough trade. I think that Vol-Arb maybe within the VIX complex, it's gotten a lot more press in the last few years than it's probably had in the prior forever years. Thanks to this podcast. Sorry. Yeah.

Yeah. So Vol-Arb within the equity space, I don't think has really been that difficult anymore or less difficult, which is always to say it's a little bit difficult. Vol arb within the VIX space especially has changed in the sense that the slope of the curvature and the contango to a backward-headed space has been more violent. And the rate of change within the front has also been more violent. And what will happen is if you are long second and third month products, and then you're short the first month, the first month can go crazy. And then your second, third month do nothing. And then it goes right back. So at that point, you have to decide, what do you do? Do you fade it? Do you add? Do you trade the Delta one instrument? And our answer has been to trade the Delta one

instrument. Because if we think that in a backward dated state, the front month future is 38. The next month future is 28. And the third month future is 24. That's tough. Especially if you don't know if somebody's blowing out. A lot of times that will precipitate a large vol move. You're saying the naive approach there, backward dated 38, 28, 24. Sell the 38, buy the 28 and 24. There's no reason you can't go to 48.

Exactly. That's the danger. Exactly. And so the smartest guys that I know that have blown out almost invariably have been due to some level of basis risk. They have some kind of a model that tells them if this, then that. And I got to tell you, that isn't always the case. That's why options, I really like them because your risk is known at the time of execution, unless you're selling. If you're just naked short a bunch of somethings and those naked somethings can go someplace infinity, and that can be very bad for you. If you are able to define your risk at the time of execution, then you know that it's going to suck, but it's going to suck within a certain parameter and the trade is concluded.

But on the vol arb, you always, by definition, have to be selling some, right? To be the part that you're selling the volatility? We're not always selling, but in theory, we are always selling and buying. Just because otherwise, if you just always always buy vol the theta can just blow you out you know theta can get so heavy um all right well okay you you brought up some and we've talked mentioned ronan a few times do you have any knowledge on what happened there they blew up they blew up in vix in vix but were they doing some sort of Volarb something or other? It's the same thing I just said. It's basically business risk, right? You think that the term structure will ascend at a certain level and the shape of that term structure will maintain itself relative to other parts of term structure. And so you have a certain amount of vega on, but the vega never pays you, but the gamma blows out. And that's how people blow up.

And I didn't work at Ronan. I don't want to say things that I don't know anything about, but I know enough people in the Chicago trading community where I think I know what happened. And that was it. It was, in essence, a basis trade within the VIX complex for them. We should write another book. The 95% of all blowouts are gamma driven. Gamma is one of those things where it's like, you don't worry about it until you're at death's door. Moving on, dispersion. Sure. This seems to me to be where the pros separate from the vol-tourists. So explain what dispersion is,

or diversion if you want, but explain what dispersion is and how you think about it and implement it in an example, Trey. Trey Lockerbie So think about dispersion as, say you have a handful of marbles and you drop them into the mud. They go nowhere. They basically land where you drop them and they just kind of don't do anything. Then you take a handful of marbles and you drop them onto a ceramic floor and they'll scatter everywhere. The ceramic floor and they'll scatter everywhere. The ceramic floor is a high dispersion. They kind of go everywhere. And the mud is a low dispersion. It kind of just doesn't go anywhere. Yeah, you have a hundred marbles and they all drop, but they stay within a very tight pattern versus kind of going in a very dispersed manner.

So dispersion is a trade that is, again, it's very different than picking stocks because you can make money in dispersion in almost any marketplace. You just have to be able to be right in the correlation. So what we do is we run a correlation algorithm and we run it against where the market is trading and where the market implies it. And then we try to pick our spots and make money in it. So a dispersion trade in its most basic form, you think about stock A, stock B, and stock index AB. And the dream is that you are long volatility in A,

you are long volatility in B, and you are short volatility in index AB. Then the result is that A goes up 20%, B goes down 20%, but index AB goes nowhere. So you make money on volatility sale on the index and you make money on A and B individually. So you make money thrice. That's the simplest, dreamiest way to have it out there. Market is much more clever than that, much harder than that. Realistically, what happens is you make some money on your dispersion trade as you model it. And then there's just always every year, some kind of a thing that goes wrong in the equity space, whether it be a takeout, a scandal, a pre-announce, a miss or whatever else in the options market doesn't properly price it. So company gets taken out, the stock goes up a hundred percent. Marketplace had no idea that

was going to happen. And you make money in that money in that little slice of your dispersion trade. And just having it on can make you more money than the model would otherwise imply. Robert Leonard And in theory, the theta should be cancel each other out. They should bleed at the same rate. Jason Lowery Yes. The theta in the trade is not that painful. It is a Vega weighted neutral strategy. So we also don't have much of a Vega opinion. And so that seems like it should be doing gangbusters right now, right? Like NASDAQ, there's tons of these stocks down 80%, but the index itself is relatively, what is it, down 20. So I guess not relative, but all things held equal, it's not nearly as close as some of the single names.

