The Derivative - Vol - Benn There, Done That with Benn Eifert of QVR Advisors

Episode Date: February 11, 2021

Why can't vol managers tell good jokes? Bad timing? Buh dum tsss. All jokes aside, we’re excited to be back talking Volatility on The Derivative with the Professor, the DJ, the Han Solo of Vol trading, the one and only Benn (with two N’s) Eifert. Benn is Founder and CIO of QVR Advisors and joined us to talk about VIX and options and the overall volatility space. We’re digging deep in this episode about matching hoodies, delta hedging driving gamma flows, hedge funds ability to be aggressive, quantimental approaches, big players & flow dislocation, what the VIX highs really mean, structural patterns in flows, tail risk vs absolute return, the force being out of balance, DJ D-Vol, retail call buying, QVR Advisors, institutional pension volatility sellers, FinTwit, and what professional vol traders are overlooking. Chapters: 02:40 = Friday Interview Questions, Good Seats, & Prop Desks 27:51 = QVR – Market Neutrality & Managing Tail Risks 49:29 = Players & Flow 01:11:31 = Are We Seeing a VIX Echo? 01:24:36 = Favorites Follow along with Benn (@bennpeifert) on Twitter, and check out the QVR Advisors website. And last but not least, don't forget to subscribe to The Derivative, and follow us on Twitter, or LinkedIn, and Facebook, and sign-up for our blog digest. Disclaimer: This podcast is provided for informational purposes only and should not be relied upon as legal, business, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations, nor reference past or potential profits. And listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. For more information, visit www.rcmalternatives.com/disclaimer

Thanks for listening to The Derivative. This podcast is provided for informational purposes only and should not be relied upon as legal, business, investment, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations nor reference past or potential profits, and listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk

of substantial losses. As such, they are not suitable for all investors. Welcome to The Derivative by RCM Alternatives, where we dive into what makes alternative investments go, analyze the strategies of unique hedge fund managers, and chat with interesting guests from across the investment world. You know, VIX is not really a reflection of the level of the S&P, right? It's a reflection of the volatility regime that you're in. And, you know, we've gone for years in the past, you know all-time highs with vol above 15, above 20. Think of the 90s was a VIX 20, 25, 30 regime making new all-time highs.

And it is, how are markets moving? It's the prices of options. And if markets are moving, markets are gapping, markets are trending, and people are buying options, then implied volatility will be elevated. And you think about a world where people are piling into crypto like crazy. There's a huge SPAC mania where pop stars are launching SPACs. You've got stocks going parabolic. You've got Wall Street bets buying, you know, crazy amounts of short-dated call options. That's not a VIX14 world, right? We, you know, there will be VIX, we will see VIX14 again, but it won't be

with these kinds of underlying market dynamics, right? It'll probably require a washout of the crazy frothy, you know, environment. And maybe that's with stocks a lot lower, or maybe it's just somehow we get a year or two of sideways markets or lower volatility markets. Welcome, everybody. We're back to talk VIX and options and the overall volatility space today. And while those were typically the realm of only institutional investors over the year, they've made their way into the overall landscape. And when asking around for the best names in the biz to learn about said strategies, more often than not, you'll find the name of today's guest being thrown into the mix. Between his being vol f twit royalty and work over at QVR, Ben Eifert is among the leaders in the volatility and options space. And he's joined us on The Derivative today to go through

it all. Thanks for joining us, Ben. Hey, absolutely. Great to be here. I'll say quickly, when we both got on, Ben had the hoodie and I went and did a quick change into my favorite fandango hoodie so where is that over here looking looking good looking good both of us i did the same thing we had jack schwager on and i he had a plaid shirt on and i was like i want to wear my plaid shirt that might this might be my new thing just hope people don't have like armani suits that i have to match up um so i don't know where to find mine after this year, man.

Yeah, exactly. You're in California, in the Bay Area? Yes, sir. San Francisco area. San Francisco, we're in north of the bridge? About a half hour south. South, okay. Down on the peninsula. In Silicon Valley area? Yeah, thereabouts.

Not that far? And you have two small kids, right? Three now. They're multiplying. Three. They're multiplying. You done? We're outnumbered, outgunned, and hopefully done.

Yeah. I was lucky enough to have the boy and the girl right off the bat and said, that's it. We're covered. We're diversified. Nice. And you were a Stanford guy, then UC Berkeley PhD, right? Yes, sir. California through and through?

Yeah, I spent a little while in D.C. a long time ago for a couple of years and then kind of commuted back and forth to New York for a little while. But I've really always been a California kid. You grew up out there? Yeah, I grew up in L.A. All right. Who do you like better, kid. You grew up out there? Yeah, I grew up in LA. All right. Who do you like better, LA or San Fran? I'm a San Fran convert. LA has its cool things.

I mean, the beaches are certainly nice and warm and all that kind of stuff. But the thing about the Bay Area is like, in LA, depending on where you're starting, it might take you like two hours to get out of the concrete and the traffic and all that stuff kind of in any direction, you know, whereas the Bay Area is, you know, really kind of built around, you know, all very close in around like some of the coolest, you know, outdoor stuff you could do. So if you like biking and hiking or just

getting away from people and getting into the trees or, or whatever, the Bay Area is really fantastic for that. Tahoe is three hours away, the beach is, you know, 20 minutes. getting away from people and getting into the trees or whatever the Bay Area is really fantastic for that. Tahoe is three hours away, the beach is 20 minutes. It doesn't suck. Your answer to this next question will depend whether I trust you or not. What do you think of Angel Island that's next to Alcatraz there? You know, I've actually never been on Angel Island. Okay, good. Don't go don't go yeah i mean it's the whole alcatraz tour and like we messed up the tickets but they'll be like if you go to angel island first and then you can take the angel island to alcatraz and then they put you on these

like disney world parking lot shuttles and drive you around the island and it's a scratch if you could just like roll around by yourself or something like maybe that'd be kind of cool yeah i mean i guess if you could hike up it but it was it was a brutal experience um totally and then my last time i was out there was staying down by the wharf or whatever and uh my son actually woke up and he's like i think there's a fire dad and he's shaking me in the hotel room and i call actually called down to the desk i'm like i think is the my son saying there's smoke in the building she'm like i think is the my son saying there's smoke in the building she's like no there's a big forest fire so it's the two times ago um napa valley fire and there was ash on the cars that was that was nasty for sure i don't know

how you guys do that day in and day out a lot of wildfire issues this last five years for sure um so let's get into your twitter persona so So DJ Deval, where did that moniker come from? Oh, I think that was a, you know, David Solomon is a is a, you know, smart and very serious guy who also happens to, you know, to be an EDM DJ on the side. And at some point in conversation with, you know, some other pretty senior Goldman Sachs people, it turned out that as you would expect, um, all of the other senior partners at Goldman have their, their secret DJ names. Um, uh, I mean, you just can't be left out of, as of something as awesome as DJ Deval, you know, the CEO of Goldman Sachs. And so I think that started to percolate through

the broader, you know, the broader system. So DJ Deol is my not uh not that secret um dj name what's his secret dj name i don't even know he's dj desol david solomon desol got it i get now i get it devol desol and he's he's actually got some okay stuff it's uh it's pretty entertaining i've seen some of that is one of the weirdest things right ever you would never paint the Goldman Sachs leader to be a DJ. Absolutely. And I think the board of Goldman Sachs doesn't particularly like it. And they're like, yeah, can you just stop doing that? And he's like, no.

You don't tell that other guy to stop playing golf or whatever it is that he likes to do. And this is what I like to do. Right. To each his own. Exactly. So I love following you on Twitter because you're it feels very balanced right you're showing pictures of your kids and running around doing hikes and stuff um a little bit of snark in there show the kids soaking the car you made me cry a little the other day because you had the kids at the train station

and my son now is 12 and he's like over trains but those were the days I could just take him on a train especially in Chicago going to L was worth like two hours of entertainment totally that's the thing about kids you know the simplest things just make them so happy but you know just seeing big trucks or seeing trains or you know seeing airplanes or whatever it is and you can just do that all day long I love it and then but on all the pods and conferences, I've seen you on your little more buttoned up. So who's, who's the real Ben Eifert? Oh, I will. I only button up if I absolutely have to. And I try not to do it too much anyway. So the, the Twitter persona is the real persona.

The Twitter, Twitter persona. Well, there's, there's probably a little more snark than, you know, your, than the, the average non-Twitter engagement, but that's there's probably a little more snark than uh you know you're the than the the average uh non-twitter engagement but that's because it's a little bit of a forum for that it lends itself to that yeah what was the uh little graphic i saw the other day it was like anonymity plus network effects equals fuckwad or something it was like twitter and the internet explain and a nice little uh whiteboard exactly um and then out of all your twitter and qvr duties you're also do you still teach or you used to teach the master's in financial engineering i used to teach for uh for several years it's one of those things that um is is great to do and there's actually there are like business benefits to you know to teaching you know, to teaching,

you get a really good look at some young talent and stuff, but it's also very time intensive. I haven't for several years. We'd love to get back to that at some point, but, you know, growing, you know, growing new firms in the earlier days is just pretty all consuming plus kids, obviously, as you know. Yeah. Well, that's the best like retirement plan, right? Just make some money in the hedge fund and go be a professor. What do you miss most about it? Was the kids or the material? I mean, I think the, you know, the interaction with the kids and the teaching process is really fun. And, you know, one of the nice things about, you know, something like master's in financial engineering programs is, you know, it's pretty different than undergrads. It's fun to teach undergrads, but also half of the class is hungover and they may or may not really care that much

about what you're talking about. Whereas, you know, MFE students are motivated. They're, you know, they're probably paying for it themselves, both through, you know, hard dollars and through opportunity costs where they could still be working at, you know, whatever decent job they had last. And, you know, a lot of them come from strong technical backgrounds and know more than you about some set of stuff, you know, whether they be PhD computer scientists or PhD physicists or, you know, whatever it is. Right. So you're actually learning from them at the same time. Yeah. The, how, who was the first to call it masters of financial engineering? Because it felt like

10 years ago, there was a bunch, they were all kind of doing the same thing, all these grad programs, but they were named different things, right? Yeah, that's a great question. I don't actually know who the first was. I think, interestingly, if anything, there's probably been a bit of a turnaround in the popularity of that term in favor of more general quantitative finance

or something with kind of financial engineering becoming somewhat of a bad word associated with the credit crisis. Exactly. You're sort of, but I think, you know, taken the, I think the initial point was, again, this was a very practical, you know, practical type of training program where you're, you know, you learn quantitative tools and in real world applications. And when were you like teaching and delving into machine learning and that kind of big data approach as well? Or was it more statistics?

You know, you ask an old guy like me a question like that, and I'll tell you, machine learning is statistics. Yeah, I agree. You know, but with a 25% increase in base salary. Yeah. And processing speed, right? That's right. And so out of that teaching professor kind of thing, is that where your Friday interview questions came from? I think that's definitely part of it. I mean,

the Friday interview question, I don't actually remember what the first one was, you know, I think I was just having fun at some point, but then, you know, people would start to ask like, Hey, where's the, you know, where's the interview question. And, you know, I think that people really like it. And I think part of it, you know, as, as you know, like I try to describe a little bit, you know, the, the type of questions that I'm asking. And, and I think the key thing is like, if you're looking for, you know, interview questions that are sort of general entry level kind of thing, you're going to get in a coding interview or a quantum interview or something like you can buy books for that. And

it's kind of standard, like brain teasery stuff or general knowledge kind of stuff. You know, but if you think, you know, three years down the line, so what about, you know, the kid who got that job, you know, sat on the trading desk at BNP for three years and is now interviewing for, you know, now interviewing for a job at a hedge fund, or now, you know, maybe interviewing for another job at a bank or something. And that level of knowledge, again, it's not, it's the kind of thing that just there isn't a lot of common, you know, you can't buy a book on that. Yeah, the way you learn, you don't know who to call, you don't know who to call the kind of thing that just, there isn't a lot of common, you know, you can't buy a book on that. Yeah. The way you learn, you don't know who to call. You don't know who to call.

The way you learn that kind of stuff, really there aren't paid for the most part. They're going to be, there's going to be relevant things that you can read to some extent, but it's very hard to piece together the context and all the different pieces. You learn that stuff, you know, by sitting next to somebody senior who teaches it to you. Right. And that I think is, is the thing people really like about it, where, you know, folks who don't have, you know, who don't have that senior person who's teaching

them, because they don't, they aren't sitting in the right seat can, you know, can try to do some learning that way. And also the people who, you know, kind of are in that seat, but but it's 2020. And it's virtual, right? And it's like like you think about how much harder it is to be the junior trainee or the junior mentee in a world where you're sitting you know in your basement you know in front of a computer you're not having those casual interactions and teaching interactions with management or with senior traders i think it's given people i think another way of learning some of that which has been and you are doing it just out of goodness of your heart or you get more Twitter followers? Like what's your end game or have none?

Yeah, I mean, the vast majority of the Twitter stuff is just fun. I mean, and, you know, a lot of it, to be perfectly honest, happens between, you know, when you're a parent, right? Like you spend some time just sort of chasing your kids around while they're riding scooters out in the, you know, out in the cul-de-sac or something like that. And, you know, then you can sneak some tweets up. The, what, do you have an example of one of them? I don't have them in front of me, but like, what was a quick one you could give an example of? We don't need to go into the answer, but the question. Sure. so take a simple example. I called this a Saturday morning junior trader

derivatives interview question, but all right, on February 20th of 2020, you bought a million dollars of Vega Notional of an S&P March 20 variance swap at 17 vol. On March 16th, we all remember how fun March was. With the S&P down 10% intraday, you check your risk report, what's your dollar delta on the position? That's the kind of thing where, you know, variance swaps are a thing that if you Google

variance swap, you know, it'll come up and you can find academic papers referencing variance swap. But I promise you, none of them are going to explain what it means that a variance swap has a dollar delta the same way that your stock positions. Yeah, usually they're talking about a start point and end point. Yeah, exactly. You know, and but you better believe that a variance swap has a dollar delta when the market's down 10 percent. And, you know, the two risk report, again, that you realistically would only learn in practice, you know, work in a job, sitting there getting taught by somebody.

And it's the kind of thing that it's not that complicated. Most of this stuff isn't, it's not complicated esoteric math for the most part. It's more understanding, you know, practical, you know, market conventions and applications and things that you just wouldn't learn in academia or from reading. It's more in my mind, right. It's more academia versus real life trader, which we see in trend following and all sorts of, right. Of like, you've built the model. You think it's great. Okay. In real, real world, do you know what it's going to react to each thing? Do you know how those trades are going to go in are you just assuming you can get the trade off when there's a spread you know all sorts of

exactly and that ends up being stuff that matters you know as much or more than you know did you do the math right or whatever but i think it also serves a huge purpose of some guy who wants to be one of those traders like oh okay this is what it takes I got to be smart enough to answer this. You mentioned seat. So I want to ask you and maybe I'll do your bio first, but like you, you came out of Stanford, out of Berkeley, you got a good seat at big firms, kind of paved the way for you to go. I've been talking to a lot of people like in the old days in Chicago, you had nothing.

You could just come to the floor and learn all those lessons, different lessons but similar lessons on the trading floor without any pedigree you know you could kind of walk in there like the floor is gone it seems like more and more you have to have the you know you have to go down the right path to get that seat um so we can answer that after you give your bio or before whatever you want yeah i mean i think that's right. There has been, you know, definitely a shift in, you know, the markets and in the typical background of people being hired into, you know, your classical entry level roles, right. And a lot of that, that's been associated with, with, you know, the rise of technology and the rise of quantitative

methods. And again, not that everybody is a quant, but like, you know, the rise of technology and the rise of quantitative methods. And again, not that everybody is a quant, but like, you know, the importance of being able to, you know, understand models to use computers to, you know, to, to write code to some extent, especially these days, right, where if you look more and more, you know, the background, the most common background, you know, hired into like a trading desk at a bank, it's going to be, you know, engineering majors and math majors and computer science majors from, you know, hired into like a trading desk at a bank, it's going to be, you know, engineering majors and math majors and computer science majors from, you know, from, from, from decent schools. And it doesn't mean you have to go to, you know, Harvard or Stanford or MIT or whatever necessarily, although I think like, like a lot of

things that certainly doesn't hurt. But there's much less of the, you know, kind of high school graduate kind of hustles and then like gets that job the way that you used to be able to on the floor, right? Right. In some sense, in the old days with the explosion of finance, you know, in the 70s and 80s, you know, there wasn't really a well-defined skill set that you could be taught in school that was in any way relevant or useful to what, you know, the job was. Why require them to have the degree? You know, people, you know, needed to be smart enough. Depending on what you were doing, there was a good value on like, you know, mental arithmetic or just being able to keep track of stuff quickly, right? Because you're doing trades and you're writing things down. And I mean,