No, your instinct is correct. Our dispersion trade is positive for the year. Yeah. And then that can only work in single names, right? So do you have any dispersion? So within the futures complex, we don't have an answer to the dispersion trade because it does require you to seek out, filter, and try to figure out what names have cheap volatility relative to whatever metrics you were posting them against. And then you sell index against it. And then you also kind of have to pick your spots. And then you also kind of have

to figure out the macro part of it, which is sector dispersion and sector rotation, which is also quite relevant to the trade. And why don't I just buy all 500 names and sell the index fund? It seems like warehouse all that because one of them is going to pop out. Oh, you'd only get one 500th of the weighting. In addition to that, the amount of slippage it takes just to execute that trade would probably totally negate and then take some of the money out of your model. So in other words, you can't do that for nothing. And getting out of it is even harder. And if you are right on that thing, then getting out of that thing at that new price might be much more difficult. Got it. So it's almost,

right, it's equal parts the picking of the stock, not just what's cheap, but what might have some catalyst that could move it. I wish you were that clever. What we really are doing is we're trying to figure out, we're trying to lean into sectors based on what we think from a macro standpoint. And we apply those. In other words, if we think sectors are going to do well, we think that the volatility will compress and so we do less of them. And if we think sectors are vulnerable, we think the volatility will expand, we try to do more of them. So that balancing and rebalancing constantly factors into our model in terms of a scandal or a takeout.

Preston Pysh, We have no- Robert Leonard, We have no idea. Robert Leonard, Energy, financials, tech, whatever. And what happened in, can dispersion get hit on the other side? So if you, for some reason, were short the vol in AMC and GameStop, right? That ball exploded versus the industry. Yeah. So, you know, AMC and GameStop, we're trading both of those as well. That's a separate category that doesn't really factor into dispersion.

It does a little bit because AMC is in the Russell. But yeah, as correlation goes from a very low state to a very high state. So say, you know, the marble floor starts to screech in a little bit more and becomes more of a mud floor and it's a correlation of one, that trade will lose money as a function of where you put it on and where it is now, and then how much time it takes. And you have to figure out where are you in the trade relative to where you put it on. It's like everything, it's like time and place, it's all relevant. And the meme stops, by the way, those have been great because what happens is that people are buying these extremely out of the money strikes. And so what I do is I go out there

and I try to pay zero or less than zero for out of the money call spreads. So say, for instance, you have GameStop trading, I think it's like 130 now, but 150 at the time. You look at the 300 strike calls, right? And they're trading for 40 cents, but you can buy the 290 strike calls for 40 cents. So what do you do? You buy a call spent for nothing. Or maybe you get paid a nickel or something like that. Right. You can't buy them for less than zero. So that's because you can do the spread. Yes. You can like the spread and you can get paid to take upside risk. Well, no upside risk. You can get paid to take upside gain.

And then because I don't think GameStop has any business where it is, I take those proceeds and I buy some points. So I kind of can't lose on the trade. And so those types of opportunities are there in equities that are otherwise missed in other index or macro products. So why isn't the AI world figured that out yet, right? Why aren't their computers just hammering that and anytime they see they can get a free trade, put it on? Because you have to like it because the computers are out there doing that. And if you can trade it

as a package for nothing or less than nothing, it won't exist because they'll arb it out. But if you will take the leg risk, in other words, I'll sell some of the 300s, but then I'll have to wait to buy some of my 290s. But you just have to set your parameters so that they can do that automatically, but you have to take a leg risk. That's a risk we can take. It's not that big of a risk. So for whatever period of time, but you're not going to sit there with that leg risk for a week or even- Oh, no, no, no. It would be- Hours? The most it would be would be like three to five minutes or something like that. Oh, really? Okay. Yeah. Not even hours,

three to five minutes. No, it's nothing. And then is your... So you run the dispersion back test, hard to back test, but if you ran that versus the other thing, these are uncorrelated? So we don't really need to run back tests on these things because we've been doing them in real time. So I have real data as opposed to theoretical data. The dispersion trade has, it's like every trade, it has times in which it does really well and times in which it doesn't do that great at all. And this has just been a time where it's been a good trade.

And conversely, like our vol harvesting trade, we don't even have it on because it's a bad time to do that trade. Is it a bad trade? No, it's a fine trade, but not when VIX is at 30. So we have it in our arsenal when VIX goes to 12 in three, six, 10 years, who knows. But right now is a good time for dispersion and a bad time for vol harvesting in six months time that may invert. And good segue, that's the third pillar, risk premium. That's your vol harvesting. Yeah, risk premium. So it was a trade I kind of invented in 2017 when the VIX was realizing or ZSP was realizing six and a half and the VIX was a low of eight and a half or nine or something. And there's basically nothing going on. And the

only trade to make in that year was really sell premium. And that was a great trade for that. So what we decided to do was try to harvest that. Anybody who pulls up a chart of VXX before it got blown up by... Before it stopped issuing new shares, but VXX, that chart just does right? It just permanently dies. Then you zoom in and you zoom in a little closer and you realize that every now and then it also goes up 100%. So that's a tough trade to have on. So what we try to do is participate in some of that. So in a risk-defined manner so that we can capture a lot of that death of volatility, but also do it in such a way that if volatility does spike 100% or infinity percent, we have a known quantity of risk on the table so that we can incrementally lose money if

we're wrong. And then we re-engage the trade so that we can in aggregate make money when we think that volatility is dying. And what does that look like? That's calls on the VIX or something like that? We're typically long puts, put spreads and calendars, sometimes ratios. So what we do is we try to engage on the short side of the VIX with options and a calendarizer ratioed manner so that we can make money when VIX goes down. But if we're wrong and VIX goes to infinity, we'll lose the premium. We'll lose some premium and that's it. I like it. And then we also sometimes counterweight that with other things as well, but yeah.

And what do you think about the strategy? They're like, I'm going to just sell VIX and buy calls to protect. What are the holes in that? Well, you're selling a volatility of X and you're buying a volatility of multiples of X, probably. The problem with options, and most people don't really get their arms around this for a while, is the market makers, especially in the options marketplace, are very smart. And so you really have to, it's about exceedance. You have to be able to exceed what their models are telling you. So you have to be able to either have better information, more illegal information, or just new information has to come in that was not previously modeled in.

And that's what I mean by exceedance. If you think that the Wrigley Field holds 44,000 people and you and I make a bet, what's the attendance of the game today? And I say 48 and you're like, well, it only holds 44. It turns out it is 48. You lose money. Yeah. Your short strike has been violated because you didn't accurately assess the standing room only crowd or whatever. There are ways to exceed, but if you don't exceed what the other models have, you probably won't make money. And so if you buy a hundred vol, but it realizes a hundred vol, nobody cares. If you buy a hundred vol and it realizes 90 vol, you lose money. So that's what I mean by if you have VIX versus VIX calls.

Now, it's a ratio that works, but the VIX calls are basically S&P puts. So those things are crazy expensive. And you'll see almost nobody go out there and just buy calls unless they're really cheap priced calls. Now, that doesn't mean they're cheap in terms of their model value, but they're cheap in terms of dollars. And those you will see trade, but generally- Mr. 50 Cent? Who is that guy? Yeah. That's the guy, the guy to London. And if you look at that, even that trade in aggregate,

it lost money a year. And then he had a spectacular rip, and it paid for itself. But that was a losing strategy for a long time. I'm not saying it wasn't a losing strategy against his book. If you have an $8 billion gross notional, and you want to go out and buy 100,000 50-cent calls, fine. You're going to spend a little bit of premium, and you cover your butt. But to think that you're going to make a bunch of money by buying 50-cent calls, fine. You're going to spend a little bit of premium and you cover your butt. But to think that you're going to make a bunch of money by buying 50 cent calls, unless you have knowledge that nobody else has, I just don't see how that makes money reliably. Maybe here and there,

idiosyncratically. But to say that's my strategy, that sounds like a money losing strategy to me. Or a terminal break even at best. Exactly. And sidetrack here. So what do you think all these Robinhood option traders, retail option volume at all time highs, I feel like they still don't get what you just said of, cool, I think Tesla's going to beat earnings. I buy the calls. They beat earnings. I lose money on my call. I'm like, what the hell happened? Well, so did the market makers thought it was going to beat earnings too. It's already priced into the option. It's already priced in. So the exception would be something like a GameStop where

market makers price in the at the money straddle for a certain time is this. And then they say to themselves, okay, well, here's the bid on the straddle. Here's the offer on the straddle. And we'll make money no matter what. So then when everyone comes in and gangs up on the out of the money calls, and this goes into the Vanna trade, the tails of this distribution go like this and everything goes up. So if you're selling a three Delta call on a hundred vol and the vol goes to a thousand, well, your three Delta calls in a three Delta calling more now it's a 50 Delta call and it just changes everything. So yeah, if a hundred thousand people all go out there and they buy these tiny little calls, it can move the marketplace. It doesn't mean that the math is broken because the math is never broken. It's just that if you go to a casino and you get 10,000 people to hit on 19 and they all hit, it doesn't mean your casino is broken. It just means that they all got lucky. It's one of those things.

Change the rules. They can't hit on 19. Well, there's a core difference here. Volatility can affect the outcome of the thing. If you and I are in Florida and we both buy hurricane insurance, it has no bearing on the likelihood of us getting hit by a hurricane. But if you and I are both size players in the S&P 500 or VIX market, and we buy tons of insurance, the relative likelihood of us getting hit with a crash is less. And it is less because we have that protection and we can hedge that gamma.

So it is an input into the model in the vol space, where in the hurricane space or the blackjack space, it is not an input. They are mutually exclusive. And that's a very core difference that a lot of people don't fully understand. Or sports betting versus horse race betting, right? You get your line, you're in, you have minus eight on Golden State Warriors. I bet the horse, if everyone else bets them, my odds go to basically converge. Right. Unless you get a fighter that's willing to throw the market or a player that's willing to shave some points, then it's a pretty fair bet. But again, unless you are affecting the inputs of the model, then it's different.

But in volatility space, you are impacting the inputs of the model. So let's dig into that. What percent? So there's debate out there. We had the convexitas guys, not convex, you guys, basically saying, ah, that's not really that big of a thing. Like maybe it affects the market a couple handles, but it's not like moving the market tens of percent or anything. Right. And Jem on the other side would say, hey, this is a huge deal. Modeling those flows. Where do you stand? Not to name names, but where do you stand in impact of that input? Those guys are knowledgeable. They know me and I know them. So no problem.

The VANA charm terms that are being thrown around are not new. They've been around since I've been around well before then. The idea that the marketplace will go up as a result of vol compression or time, vol compression being VANA and time being charm, and how those things affect volatility in the here and now is somewhat predictive and somewhat an observation. And it is useful when there are other non-exogenous events coming in. And you'll find that those rules are violated around the same amount of time as other things like an at-the-money straddle. So if you go out and buy an at-the-money straddle, you would say that one standard deviation of the straddle is this. And 67% of the time, you're right.