and also, you know, if you're a pit trader, I mean, literally just advantage to being big or being loud or, you know, being able to being able to, you know, have a physically imposing presence, you know, because you're shoving people out of the way sometimes or whatever, right. So it's just a different world versus, versus today, when again, much more value on technical skills. Yeah. Yeah. I remember my first interview with a firm at the board of trade and I came in and I was, I thought I was pretty good at math. And this guy just starts throwing fractions at me like crazy because bonds were traded right in 30 seconds and 10 years and 64. And he's like, I can't remember the questions, but I was like overwhelmed. And he's like, all right, we'll see you next time. Yeah. Okay. Thanks for playing. Yeah, whereas it's funny, but a lot of, you know,

it really depends, but a lot of, you know, young, very good traders today probably wouldn't be as good at some of the types of mental arithmetic games that, you know, some of those old traders would, because you don't have to do that. You've got, you know, you use computers, you double check things, you're still fast,

but you're doing, in some sense, much more complex things, but therefore needing, you know, systems and technology and computers to do it. And then you'll see some of the prop firms, right. They'll go hire professional poker players and gamers and things like that, or just have the game theory mindset. I'll teach you the math. I just want you to have the right mindset of how to play the game. Yeah. So, yeah. So give us a little background.

So after school went to new york went a few different big firms before starting qvr yeah so you know my background again i was um i worked for the world bank uh out of undergrad uh in in a research division you know worked for the chief economist um did went back to do a PhD at Berkeley, started out similarly, like an emerging markets macro type of research. And then after about halfway through the PhD, realized I didn't really want to do the academic thing. I wasn't that good at the emerging markets stuff and got more and more interested in finance, started picking up, you know, some coursework. And at that point, at that point, you don't necessarily want to change your PhD project,

because you're like, well, I could just get out of here in a year and a half without too much work versus if you start all over. So I just I kept going in that same field. But you know, build up built up a lot of side interests in finance and did some some actually my first teaching and the master's in financial engineering department kind of as a graduate student TA, you know, build up, built up a lot of side interests in finance and did some, some actually my first teaching and the master's in financial engineering department kind of as a graduate student TA, you know, where, you know, the underlying methods, like I taught the empirical finance class and, you know, you know, you know, statistics, then you just figure out what the financial applications are. Then I, my last couple of years at Berkeley, I was working first part-time and then mostly more or less full-time by the last year for a hedge fund in Sausalito as I was finishing up my dissertation.

Then first real job after that was on the Wells Fargo prop desk in San Francisco. Wells Fargo prop desk was a great place actually at that time. It wasn't the most famous of prop desks by any means. The Goldman and Morgan guys were definitely. Yeah. I mean, you don't hear of big prop desks in San Francisco. Yeah, that's right. But the important thing really was that come 2008, all of the other major banks were under a lot of pressure and their prop desks were getting downsized, shut down, getting their positions liquidated just because they were risk for the banks. Right. Even if they were making money.

Even if they were making money. Absolutely. Right. Because at that point, you cut any positions that you have that could lose you money, you know, even if even if they've been making you money. Right. Yeah. But you weren't making enough to cover the 80 billion they were losing in the. Yeah. But Wells Fargo was, Fargo was a very big, very conservative bank that had exactly zero exposure to any of the structured credit type of stuff that was at the epicenter of LA. They obviously had real estate exposure and so forth. But so the bank was in very good shape. And they made some aggressive acquisitions and so forth because of it. But what that also meant was that, you know, the prop desk was in a position actually of great

strength versus other banks. And, you know, they, you know, dramatically increased the capital and risk tolerance for them, the balance sheet available for the prop desk. And so, you know, we were a very large force in markets actually at the at the time. We were one of the last bids in the world for distressed credit assets and all kinds of stuff. I was the quant on the desk at the time. I wasn't the PM. But I built the quant team, built a lot of the risk management system. Were they very unquant when you got there? I wouldn't say that, but they didn't have, they didn't have, you know, they didn't have, you know, a formal quant function. Yeah.

They were all smart, very smart folks who, you know, had some, some analytics and some systems and so forth, but I was the first real quant hire. Did they have the stage coach in the lobby like they do here in Chicago? The stage coach was in the lobby, not of our building, but of one of the other buildings. It was, it was pretty funny. And we, yeah, we referred to, to Wells Fargo as the stagecoach at the prop desk. And so, you know, that was a phenomenal time for the prop desk. You know, we did very, very well. And the bosses of the prop desk spun

it out as a hedge fund called Overland Advisors after the credit crisis with the support of the bank. Yeah. And what were you trading specifically or looking at? What were the main trades going through the desk or it was far in a field? So the prop desk was doing a wide variety of things. The home base was corporate capital structure. So think of things like convertible bond arbitrage, cash versus synthetic basis trading and credit, senior versus sub versus unsecured debt, and loans versus CDS and bonds. And wasn't that all getting hammered? Special situations. Wasn't it all getting hammered alongside equities in 08? Or you guys were buying at the lows? Yeah, I mean, it was definitely choppy right through right through Lehman. But then the, you know, the balance sheet and risk tolerance was tremendous. And so, you know, we were able to be aggressive when other people were, were just being forced to sell. Yeah, you know, that was,

that was kind of the key thing. And the, you know, I was, I did start to run some of the, you know, center hedging in derivatives outside of the core corporate asset classes. So things like currency volatility. But I wasn't primarily, you know, a trader in that role. The around 2011, that started to change when my old partner, John Laughlin, joined the firm. So John had been a early managing partner at Blue Mountain and he had started and run the Blue Mountain Equity Alternatives Fund, which was really one of the foundational businesses in relative value derivatives trading on the buy side

in the early and mid 2000s. And, you know, John and I got along really well. He joined Overland Advisors, the fund that had spun out of Wells Fargo. And I went over actually to work for John, hired a replacement to run the quant team. And we built a, a business there doing, you know, relative value trading and derivatives. And that was, you know, where I learned, you know, relative value trading and derivatives. And that was, you know, where I learned, you know, a lot of the foundational things that, you know, have built, you know, investment process that have that we run today at QVR, many things are very different than they were at the time that was, you know, 10 years ago. But and markets actually look very,

very different now. But, you know, that was really the But that was really the early days of these strategies. And so then somewhere in there said, hey, I'm going to go out on my own, QVR? Yeah, so John and I eventually started our own fund on the Mariner Investment Group platform called Mariner Coria. That ran for about three years. That was a great fund. My main thing, it was built on Mariner Investment Group's infrastructure. That run ran for about three years. That was a great fund. My main thing, it was, you know, it was built on Mariner Investment Group's infrastructure and they were based out of New York. So I was commuting between San Francisco and New York every week.

And then we had our first kid at the end of 2015 and I couldn't keep that up. And so ended up, ended up starting my own thing back out here on the West Coast. But the miles, right? I'm a lots of frequent flyer miles man, Virgin America. Yeah, not worth it. So give us the elevator pitch on what QVR does, how they look at the world. Yeah, absolutely.

So, you know, our investment process, well, Yeah, absolutely. So, you know, our, our investment process, well, I guess, first of all, you know, we are a boutique, you know, derivatives, options and volatility shop. We do a variety of things. So about half of the business is absolute return business that you would think of as, you know, traditional hedge fund style, style business. The other half of the business is a solutions business that you would think of as bespoke, customized mandates from very large institutional investors where we're doing something specific for them.

It's like hedging the tails of their portfolios. On the absolute return side of the business, it really is an evolution of the same type of thing, you know, that we were doing at Overland and again at Coria, but with a very, with a couple of important, you know, updates for the modern environment. So the, you know, the core of how we think about the world in absolute return land is really understanding derivatives markets and dislocations and derivatives markets that mostly come from, you know, the behavior or the actions or the flows of end users of derivatives, right. So the thing that's different about derivatives markets is the marginal,

you know, the marginal price isn't set by two big hedge funds, you know, buying or selling a stock or the end investor, right? They come from just large organizations that are just doing stuff that to use derivatives to achieve their goals. That's why derivatives markets exist so that pension funds can put on, you know, hedges or so that, you know, corn farmers can hedge forward their corn exposures and all this sort of stuff. So it's not a market that's dominated by people who are doing sophisticated nuanced pricing. They're just trying to achieve their goals. And as a result, sometimes there are large persistent or temporary dislocations in those markets that just come about from large trades having to go through the market that need to be warehoused someplace.

And it's really a systematic process of understanding and identifying those dislocations and then creating strategies around them that defines the absolute return business. Go ahead. Sorry, just quickly, I'll push back on you a little bit saying absolute return is like other hedge fund strategies. I'd say no, because it's not negative skew, right? Like most hedge fund strategies are a different type or different strategy of just being long equities and still having a big left tail exposure. Yeah, I think that's fair.

I mean, there are many hedge fund strategies that have a large component of some kind of alternative beta to them, right? Where they're giving you a beta, maybe to some unusual factor, and maybe it's only partly correlated with risk assets, but there's still some correlation, if not locally, at least in the tails, because there's some leverage to funding or something like that. Generally speaking, that doesn't have to be true, and we certainly emphasize very heavily on market neutrality and managing materials. The thing that is really new about QVR in terms of how we set up the business and how we manage

risk relative to, you know, what we had done historically, you. It comes back to some of the big changes in markets more broadly, but especially in derivatives markets over the last 10 or 15 years. So if you think back to the days of the credit crisis, or even the few years after, derivatives markets were really the Wild West. Banks took a ton of risk. I mean, even during the credit crisis, banks were very aggressive. They held a lot of inventory. They traded very aggressively. A hedge fund like ours could comp out a dozen banks on a very large, complex transaction, and they would show up, they would make good prices, they would make them in size, they would make tight markets, and you could trade almost anything that you wanted to at or very close to mid market, you know, finding the ax

on the other side, finding somebody who was, you know, willing to be aggressive. And as a result, you could, you know, you could have an investment process, and you could execute that process, you know, very efficiently, taking some counterparty risk, because a lot of those trades were OTC, but it was a market where, you know, that execution process was really, was facilitated very heavily by the risk-taking activities of banks. And before you go to the other side of that, let me dig into that. So what, why do you think they were taking so much risk? Were they incented to like in their, I mean, I know we had Dodd-Frank and it kind of made that go away. But right, the banks didn't want to lose tons of money. Did they just believe they weren't going to lose money? Certainly, there was some element of that.

And in general, they were making tons of money throughout most of that process, right? And, you know, using the bar instead of a more meaningful metric to measure true risk. And even when you look at, you know, when you look at 08, you know, many of the businesses at banks made a ton of money and continue to make a ton of money, but there were certain areas that lost absolutely catastrophic amounts of money, right? In particular in, you know, in the synthetic credit derivatives area where risk was just so extremely mispriced. And, you know, some banks recognize that earlier than others and moved to mitigate those risks. Other banks weren't really able to do that. But generally speaking, the business of facilitation of clients across a spectrum in derivatives markets is very profitable.

But what I think one thing, it wasn't necessarily profitable for those banks to be doing those aggressive trades specifically with smart relative value hedge funds. It was profitable on average for them to be trading aggressively with lots of types of clients, right? So they might be selling it to a pension

who thinks it's a good idea, but they don't know the math exactly correctly or something of that nature. Yeah, that's right. And so the, you know, there was, so another version of your question was, well, why, not just why were they willing to be aggressive in the business in general, but why were they willing to be aggressive in the business with smart relative value hedge funds that appeared to actually make money? It feels like if you beat them enough times, they're going to take their ball and go home,

right? Like, hey, I'm not trading with him anymore. He kills me every time. Yeah, and this was always actually, you know, would come down to fights between traders and salespeople, right? So generally speaking, generally speaking,

the smarter traders would understand that and wouldn't really like, you know, wouldn't be that excited to trade with, you know, the well-known hedge funds. On the bank desk. On the bank desk. On the bank desk. And the salesman saying, no, that's a good client. That's right.

But salesmen and senior business managers push very hard to have the volumes up. So salespeople get sales credits, whether or not the trade makes money, and they sure like that. And senior business people like to see their bank at the top of the league tables because their view is it's not just that trade. It's not just that client. It's an entire business franchise. And being number one in the entire business franchise matters. It means that the corporate clients are going to come to us.

And maybe we lost some money trading with these two or three hedge funds, but it's small potatoes compared to the money that we're making, because we're perceived as the biggest in the business in equity derivatives, or in, you know, rates derivatives, I think that's, and there is some truth to that. Would your former colleagues at the Wells desk trade against you? Or did they know better? They were not. Wells Fargo was never a very aggressive derivatives trading house. So generally speaking, they weren't somebody that you wanted to call for a price.

Yeah. That would have made a better story, though, if they're like, I'm not trading with that guy. I used to sit next to him. Sorry. So I interrupted your story. That's the way it used to be. And now the way it is now.

Yeah, absolutely. So that really started to change very fast when Dodd-Frank started to be fully implemented. I mean, Dodd-Frank itself dates, obviously, to the days of the crisis, but there wasn't that much change when the law was written. It was kind of phased in implementation over time in terms of, you know, stress test requirements and capital requirements and, you know, liquidity coverage ratios and all this sort of thing. And what you started to see very quickly around 2013 or 2014 was, you know, banks really losing that risk tolerance, right? So, you know, old cowboy traders getting moved out, you know, smart, young, less experienced, but very well overseen, you know, traders getting moved in, getting fired

for, you know, taking too much risk and losing what historically would have been relatively small amounts of money. You know, regulators actually, you know, getting risk reports in much greater detail than they used to and looking at them and asking questions about them, you know, all the way down to, you know, the VP level traders running, you know, running portfolios, you know, much tighter and much more sophisticated constraints on stress test losses. And the result of all this was, or the, well, first of all, the intention of all this was, you know, the regulators viewed 2008, you know, correctly, to some extent, right, as a systemic banking crisis caused by the fact that banks were taking and warehousing so much risk and made some very bad bets. And so the antidote was don't let them do that. It may have been more correctly warehousing concentrated risk in a few areas.

Yeah, I think that's right. And so what you got was the evisceration of the risk-taking capabilities in inventory warehousing capabilities of banks. And that's something that was discussed very intensively all through. This isn't sort of something that we noticed. I mean, in fixed income markets, people were talking about this to no end. And there was lots of discussion at the time about the potential liquidity implications. But it really took a while for this to work through. And those, you only got hints of how bad liquidity could be when markets came under stress, right? And the result of that was, you know, over time, if you were an aggressive relative value hedge fund trying to quote banks on, you know, big variant swap trades or big forward starting option trades or something, you know, the number of banks

that would, you know, would price it shrunk. They, the number of the banks that would price it would price it in a fifth of the size that they used to and five times wider than they used to. Right. And so if you tried to run your business the same way, it just wasn't going to work because you'd be, you know, getting, you wouldn't be able to take enough risk and you'd be paying a lot more to get the risk on. And it'd be much harder to get off, get the risk off. And you're much less nimble and this, this whole thing. I think you saw that affecting a lot of people in the space.

And, you know, you saw returns struggling across. Would you agree that was across, yeah, across the whole space is why hedge fund returns came down? Yeah, I think that certainly in our space, you saw that very clearly. I mean, I think that there's a variety of things that were playing into overall hedge fund industry returns over that time. I think you can also fairly point out that the aggregate hedge fund industry grew very fast and arguably way too fast after 2008, 2009, right? Just AUM and the size of funds grew astronomically. And to some extent, if you're really in alpha

strategies, there's only so much capital you should be able to put to work in alpha strategies before you start to dilute those returns or start to take just more and more hidden beta type of risks, right? And to your point, selling hidden tails and things like that. And what's the quote, there's more hedge funds than Taco Bells, I think. Yeah, something like that sounds about right. And so, you know, I think the natural evolution of that from our perspective was when we were building QVR, our view was the underlying problem was not the, you know, activity levels and derivatives markets being too low. I mean, if anything, that was the opposite, right? If you just, if you look at any, if you look at volume metrics in listed options and equity, for example, first in index, index options just exploded parabolically in adoption and volume over the last 10 years.

Single name options lagged a bit, but then the last couple of years have actually kept up or caught up very dramatically with explosive retail participation. The underlying issue was just bank facilitation of markets for hedge funds and for aggressive relative value players. And so our thinking was to just cut banks out of the loop. And not exclusively. I mean, we're happy to talk to banks if they have inventory, they have access, they want to unload. I mean, we're happy to have those conversations, but that's not our primary business in terms of execution.