And then some other different percentage of the time, you're right. And then some other different percentage of the time, you're right by some other magnitude. The VANA trades tend to work out around that same mathematical distribution. And to use them as a guidepost as when to exit or enter trades can be useful. To use them as a standalone strategy, I haven't seen the math to support that I can hang my hat on that as a business. Right. Which in Jem's defense, he has many other strategies. He's not making it the sole signpost. But I think that there's so many things that are unknowable because your assumptions on those trades are that you know that the market basically has a risky on, right? Which isn't necessarily the case at all for Tesla or GameStop or whatever else. So your assumptions as to what cards the other guy is holding are totally flawed. You don't know what's happening in the dark pool. You don't know what's happening in the OTC market. You don't know fullness of that information, then your assumptions get weaker and weaker and weaker with each, you know, however, whatever, whatever percentage of full information you have degree of freedom on the, on what's not showing in the actual volume.

Yeah. I deliberately try not to use math terms. So I feel like it, you know, it bores people and it tries to, it tries so hard to sound smart and I try to avoid it. I appreciate it. Yeah. I've forgotten all my math terms except a very slim few. So like squeeze metrics, all those guys like putting together all those graphs, pretty look at, have some information, but how do you know if it's the right information and at what time? It's the same thing as any indicator, right? Like, okay, the golden cross or this or that.

Exactly. Exactly. So if you look at the RSI- All the time, some of the time, what's that like? Exactly. Exactly. So if you look at any one of these, say you put Bollinger Bands around a squiggly line and says, okay, if it reaches one standard deviation, it should go down. If it reaches one standard deviation down, it should go up. That works exactly in line with the math. And every now and then it's just dead ass wrong. And the magnitude in which it's dead ass wrong usually will either blow you out or not maybe blow you out, but it'll blow up the trade for whatever pro rata amount of money you had on it or vice versa. So it's just like selling it at the money straddle. It works exactly as often as you think it would based on the math.

And if you buy it at the money straddle, it works exactly as often as you think it would based on the math. Or if you buy it at the money straddle, it works exactly as much as you think it would, which isn't to say that buying at the money straddles is, I think it is a bad idea, but I'm saying if you can come up with a justification for it, which I can't, buying at the money straddles only works in times of exceedance, right? If the marketplace is pricing a 20 vol and you buy a 20 vol and it goes to 30, great, you made money. But now the marketplace is pricing a 20 vol and you buy a 20 vol and it goes to 30, great, you made money. But now the marketplace is going to price a 40 vol and good luck making it. You have to make incrementally more each time in order to keep doing that, which is a very

tough gig. Or you could gamma scalp it in theory, right? Oh yeah, right. Exactly. But then what happens is that as the marketplace re-engages you, then the crowd now either sell less or buy more, and then the gamma scalping parameters will compress. What happens is that that is the basis of where the VANA trades and whatnot can be accurate, which is to say if the marketplace has a billion calls struck at 4,500 in the S&P and that the marketplace in aggregate is long. The market makers are long a bunch of these calls. Well, they will scalp each other and then end up pinning. Pinning is a real thing. It definitely exists. And if you know those strikes and your

assumptions are correct, you can use that as a place, as a bogey, kind of a spot where you don't think it's going to radically blow through, again, barring some kind of new news. But in a no new news environment with somewhat accurate assumptions on index, I think that VANA and Charm are things that exist and can be useful. And we're talking like JP Morgan's hedged equity program and stuff like that like so just it's disclosed what where they trade with the yeah it's in the perspective so that strike is known although at the end of 21 right they said uh everyone thought it was going to be i can't remember the level 42 50 something like that and then but then they went to their brokers and

basically synthetically covered 42 50s i I think, as I remember the story. So there's, right, that's, hey, there's new information. They don't, per their prospectus, they don't actually have to execute in that strike. They could do it synthetically. Right. And that trade is really just a nerfed equity long book anyway. I mean. Yeah.

A nerf? Well, yeah, you can say that, okay, if you have a hundred units of risk or you can have the same lower volatility, 70 units of risk, or probably more like 66 units of risk, it's the same trade. So whether or not you hedge your book with these collars or you don't. Yeah. Do 70% of the exposure, same thing. Or just use the same amount or use less amount of money, then it's kind of the same trade. Well, worse because you could take that other 30% and do something else with it. There you go. Fourth pillar, bond vol arm. So this is a bit of a new one for me and our listeners. So tell us what it is, how you trade it. Why is it in

the portfolio? Sure. So there's the yield curve, right? We have twos, fives, tens, thirties, ultra bonds. That's the yield curve that people talk about. So sometimes it goes this way, sometimes it goes flat, sometimes it goes inverted. People say there might be a recession. But if you take the yield curve and just ignore it and you look at just the 10-year notes, right? So we're talking about the 10-year note, options, and then you just look at the volatility within these, which is to say the term structure, which is the Z-axis in my hand example. Yeah. It looks really good on the video here. It's coming right at me. Yeah. It's like the old second city thing. That's such an old guy joke.

So you have not the yield curve, but you have the term structure. And then you look at the volatility surface within the term structure itself. The term structure will price volatility just like anything else, whether it be Tesla or anything. The difference is that trading bonds are typically easier than trading stocks because less wacky things happen in the bond market than Tesla. If Elon Musk decides to tweet something nuts right now, Tesla will go nuts. And I have no idea. I have no control over Elon Musk. But the bond market tends to work with the Fed, macro announcements, numbers that are posted like FOMC tomorrow and jobs number on Friday, et cetera. Those things have a historical

precedent. So assuming the FOMC titans raises 50 bps tomorrow, not 75, and the jobs number ends up coming in around 390 on Friday, you would say something like, well, we think the bond market is going to move 15 ticks and have the money straddle in the next, between the time of the announcement and then decay that in-second increments. Because if you look at the announcement, usually you'll see all kinds of shocks, right? Up or down, down and up within five seconds. But then you decay it as that information becomes less machine-read and more human-read, then that will come up to a general move of the athletic money straddle. And you can use historical straddles to give you some kind of

an idea of what that is. So if you think a jobs number is worth 15 ticks in the at-the-money straddle and the at-the-money straddle is only priced at 12 ticks, then maybe you think that's a buy. Or conversely, you think that 17 ticks is too much, then maybe you sell it. And then you don't want to be short a bunch of at-the- the money straddle. So you try to hedge it out somewhere else so that you can capture maybe two or three ticks of straddle in that event, but you can cover your ass and 15 ticks of straddle somewhere else. So the idea is that when you look at the term structure of the options, you will see kinks and valleys, kinks and valleys. And it's your job to kind of know, are the kinks being generated by the valleys being wrong? Or are the kinks being generated by a sovereign wealth

fund buying a bunch of notes because they need them? Or is it generated by somebody blowing out and they have to change their position? There's all kinds of reasons that the term structure can change on a very momentary basis, and you have to be aware of it and see what's going on. Otherwise, what you do is you model a move, just like you would a move in earnings of Apple. Apple, we think is going to move 4.5% on earnings. Well, they already moved 3% the day before, so now they might actually go down, which is what they did. It's kind of the same thing within the bond market. The difference is that it's very near term. In other words, it's like tomorrow, next week. Nobody is trying to price the at the money straddle for the one year hence job numbers. There's just no market for it.

It just doesn't exist. So it's a way to keep you in constantly engaged. They can't get this month's job numbers, right? Much less a year from now. So think about this from my perspective as a guy that ran a prop firm. You've got a guy standing in the bond pit. You've got a guy standing in the Eurodollar pit. You've got a guy trading Microsoft, another guy trading JP Morgan, right? And then there's this big move in the bond pit or bond market that you notice either electronically or

however else you get the information. And then you start to reprice everything. You start to understand this stuff. And then as you see how interest rates and cash flows and liquidity inform so many things, you start to see through the matrix and you get a better idea as to what's actually happening here. And then you try to find where you can find exceedance. And sometimes the answer is there is none. Like right now, we don't have much on the bond trade because the move is at 123. How many straddles do you want me to buy when vol is at very local high and not really since the 2020 pandemic? In the 2020 pandemic, they were pricing out-of-the-money calls like it was a negative 2% interest rate on the 10-year note. I mean, those out-of- calls, I was talking to the other guys in the office and like, these are either the best

sale I've ever seen, or we're just dead wrong about where rates are going to go. It turns out they were a great sale. But I mean, tens of thousands of calls traded in the 10-year note futures options, like deeply negative rates were going to happen now. And that just never happened. And define the move index quickly for the listener. The move index was created by a guy I don't know by the name of Harley Bassman. And it is a proxy for the VIX. It's not exactly the same because it looks at multiple tenors, but it is a proxy for

the VIX in the bond market. So it is a cheap and easy way of looking at the bond market volatility. I don't look at the move as much other than I look at the VIX because I don't look at the VIX as much as people think I do because I can't trade it. And I can't trade the move. So what I really care about is the term structure and the at the money straddles within the 10-year note options because I can trade those. And I use the move as just kind of glance over the side of my screen and see what's going on. Move hasn't moved, so I don't care. And what's a 123 move in VIX terms, just to give people some bearings?

Actually, I don't know what it equates to. If I were to guess, and this is a guess, like 50. Really? It's high. It's very high. But I don't know. I could probably figure this out in my head. But that's also because it's coming from the zero bound, right? So any increase in rates is a huge percentage.

No, it's different though, because rates have a different distribution than stocks, because stocks have a log normal distribution. And the reason is because it's not going to go below zero unless it's oil. Whereas rates can go up, they can go down, and they can invert. Okay. And they can invert via different tenors as well. So it's more complicated than that. You have to look at where are the options priced and where they're priced relative to where they can go.

And they also convex to the downside. If rates go to zero, like they are last quarter, there still is a bond price and it's just not the same. Preston Pysh, MD, MPH So if you have to think about the way the distribution is plotted and you have to look at where the skew is and where the skew can flip. So it is a more complicated trade, but it is less complicated in the sense that you're not really subject to scandals. But there are things that are exogenous like wars or pandemics, things that can make the bond market go crazy. But generally speaking, is bond vol cheaper than equity vol? For sure. Yes.