We took the long view and built the technology and the systems to be able to work, you know, to participate in that tremendous volume on listed markets, to be able to work into and out of positions that we want, you know, on the screen by acting like one-sided market makers where we're dynamically best bid in the market for everything we want to buy, dynamically best offer in the market for everything that we want to sell. And we're liquidity providers, as we work into that process, as opposed to, you know, quoting a bank and saying, yeah, I want to buy this is what I want to buy, what's your offer, and you're hoping that there's a good offer there. And so that was a big change. In theory, that gives you worse pricing, like in

the past, if you could have gone around to eight banks and found the one sucker for lack of a better term. And now that you have to just get the worst offer and the worst bid on the screen, right? Yeah, I mean, what it does, right, in the old days, when you could, and it wasn't necessarily that you found a sucker and, you know, like bought way below mid or anything. But what it did mean is that you could have a trade you wanted to do, have the exact structuring of that trade and the risk targets of that trade, and you could just go do it, right? Or maybe if you're big enough, maybe you have to do it two or three times or something, right? But it's, you know, you have exactly the risk. You say done and you're done, right? Now you have to say, here's my target and then you have to spend some time working into that. And, you know, maybe it's minutes or maybe it's hours or maybe it's days. And you're going to have to have, you know, sophisticated systems for managing the process

over which you leg into all that risk and making sure that you're not exposed to, you know, getting too many of your shorts filled before your loans and all this kind of stuff. Right. So it's more complex. But importantly, it's not, it's, you know, it means that you're able to work trades over time and not necessarily be paying bid-ask spread. You're not lifting offers on the screen. You're showing bids and people are hitting them. And so then coming back, because you're in the vol space, I feel like you get lumped in as tail risk. Talk to that a little bit. You're saying, no, we're absolute return.

But is the structure such that you're looking for convex payoffs? Sure. I mean, there's a few different things, right? So first of all, there's two sides of the business. We do very explicitly have mandates for huge institutional investors where we structure tail risk portfolios from them. That's separate from the absolute return hedge funds side of the business. On the absolute return hedge fund side of the business, the mandate is absolute return, not to be bleeding away, carry and

hoping that the world blows up or positioning for the world to blow up, right? That said, you can, you know, broadly speaking, you can imagine two different types of absolute return trades that have different shapes of the distribution, right? I mean, one might be a trade where there appears to be a dislocation, and there's some risk reward for that. And it's a symmetric thing, maybe it's, you know, a 55% chance of win and a 45%, you know, chance of loss. And it's, you know, a dollar if you win or a dollar if you lose, and there's some positive return to that and it's symmetric and that's fine. But another type of positive, positive, you know, forecast expected return trade is one where you're just buying a really cheap option that, you know, 10% of the time, if something really bad happens in the world is going to make a bunch of money, you know, and 90% of the time, if something really bad happens in the world is going to make a bunch

of money, you know, and 90% of the time has some very small positive carry or something like that, right? Yeah, that's, or zero positive or zero or flat carry, depending on how the trade is structured, right? So, you know, if we can find, you know, significantly, what we perceive to be significantly positive expected return trades that happen to be very asymmetric, you know, that's, that's great, too. And generally speaking, in very quiet market environments with suppressed risk premium, like 2017, 28, 29, 2019, you know, you tend to find those kinds of opportunities, there tend to be somewhat less of those kinds of opportunities in the wake of crisis events when, you know, shorts have gotten blown out. And would you, is it a go anywhere? Like where you would look at like

palm oil or something of like, there's positive carry there. And I have this huge right side asymmetry. Yeah. So, you know, we, this portfolio is one where it's the investment process is not showing up every day and kind of like looking at the news and thinking about all of the entire universe of all the possible things you could trade and do and sort of what's going on. That's a little bit more of a macro, you know, macro guy thing. We're very process oriented. We have, you know, a set of strategies that, you know, all tie back to something that we fundamentally understand as traders or as, as market participants, strategies that, you know, all tie back to something that we fundamentally understand as traders or as market participants, but that, you know, we've built a big set of quantitative research around and we have a process around for how do you understand this dislocation? How do

you measure it? How do you know if it's big or small? How do you assess the expected returns and the risk? How do you think about that? And then we allocate risk across the set of strategies that we have in a portfolio construction process, right? So we do also have an opportunistic bucket. And when there's something that presents itself, that's very compelling, that doesn't fit within our more formal strategy set, we definitely will look. But it's not a process that's first and foremost kind of going around the world looking for kind of some odd new thing that we, you know, that we've never seen before. Because usually, to get really comfortable with, you know, a decent sized trade, you need to be pretty familiar with

the technicals of that market with the products with the participants to make sure you're not missing something and to make sure that you really understand what's going on. And I think that's very much more our approach. So I won't hold my breath waiting for the effort. QVR kills it in Palmwell. So would you call it more of a quantum mental then? I don't know if you like that term or what that even means, but right. So it's the whole process, but then you're basically using not discretion, but you're saying we're going to check that versus reality

before we implement the trade. Yeah, I think that's a reasonable way of thinking about it. I mean, I always think of there being a spectrum, right, from at the one end, you know, very opportunistic, one-off, you know, gut feel type of, you know, investing to at the other end, you know, fully automated back to front black box, you rent type of investing yeah um almost nothing in derivatives is at uh is is at that end right uh other than uh small you know electronic market making and high frequency like a citadel securities or something um because derivatives markets are two multi-dimensional um data by derivatives you mean more options right not like single futures right because there's a lot of it in planning. Yeah, yeah. I mean, nonlinear derivatives. Futures, absolutely. There's plenty of purely systematic stuff. But when you're thinking about strategies involving options, or certainly like light exotics or anything like that, it would be very, very rare to see, you know, fully automated front to back type of strategies.

Again, there will be a few specific exceptions, but it's pretty rare, certainly in multi strategy type of approaches like ours. So, you know, we, at the end of the day, you know, have a strong process that makes, we have a strong, you know, quantitative process that makes, we have a strong quantitative process that makes investing much more efficient because, again, these are repeatable themes where we have data that helps us to track and identify what dislocations there are, how big they are, that quantify how we think about the returns and so forth. But we're always going to be evaluating all of that data and then making incremental changes as we think is right. And we're going to be thinking about things like, is the data clean? Are there any issues with data inputs? Are there new dynamics at play here that our model isn't

really capturing that are important risk dynamics that we think you have to take into account? Are there, you know, is, are there, has there been a regime shift? Or is this apparent dislocation, not really a dislocation, it's actually a big macro theme that could have important implications for changes in markets. And we don't want to be on it, you know, we don't want to be betting against macro guys, we're buying a bunch of options, we want to be taking the other side of, you know, price insensitive, you know, end users of derivatives. derivatives so there's a there's very much a qualitative process that sits on top of of you know the systems and the models and then the the process lets you be able to be out in the cul-de-sac with your kids on their scooters too right so you're not sifting through all the data every day You mentioned in there somewhere of like the players and the flow and kind of just mentioned

if there's a big dislocation. So I've heard you talk before about PensionX. I don't know if you want to mention names here, but PensionX came in and had all this to sell or this hedge fund blew out. Like talk a little bit about how was that much bigger in the old days, or you still use those kind of, you know, it's not necessarily inside information. I'm going to get us in trouble here, but right. It's not, it's not on front page of Bloomberg either. So. Sure. Yeah. I mean, we, we definitely like to, particularly if there's something that appears to be a very large dislocation and we're going to take a lot of risk on a trade, we like to understand what's going on and what's causing the dislocation, right? And usually large dislocations are caused by large transactions. And we're talking like VIX, Mageddon, like February 18 or something?

Yeah. I mean, think about February 18. Of course, you could have looked at... So that's a great example. So let's talk through that, right? So, you know, let's say you have a set of quantitative models thinking about, you know, dislocations in the VIX futures. So what are you going to notice in, you know, January of 2018? You're going to see that, you know, VIX itself is a nine or 10, which is, you know, historically very low. You're going to see that the VIX term structure is extremely flat. Right. So when, you know, when you think about the short volatility trade that, you know, many people were piling into in the run up to, you know, through 2017 and the run up to 2018, you know, you can make money on a short volatility trade either by having implied volatility go down

more or by having, you know, time pass, and there'd be risk term risk premium in the curve, and contango in the futures curve, by which, you know, you sell at 12 a month out, and then it rolls down to 10 by the time you expire. If volatility is already at an all time low, and there's almost no term risk premium in the curve, there's essentially no way to make money on a short volatility position. But there's some really nice opportunity to lose a lot of money. That target manager was making money, right? Exactly. And then it was a rough ride. So, you know, any type of reasonable quantitative analysis, you know, from a historical perspective, the VIX term structure is going to tell you, yeah, something's wrong here. There's no risk premium in the VIX term structure. And also there's huge asymmetry in where it could go. And you could also

look in the data because you could see this and you could see that the size of the VIX ETMs was quite large, right, on the short side. So there was a lot of retail money in XIB and in SVIXY and trying to short double lever ETFs. Something that you could model, but you really did need to understand fundamentally as a trader was the way that that whole ETN complex worked and the way that it has to rebalance itself, right? So the way that either an inverse ETF or a levered long ETF or levered short ETF by that matter. They all have to trade in the same direction in response to a move in vol, right? So if vol is higher, they all have to buy vol. And if vol is lower, they all have to sell vol. And if you

understood all the magnitudes involved and the positioning involved, it gave you a whole lot of confidence that there was the potential for an extremely asymmetric squeeze higher in volatility if there was some kind of market sell-off. And it didn't have to be that big of a market sell-off because from vol of 9 or 10, it's kind of a fallacy. A lot of people will think about percent changes in VIX. And they'll think, oh, 50% is like a huge percentage change in VIX. Well, if VIX was at 30 and it went to 45, that's, you know, that's a pretty darn big move could happen, but it's, it's pretty extreme.

For VIX to go from 10 to 15. Right. $5,000 per click. Yeah. Is not a big move at all. And, you know, you can imagine that happening on a one, you know, 1.2% S&P sell-off or something like that, that happened on some minor bad news. So the potential for, if you understood all of those

pieces, you probably should have a quantitative model that assesses that term structure relative to slope. But if you really understood the positioning there and who you were really on the other side of and what mechanical forced buying that your counterparty had in an event of a market sell-off, that would give you the confidence to have a very large position. That was one way or another along the front end of the VIX curve

and in an absolute return context, probably hedged with something else. Okay. But then you've also had Intel on, right, like these pensions are all selling tons of volatility um maybe that's available in all their report you know investor reports i don't know but how does how does that all play in you just see that as the overall landscape yeah well i suppose there's there's you know two distinct things, right? One is understanding, you know, big structural patterns in flows, right? So you're kind of alleging to, for example, you know, the huge

rise in institutional, you know, call overwriting and cash secured put selling. And that's been, you know, just kind of a front starting from, say, 2012, 2013 onwards, you know, just kind of a front starting from say 2012, 2013 onwards, you know, that was just kind of a steady freight train where, yeah, much, you know, a ton of that stuff is just, if you're a public pension, generally speaking, you disclose everything that you're doing, right? You disclose every search, you disclose every, you know, every time you hire a manager, what the program is, you see the pitch book, right? And none of that stuff is, is stuff is in any way secret or proprietary,

you just sort of see it all happening. And everybody knows about it. And everybody talks about it. And, you know, the and the market makers see all the flow and, you know, so forth. Well, everybody within your small circle of everyone in that space, like the rest of the world doesn't know about it until it's right in the financial times. Yeah, no, that's right. A secondary thing is, you know, when things are getting exciting, and unusual flows are hitting, and big players are doing unusual things, then market participants are talking about them. And, you know, that's a little bit more like the other thing that, you know, that you said, that's not kind of general knowledge of the types of

things that have been happening in the patterns over the last bunch of time, that's, you know, hey, there's this, this manager that usually just sells various forms of S&P volatility, and now they're coming to us, and they just sold a million March VIX upside calls. And then next, you know, two days later, they covered those and sold twice as many, you know, of the 10 strike higher calls. Yeah. Right. Whoa. That's, and that's the kind of thing that when you are us, you, you know, you're seeing

the impact, the price impact of those kinds of trades, and they're affecting your models and your models are saying, Hey, there's a big dislocation here. What's going on? And when you, and, and, and so you want to find out, you know out what the big flows driving that are. And generally speaking, we're talking about a March 2020 example, but again, it's a small community and it's a community that shares information, not necessarily in an inappropriate way, but shares market color about transactions that are happening because it's beneficial to all of the sophisticated market participants to understand what's happening and why and how it's impacting, you know,

And they don't want to see their client get blown out or something either. Like, Hey, be careful. That guy just puked out of those positions. Yeah, no, that's right. And so it's, it's certainly something that we, you know, are very traffic very actively in this is, in this is an understanding of what's happening in the market. And this may fit, but I read somewhere you equated all this vol activity to the force being out of balance or something. So I'm a huge Star Wars fan. So talk some Star Wars to me. What do you mean by that? I think that was I think that was a quote maybe from maybe from a Corey Hofstein chat that we were having. But it's this notion that, again, if you think about what a long short equity manager is doing, they're trying to be the

smarter guy than the other long short equity manager and buy Facebook when the other guy thinks it's not a good trade and short Netflix or whatever it equity for that or whatever it is. Right. So it's sort of a zero sum game over being, you know, having the right trades on. Whereas when you think about derivatives markets, again, derivatives markets exist because of the end users of derivatives that have needs that they're trying to achieve. Right. So, you know, pension funds that are trying to put on hedges and corporations that are trying to hedge their jet fuel price exposure and all this kind of stuff. Right. And there's, you know, real economic value there to those end clients and those end clients and users are paying a pool of market impact and bid offer

spread into the market, you know, to achieve their goals, right? And sometimes those flows are idiosyncratic and balance out and so forth. But sometimes there's big themes in those flows and they're very persistent. And there's a bunch of different, you know, the call overwriting and put overwriting flow, you know, that we talked about is a good example where, you know, the clientele is one way in that trade in huge size or what, you know, particularly 20 you know 2014 to 28 2018 2019 and so that creates a dislocation because all else equal just market makers are constantly getting hit on the same thing over and over and over again and they have to adjust their prices and adjust their prices and that changes the landscape and uh the the market needs secondary market participants that can understand those dislocations and then warehouse that basis risk, right. Take down.

Basically come inside the market makers widening spread. Correct. Cause the market makers, you know, can't just indefinitely warehouse an infinite amount of that kind of trade, right. They can hold some, but especially in this environment, right. They can only hold a limited amount of inventory. At some point they have to recycle that into the market. right? Right. So the first thing a market maker does, when, you know, a pension fund hits them on, you know, 10 million vega of short dated, you know, short dated calls is they're gonna, they're gonna buy those calls, and they're gonna

sell out some two month calls, or some three month calls or something to kind of proxy hedge the volatility exposure. But then when another guy comes in that size, and another guy comes in that size, right, they're going to be trying, they're going to have to be recycling that risk out into the market. And, you know, someone else is going to have to be buying that exposure, and then set figuring out what's the hedge and figuring out what's the trade structure and what are the risk factors, what kind of a portfolio risk return does that create, how do you do it? Right. It's only that, you know, that, you know, it's, and it's that kind of balancing of the force act, right. Where, where sometimes there are temporary big dislocations that are caused by, you know, big, big trades going through and someone has to step in and kind of restore

balance there. Sometimes there are these big, more, more thematic dislocations that require, you know, folks to hold, you you know basis risk in some size or another over long periods of time and do you only come in imbalance you you're the it's the dark sides providing the imbalance you're coming in as the light side of the that's right that's we're good guys so that touched on something i wanted to like this all this retail call buying, you just tweeted out today, the call option contracts, but I got the graph here, right? It was at by retail, small customers, one to 10. I don't know what that means. They do one to 10 contracts, one to 10 lot transactions. Yeah, so it's not maybe not necessarily a small customer, but they're small orders. And most of that is going

to be is going to be small retail flow, you it will be mixed up a little bit with the small number of firms that are batching out orders into very tiny sizes and things. That's a pretty small percentage of the market, though. Generally speaking, when institutional customers go to do option trades, they trade 10,000 on the floor or whatever at S&P. So the graph you shared was 3 million at the start of 19 to 6 million at the start of 20 to 20 million to start 21 here. So up almost sevenfold in two years.

So to your point, these market makers can't keep just churning that along and warehousing that risk, right? And that's the whole concept of their delta hedging. It's driving all these gamma flows. It's driving the market higher. Like how does, how does this all end? Does it end poorly? Is it, can it keep going indefinitely? What are your thoughts? Great, great question. And one that comes up a lot. So I think you can't go on indefinitely for sure. It can go on longer than people think. So I think the couple of things to point out, you know, about this flow. So a lot of it is very short dated. So it's weekly, you know, 10 Delta calls or weekly 20 Delta calls.