Right. That seems like an overhand. But so this is somewhat historic that right now it's insanely high. The at-the-money straddle for the 10-year note has been higher than the at-the-money straddle for the S&P 500 at times of this year. In other words, just the absolute value, not even handicapping it for risk parity. The at-the-money straddle has been a greater price than the at-the-money straddle within the equity complex, which is exceedingly rare. That's why these risk parity funds have just been getting wrecked because not only is the TLT or whatever down 18%, NASDAQ's down 19%, the SPI's down 12%. If you have a levered bond position, depending on where you have it, what tenor of bonds you have it, you could be down

multiples of that multiple, but you could be done a lot more than that. Yeah. Well, the next pot after yours with the guys from Resolve talking about this is, I had this misconception too, that's not a risk parity portfolio. If you're just stocks and levered bonds, that's a... It's not. Yeah. So they're like, well, no, a classic risk parity has commodities and that have done really well during this period. Yes. That's actually one of the reasons I like what you guys do. I'm not trying to reverse plug you on your own podcast.

I think that what you're doing, which is there's this ludicrous misconception that alts are anything that's not 60-40. I just totally disagree with that. You can make money in so many different ways with size that is mathematically verifiable, which is why momentum strategies work, commodity strategies work. There's a time and a place for all of these things. Like lumber, lumber was super hot and it's still hot, but it's come down. Is lumber a good trade? If it's hot, yeah, then it's a good trade. If it's not, then it isn't. And to ignore that alpha,

to me, it's a waste of energy. Agreed. Speaking to which, so why not take this bond vol-arb and extend it into crude vol-arb or Swiss franc vol-arb? Go into all these other different markets that could have the same dynamic? So crude is different. And so the answer is I've given a lot of thought to that and I've failed. That's the short answer. And why have I failed? Because I don't have the data or the data that I have access to is too unreliable for me to use it as a business. If I get in front of an investor, everybody I talk to, I talk to zero mom and pops. I only talk to professionals. Not that I wouldn't talk to mom and pop, but they just don't know or understand what I'm doing. So I talk to guys that are extremely knowledgeable

on this stuff and they want to see the data. Nobody cares about what I think. Everyone cares about what I can prove. And I can't put together a cogent argument as to the West Texas intermediate spread versus Brent versus Abu Dhabi. And we'll look at that. We fly a helicopter with an IR scope of Cushing. There's so many factors in that, that I have no good intelligence on versus can I look at the jobs number for the last 20 years and come up with a net-to-money straddle? It's way easier. You might see that kink in crude oil and have no idea why it's there. And so you have no information and so you don't want to put that trade. I consider it to have no superior information. I only want to trade things when I feel like I have an edge. And if I think it's a coin toss, then I feel like it's rank speculation. Anybody can go out and

be long West Texas, right? Or Brent, or the spread, or the crack spread. But unless I have information that gives me some kind of an idea as to where that's going to go in exceedance terms, then I really can't look at investor- You're just flipping a coin at them. You're the guy buying the GameStop call. Maybe it beats by more than it's expected to beat. And that doesn't mean you can't get lucky, but it is not a business. It is a trade and it is a trade that might get lucky,

but it is not a business. Finishing up, we've talked a little bit. You have these macro views. And so is the macro informing the trades or this is all completely automated and mechanical? Or do you have some of these macro thoughts that inform the trades? It is both.

There's the here and now, which is the flow and the liquidity. And then there also is just that I consume as much information as I can get my hands on. And I'm a human being and I still like, I pay attention to what's going on in the world around me. Do I think that Russia is going to invade in Ukraine? Do I think Ukraine is going to invade Texas?

I have no idea. So I try to figure all these things out. And what does it mean to inflation? What is the pro-rata effect inflation will have on my bond put spreads? Well, if we think inflation is eight and a half and we think it's going to abate to six and a half, that's different than if it goes to 12 and a half. So I tried to price all of these things in. And if I have too much bond exposure relative to my equity exposure, but inflation, I feel I can go to 15. But if it does go to 15, how long can it stay

there? Because that's like, it picks at 50. So it needs so much more energy to stay up there. And it's very difficult to maintain those levels. So everything informs everything else, which really takes us back to the beginning of our conversation. How do you get this information? Well, for me, I got this information by financially backing guys in other different products and learning some of that stuff and scraping some of that IP and then hiring guys directly. I hired a guy who does nothing but dispersion out of a West Coast firm. And I was already doing dispersion, but he improved my trade. And I got IP that I otherwise wouldn't have had,

had I not employed him. And that's kind of how this process for me at least has happened. And that's how the trade becomes informed. So as you're looking at inflation data, you're looking at the jobs number and you're trying to understand what's going on. It's not so much that I'm trying to front run Powell tomorrow afternoon. It's more that I understand that if he comes in and raises 100 bips, it's a very different proposition than if he does nothing and comes in at 50. Does at expectations, no exceedance. So with that, I say we rally a little bit tomorrow. But I also look at the amount of options that are coming off the books and how much volatility that will compress. And it's not as much as it was prior. So do I think we go up 5%? I don't. I don't think there's enough sauce in the rocket

to get us up there. Do I think we could go up a couple percent? Sure. But I don't think- In the S&P we're talking? Yes. In other words, I would be more likely to sell something like a 4,700 strike call, which I do have. So there is a mathematical and mechanical reason that some of these things are justified. And everything informs everything else. But interest rates are one of the most important things to get right. And I think that it is a difficult thing to understand because you have to understand a lot about a lot. But interest rates bleeds into housing, commodities, tech versus value. That's just a modified duration trade. How much Zoom do you

want right now or Peloton or Netflix versus Berkshire Hathaway or something like that? It's just a totally different trade. But help me explain that. I don't know if you know, but tech doesn't like higher interest rates, but they're not spending borrowing tons of money to build out capital infrastructure and whatnot, right? When they issue bonds, what do they do with that money? Yeah, reinvest it into the company. They buy back their stock. This is part of the bull case. So if you can service the debt as certain percentage that you have a less, you have a concomitant move of payment ability at a higher rate.