A lot of it is associated with, you know, groups on social media that are coordinating trade activity, right? So it's not necessarily individual, you know, groups on social media that are coordinating trade activity, right? So it's not necessarily individual, you know, humongous individual accounts, although there are some, you know, large individuals in those communities, but it's, you know, tens of thousands or hundreds of thousands of accounts following on on a trade, you know, from a heavily followed influencer in a community, for example. And it's, you know, it's often concentrated in technology stocks and momentum stocks and narrative stocks, you know, in meme stocks for to use a word from the kids. And it's, it's option buying, which means that it's inherently limited loss, right? So this is

something that, you know, the kids are getting right. And we, you know, most retail activity and options the last 10 years was concentrated in option selling. There were a lot of people telling you, you had to do call overwriting. You had to be an option seller, you know, go on tasty trade or anything like this. Right. You always hear about like, Oh, X percent of options expire out of the money, blah, blah, blah, blah, blah. These guys get that you buy options and the, and what they're, and one key thing, right, is you'd

think, oh, how can this last? And then you have these, you know, pretty decent market corrections, right? And you think, oh, they lost so much money. And, you know, the herd of call option buying folks, you know, do lose a lot of money on those moves. But unless they're literally 100% of their account is in, you know, weekly long option premium. But in the next buy, they keep rolling.

They don't lose all of it. Maybe they lose a third of it, or maybe they lose half of it if they're taking way too much risk. But these sharp, sudden corrections that then steamroll right back into rally, they lose some money, and then they get back in, and then they make it back, and then they double it, right? And so in order to really end that cycle, it takes not it takes not just a big sell off or a sharp sell off. It takes an extended period of time where the markets are chopping sideways or down, where, you know, they're buying options and losing all their premium.

They're buying options and losing all their premium until it's, you know, until it's too much and game over. And that will eventually happen. But, yeah, it could it's hard to put a timeframe on that. Right, and a lot of fin to it would have you believe, though, that it can't happen because the market makers have to prop up the price so their gamma stays, you know, and they don't have to, which works until it doesn't, right? It works until it doesn't, right? So the effect of option gamma is an effect of acceleration, right? So it's when retail buys a lot of short-dated upside call options,

if equities are moving higher, if then market makers and people who are warehousing the short side of that have to buy more stock to stay neutral, right? And that effect is strongest near the strikes. And for very short-term options, it's really a very dominant effect only very close to strikes, right? Option gamma is kind of inversely proportional to a function of time, right? And so when there's upside call buying, what that means is there's

a lot of acceleration effects to the upside. And then if those calls keep getting replenished, there's continued acceleration to the upside, but there can be negative fundamental events that can happen and selling forces in those stocks that come from, you know, the many other folks that own a lot of stock from big institutions and so forth. And that can absolutely totally overwhelm, you know, retail call buying and, you know, push markets lower. Because if I have 50 billion to buy, whatever, 10 points higher, 10 points lower, I have 50 billion to buy, whatever, 10 points higher, 10 points lower, I have 50 billion to sell. That's right. So it works both ways. And if you, let's take the example where there's a bunch of upside call buying and the stock goes up and

rallies up and now there's a bunch of those call options are in the money, but they haven't expired yet. If you then start to get a sell off, dealers have bought a lot of stock to hedge their positions. Now they have to sell that stock right back out to, you know, we hedge on the way down. Right. So it does go cut both ways. It's more pronounced to the upside rally because it's upside calls getting bought. So at least at initiation of those positions, that gamma is to the upside. But, you know, it's not a force that, you know, can overwhelm a lot of big institutions selling stock. It's just actually big institutions have been buying stock the last six months, right? I mean, we got through March. There was a lot of selling kind of towards the lows.

But after that, people have been re-risking. And then they've been looking at bond yields at all-time lows, providing no or negative forward expected returns. And you've had big institutions taking 60-40 to 70-30 to 80-20 and just rotating into stocks because they just don't like their fixed income positions. They don't view them as offsets. And that's been a lot of net buying. But if you got a fundamental backdrop that convinced a bunch of big institutions that they needed to be sellers, that would overwhelm the effect of wall street bets trying to buy some buy some you know buy some calls we were on adam butler of resolve we were saying that target dates funds

are eventually we'll see like 150 20 right because to keep up to get the yield they need they're gonna have to go above 100 yeah which will be fun but and so do you give much credence to like uh the gex index and dicks index and all this stuff um well you know dealer gamma is a powerful and important phenomenon you know get the the original gex index is sort of a toy model that i think doesn't really capture it very well because in gex is constructed essentially just as it's just the gamma of call open interest minus the all the gamma of put open interest right which would in some sense correspond to if you thought that every call option in the world was sold to a dynamic hedger by a client and vice versa which is is sometimes it's a okay first order approximation of of things

sort of and other times it's really not i think right now it's it's really not first order approximation of things sort of, and other times it's really not. I think right now it's really not. I think you said that a lot of this call buying is also from people who were nervous about the rally and not totally convinced in buying calls instead of outright stock, right? Yeah, exactly. So flows generally are much more balanced now

than they were pre-COVID. There's a lot of net option buying from institutions. There's net selling and net buying in different buckets. It changes at different points in time. You can try to have a more sophisticated model than GEX that tries to capture that somewhat. It's hard. You still have to deal with all kinds of complexities. There's a whole OTC market that you don't see. You have to deal with all kinds of things that you can't do perfectly. But so the original kind of naive Gex index is what it is. I wouldn't assign too, too much weight to it. Again, it's a good idea. So don't just follow it on Twitter and sling trades around?

That's right. Don't sling trades on anything you see on Twitter. And then the flip side, which you just mentioned, and we talked about before, are these institutional pension vol sellers coming back in the market at all? It seems like that was a big, you know, especially for tail risk funds, they were getting all this supply of cheap, cheap convexity. And with those guys gone, maybe that's why VIX is still at 25. Yeah, there's, you know, there's different sectors of flows, right? So there's your vanilla call overwrite and, you know, put cash secured, put sell strategies that, you know, very large, you know, pension funds and institutional investors participate in. And, you know, that stuff for it, it got a little bit smaller, but it's for the most part, it's business as usual, right? Because these are

very, very large institutions that took six years of meetings to kind of initiate these types of strategies. And there are some line items someplace, and they don't necessarily do a bunch of complex attribution of the performance of those strategies. They're kind of disappointed with their performance, but it would take them, it's going to take them another four years or five years or something to downsize them, right? That's just how that space works. But, you know, there's other pockets, right? So there's the large scale retail and high net worth part of the systematic ball selling space. So you could think of that as the biggest players there were Harvest, for example, and UBSES, which were, you know, trading huge size iron condors. And there were many, many smaller players. And that space has

been eviscerated because, you know, performance generally was kind of flat for the most part for the last several years before March. And then they got hit really bad. Actually, before even 2018, 2018, they got hit really bad. The downtrend started really after 2018. And then, you know, continued now. So that was a big player that's taken out of the vol selling space. So that's contributed. And then there are, you know, retail structured products globally, which is more of the selling of long term crash risk in the form of structured notes. You know, that business, again, briefly dried up after March, you know, but then has come back with a vengeance because, you know, we're back to raging equity markets. So the coupons are bigger and retail investors love those things again.

So that tail risk supply is coming back online. And a lot of the knockouts didn't get hit, right? One last question on the ball space. What do you attribute this? You know, Vicks, last time we were at all time highs, we were at 14 or something. Now we're at whatever we are, 20-something. Do you think this is an echo from March and it's going to last years? Do you think we're in a new range? What are your thoughts? I know VIX isn't something you probably put a lot of faith in, but just as a general gauge

of the volatility. Yeah, I mean, VIX is not really a reflection of the level of the S&P, right? It's a reflection of the volatility regime that you're in. And we've gone for years in the past, at or near all-time highs with vol above 15, above 20. Think of the 90s was a VIX 20, 25, 30 regime making new all-time highs, right? The key question is, how are markets moving? Yeah, exactly. It's the prices of options. And if markets are moving, markets are gapping, markets are trending, and people are buying options, then implied volatility will be elevated. And you think about a world where, you know, people are

piling into crypto like crazy. There's a huge SPAC mania where, you know, where, you know, pop stars are launching SPACs. You've got, you know, stocks going parabolic. You've got Wall Street bets buying, you know, crazy amounts of short dated call options. That's not a VIX 14 world, right? We, you know, there will world, right? We will see VIX 14 again, but it won't be with these kinds of underlying market dynamics, right? It'll probably require a washout of the crazy frothy environment and maybe that's with stocks a lot lower, or maybe it's just somehow we get a year or two of sideways markets or lower volatility markets. But still the realized is much less than the implied, right?