And what that might do is attenuate some of your stock buybacks. And then what also a stock buyback does is it is a compressor of volatility because you are an agnostic buyer of stock depending on your flow desk agreement. So that all bleeds into everything else because that is also a function of volatility. And also the credit market, if you look at the credit market spreads, they've widened as well. So think about like Jeff Malik stock. Jeff Malik, when he's got tons of cash and tons of access to credit, then Jeff Malik stock when he's stressed out and he's got no credit. They're different. So the volatility of Jeff when he has no money and no credit is much higher than when he's flush. And say you have the exact same capital position,

but you have a rich dad. Well, having a rich dad is a volatile compressor because you know that if you end up in jail, your dad will probably come get you, which is a lot less volatility than going to- And rich dad is cheap interest rates. Yeah. Exactly. I can go get that money easy. Exactly. My access to the corporate debt market is greater at zero interest rates on the Fed funds level versus 5% at the Fed funds level.

It is a totally different proposition. But they don't have to build a factory or anything. That's the weird part to me. You're a software business. You don't really have these capital needs, but I see what you're saying, on stock buy-in. They're different. And that's also the bull case, because if you look at, and this is something that very few people understand about the marketplace, at least non-professionals. Why do stocks go up? More buyers than sellers. Great. Who? Who is buying the stock? The answer, almost invariably, is US public pensions. Where do the US public pensions get their money from? Tax payers.

So if you look at what's really happening there, the more stability there is in the tax base, the more money there is to allocate from taxes to the credit markets. And the credit markets are in turn gobble up corporate debt, and that corporate debt is in turn used to buy back stocks. That still happens, and it's happening now at a greater rate than it was even happening, definitely last year, because we were in a blackout period, but for many, many years, really since the 90s. And that is something that is a strong bull case for stocks in general. I love it. Any other pillars you're thinking of adding or you've got it, the four for now? So there's really two non-pillar pillars. They are macro awareness and then just what our proprietary technology is, is a way to

mitigate risk either by being short of the marketplace or avoiding the marketplace, either moving to the sidelines or going the other way. And this actually answers the question I never answered from before, which is what's the difference between running your own money versus having somebody else trade your money versus running somebody else's money? They're all different. And in general, running other people's money is worse. I know this hurts my marketing, but I don't care. It's just truthful. Because you have to bogey against the alternatives for those people. So if you're thinking about giving money to me, you have to consider the alternatives. And if the S&P is up 40% and I'm up four, well, you say, okay, well, S&P has been doing better. So I'm going to give it to the S&P.

When you are... Like right now, the market's down 12%. If I just went out and put all my chips on the S&P 500, I'm guaranteed to outperform by 12% right now. Is that a good thing to do? I would say no, but it's an accurate mathematical thing in the sense that the statement is true. Right. It's like game theory versus trying to do what's best for the client. Exactly. And I think that investors should understand what they're doing in the sense that they should understand that the person they're giving their money to understands that and is trying to always generate alpha on a real level, meaning risk-adjusted return. And sometimes you're going to outperform and sometimes you're not. But the idea is that in times of stress,

that you're really adding value and that you're not just a beta monkey. What was our other monkey from before? I can't remember. Execution monkey. There's monkeys everywhere. This place is crazy. It's like the board of trade. All right. We're going to close it up. Two truths and a lie. Our fun little bit here at the end. Give us two truths and a lie about yourself. Past trades, experiences, brushes with death, whatever you want. I'll see if I can

spot the phony. I wrote a couple of these down. I was thinking about this. Okay. I've got two. I'm going to come up with a third so I can make this more of a good quiz. You could do something about the, what is that? Banjo up above the screens?

That is mandola. A mandola. That's what I was going to say. Not to be confused with the mandolin. It's like a viola as opposed to violin. So I play most things with strings. You can't see the rest of the room but there's guitars everywhere and i like everything from banjo music to death metal i should have made that a quiz that's a bruce hornsby uh song right mandolin rain yeah yeah so to me because i've been playing instruments since i was junior high i i've become now to where it's kind of like trading. I'm sector agnostic or product agnostic. I'm almost genre agnostic. Somebody who is a talented musician, whether it be bluegrass, metal, country, or whatever else, I just appreciate the musicianship of it. I'm like, okay, it's still hard to write cool music and it's still hard to arrange cool songs. So to me, that's very interesting. And you can do that in any genre and I still think it's cool. My brother's surf rock. I'll send you one of his albums.

I like surf rock too. Yeah. It wears on me and I'm like, all right, it seems like you're very skilled at how you're playing that guitar, but he's lead guitar too. So it's constant, right? So I was just actually learning the theme to the movie endless summer and it's a fun little surf rock tune. Nice. My roommate in college was a surfer from San Diego. So I got a lot of surf music.

You've wasted two of them that you play 50 instruments and that you had a surfing roommate in San Diego. I've actually wasted all my good true, true lies. Okay. So I'll go with two to start out with. I've done better in real estate and non-stock options stuff, period. Next is actively working with Columbia University in their AI department on derivatives modeling. Columbia and New York?

Yes. Not Columbia State in South Carolina? I actually used to live there. Or Columbia College on South Michigan Avenue. Yeah, exactly. All right. We got a third? I already gave away my third, which was if I was the only market maker in the world on a stock, which I already kind of told you. So third, only market maker in the stock, true. What was the stock? Can you remember?

There's a few. So typically when stocks, how that manifests is a new stock will be issued or there's a spinoff, right? Like US Robotics was spun off from, I think it's Micron or something like that. I'm very stretching my memory here. I own like 40 shares of Smucker's or something, right? Because it got spun off out of something. Exactly. So then you know this is coming. And then if it's a weird little pit that's the corner over by the bathrooms, it just gets allocated that way by the CBOE committee. And you literally just walk over there and you say, poof, I'm the market maker. And then if

the other guys are there, don't even know how to market. So how that really, really, really happens is that the names are hard to borrow. And so the risks are different for... And other guys can't go out there and say, okay, this is the next Apple. It's a 30 vol at the money straddle. This is a piece of cake. It's not like that. What happens is you can't get the stock. You don't know what the borrow rate is. You don't know what the borrow is going to change. And if you look at the synthetic market, it's totally different. In other words, the put call parity is blown up and you have to figure out what the pro-rata risk is in the reversal, which actually super-duper dovetails into Volmageddon. How we were able to first see and totally avoid losses during Volmageddon was in the reversal market.

What happened was, in my experience, is you would see VXX, and I think it was SVXY, those reversals would start to get quoted in the broker market. And if the reversal normally is like 20 cents, and then it goes to 25 and 35, that's the telltale sign that whoever is the issuer can't get more. They're either not issuing more or the borrow is getting tighter. And that usually means if something is getting harder to borrow, it'll get more volatile. And that usually means if something is getting harder to borrow, it'll get more volatile. So that was like the exact first red light. And there was many red lights as to why, if you're a pro, you should not have been involved in those products at that time. But that was the first thing. I'd never heard anybody else publicly talk about,

which is the reversal market was Johnny on the spot. I mean, that market was very aware of the fact that new shares were getting tighter. In those names, you're saying? Yes, in those names, right. And then if you had a general awareness of volatility, how much notional vega would it take to balance these things between 4 and 4.15? And the list, everybody probably knows by now, but anybody who's really paying attention should not have been clipped by those two products. All right. We're going to let these listeners go before we make them spend the night. I'm going with Columbia University, true, and real estate versus stock options, false.

Correct. I've never made money in real estate, which nobody in California believes because everybody in California makes money in real estate. But I've had several real estate ventures and I think I've lost money in all of them. You'd get along with my dad, except his is because he's been divorced four times. So you never want to be forced to sell. Yeah. My condo in Old Town, I sold at a massive loss and I had that thing for 20 years. Nuts to think about. Well, we did the same thing. Our Old Town condo and the price went up slightly, but the assessments started out at 250 a month or something. By the time we moved, it was like 900 a month. So the cost of owning it exploded. So the new person coming in, it costs way more to own it. So they're demanding that

lower price, right? Of course. Yeah. The Columbia thing, I've just been actively working with their AI department, trying to model some of this exact stuff we've been talking about, specifically Vanna, Charm, and just Flows Trade and whatever else. And we're using the resources of the university to outsmart the smarties. And that's what we're trying to work on. Awesome. When will that be released or put out in a paper? Probably not. I mean, if it's useful, we're just going to use it. I'll talk about it in a measured pace. Put it this way, if I start writing white papers on it means i'm not making money with it yeah got it that's that other piece of research as soon as a factor gets a right paper written about it right it's no longer a factor it doesn't work anymore exactly exactly all right uh no thanks so much we're definitely going to come visit in tahoe so i just got to

decide whether i want to do some aerials on the bike or some aerials on the snow. So we'll decide which is which. I mean, why choose? Why choose? Just get both. Can you do both sometime in the late spring? Maybe. You can do both. Well, until this past weekend, you could do both in the same day, which I have literally done. So I live at 6,700 feet and so I can bike, but if you go to like 7,000 feet, which is not that much, there's snow. So you could go to Kirkwood last week and you can bike all around town. Wow. All right. Done. Late spring. Thanks so much for your time. Tell everyone what's the website, where they find you. Convex AM, which is Convex Asset Management, but just ConvexAM.com.

And on Twitter, you're doing a little bit more Twitter now, right? I know, reluctantly. I think it's Noel Convex. I don't even know my own handle. We'll put it in the show notes, so you guys don't have to figure it out. I tweet here and there, but as anybody can see, I have like seven followers, probably 12 tweets. All right. We'll build that up after the pod. Thanks so much. We'll talk to you soon. Thanks for the time today. I appreciate it. All right, Noel. Thanks, Jeff.

That's it for the episode today. Thanks to Noel Smith and ConvexAM for dropping his knowledge. Thanks to Jeff Berger, our producer for the show, and thanks to RCM for supporting. See you next week. You've been listening to The Derivative. Links from this episode will be in the episode description of this channel. Follow us on Twitter at RCM Alts and visit our website to read our blog or subscribe to our newsletter at rcmalts.com. If you liked our show, introduce a friend and show them how to subscribe. And be sure to leave comments. We'd love to hear from you. This podcast is provided for informational purposes only and should not be relied upon as legal, business, investment, or tax advice. All opinions expressed by podcast participants are solely their own opinions

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