So we can say all that stuff's happening and causing the implied to be high, but the realized for three, four months has been much lower. I think it was a record spread in there in December. So December, we had close to close realized vol of nine. But if you look at like intradayly measures of realized vol, it was much higher than that. So it happened to be a month where we had a lot of, you know, every intraday sell-off was bought hard and we had lots of days that were down one and a half percent or down two and a half, down 2% and kind of came back to only down 50 bps or something.

You know, that's not necessarily a reflection of a low level of volatility. That's, you know, a small sample, you know, effect, right? Same thing, look at, you know, realized volatility was nine on a close to close basis, but realized correlation was extraordinarily low. We had huge moves under the surface in individual companies and sectors and in factors. And it happened to kind of average out, right? We got some days where the index didn't really move, but you know, energy was up 7% and tech was down two. That's not a low volatility regime. Yeah, that's not a low volatility regime, right? That's a, you know, realized volatility, you know, is a very dynamic thing. And, you know, when you look at nine volatility in, you know, months in 2017, or 2019, it was, you know, everyday stocks moving 30 basis points or 50 basis points and, and single name ball very low, right? Just a very different regime. That's a good way to kind of explain your overall thoughts on the market, right? Like a simplistic vol arb kind of strategy would maybe be saying hey implied's above realized i'm gonna sell vol here um way more confident if you were to look at is trailing realized versus implied

a everybody everybody kind of thinks that right look at whether that's a good signal for selling volatility or buying volatility over the last five years is absolutely zero signal, right? If not negative signal, because, you know, ultimately mark, you know, implied volatility is not as dumb as you might think. It's reflecting a lot of things about, you know, forward looking expectations and what's going on that, you know, close to close trailing, you know, realized volatility isn't. In the old days, 10 or 15 years ago, you know, close to close trailing, you know, realized volatility isn't. In the old days, 10 or 15 years ago, you know, derivatives markets and volatility markets were smaller and a lot less efficient. And those kind of signals, you know, did work somewhat. But there's just absolutely

no evidence that they're that they, you know, add any value today, right? So saying, oh, implied, you know, you know, just recently, it looks like there's a lot of, you know, volatility risk premium, you know, doesn't help you. Now, you know, just recently, it looks like there's a lot of, you know, volatility risk premium, you know, doesn't help you. Now, you can ask questions about is the volatility risk premium regime that we're in now and likely to be in over the next, you know, six to 12 months different than it was pre-COVID. And it's a hard question to answer definitively, but there's some good reasons to think there's been at least some shift there, right? Because a lot of the, you know, you did blow out a lot of the sketchiest

selling activities. And there have been more balanced buying flows on the other side. But even some of that hedge selling has not worked, right? So if I was, I'm reading the implied, it's overpriced, I'm going to sell it, I'm going to sell S&P at the same time or buy some proxies or sell some proxies like that hasn't really worked of late either. Yeah, that's right. I mean, if you, you know, really, we've had a big risk rally, right? So if you had, everything depends on timing. But I mean, if you had come up with some kind of a hedge trade where you just shorted volatility in March, and then you shorted, you know, equities against it as kind of a proxy hedge, and you just held that, you know, that would have been very choppy and wouldn't necessarily have done that well, right? Because we've had a monster rally

and, you know, any type of hedge that you would have wanted to do for a short volatility position would have underperformed dramatically. It just depends on, okay, what did you hedge it with and what kind of hedge ratio and so forth. That reminds me, everything depends on timing. That's my favorite joke. I'll amend it for our audience. Why can't vol managers tell good jokes? Bad timing. That's very true. All right.

We'll let you go here in a second. But so what are, well, just two quick questions. What are a few things most retail vol traders get wrong? Yeah. So I think, you know, certainly one thing retail vol traders get wrong. Yeah. So I think, you know, certainly, certainly one thing, retail ball traders. I'll interrupt you quick and say, go listen to your Corey Hofstein pod, because you went through a lot of this, but give me one of those. Yeah, absolutely. I mean, I think part of it depends on whether we're talking about today's retail ball traders versus, versus, you know, three years ago,

right? Let's talk today. Yeah. So today's retail vol traders are very aggressive. They're very different than three or four years ago in that they're mostly option buyers. I think they aren't very good about thinking about risk and sizing, right? So one really important thing, if you're buying stocks, it's not unreasonable if you've got a reasonable,

a decent amount of risk tolerance to say, look, I've got $100,000 in my account and I own $80,000 worth of stocks or $100,000 worth of stocks, right? Because a really bad experience, you know, you might lose 20% of that or 30% of that, I mean, more if it's really, really sketchy stuff, right? But if you're buying, you know, weekly out of the money options, you know, borrowing markets that just go up in a straight line every single day, you know, most of the just go up in a straight line every single day, you know, most of the time, you're just going to lose all your money that you,

that you put down on those options. Right. And so, you know, what, I tend to see, you know, a lot of evidence of retail traders, you know, saying, okay, well, good. I'm, you know, I've got a hundred thousand dollar account. I'm putting, you know, I've got my trade this week. I'm putting $50,000 into it. Right. Maybe that's less than this than you would have bought of stocks, but translate the risk you're taking between that position and, you know, a stock portfolio, right? And, and it's orders of magnitude higher per dollar of, you know, premium or per dollar of spend, right? And, you know, the again, you people have lucked

out to some extent, because of just the incredible rally. the incredible rally. And more often than not, you've won on that 10 delta call option, right? But that's not the steady state affairs of the world. And you go broke very quickly, putting a meaningful percentage of your net worth into short term out of the money option buying every week. And so being careful about understanding how much risk you're taking and how to size positions, I think is important to being able to survive more extended market corrections and to be able to play again next time. And then do you think, I feel like even they're going to be buying 30 Delta calls and it goes their direction, but the ball didn't come in and they lose money on it. I don't think they have that all figured out either. Yeah, I think that's, that's definitely another thing is, you know,

a sophisticated understanding of option pricing, you know, obviously is a lot to ask for most retail traders. But you have a lot of cases where there's big crowded, you know, buying of the same kind of thing in a very high volatility name. And not a lot of understanding that, you know, you could buy, you know, you could buy if you're talking about a, even like a game, well, GameStop moved 70% today. So that's a hard, you know, example, but if it had, you know, GameStop was some of those options, you know, upside call options might've been 150 or 200 vol. That worked out because GameStop was up 70%. But if it had only been up like 8% or 12%, you might well have lost a bunch of money.

And so what the heck? Like on Robinhood, it says, buy a call means bet that the stock goes up and make money if the stock goes up. And that's literally what it says. And by the way, it's like, you know, shocking that you can kind of get away with that, right? But yeah, and when in practice, it's like, okay,

you know, how long dated is this option? How fast is the time decay? What's the slope of the skew curve? And how's the option going to ride on it as the stock rallies? Is the implied vol going to come down after the event, all that kind of stuff. And you can very easily, you know, get the right directional outcome on a short term out of-of-the-money option trade, but still lose all your money or still not make nearly as much money as you thought. And that can be a complicated calculus. I called it before, 3D chess on the water with sharks with laser beams on their head. Exactly.

There's a lot of components there. And one more. I keep saying that this time I must. Before we get to our favorites, saying that this time I must. Before we get to our favorites, then that's back to personal. But what do you think some of the professional vol traders overlook? I won't say that they get wrong, but that they overlook. Yeah, absolutely. I think that professional vol traders can be overprone to heuristics, especially heuristics that there was really a good reason for, for some

period of time. So I'll give you an example. After 2008, there was a tremendous amount of risk premium, in particular in S&P options and S&P volatility, because S&P was really, and still is, the go-to, most liquid, most benchmark place to hedge if you're worried about something. And 08 was so bad, everybody remembered how terrible it was to get caught unhedged or get caught short convexity. And so there was this very persistent bid specifically to S&P vol. And that lasted for a good four or five years. And you saw a lot of managers figure that out and put on a lot of trades over those four or five years that were short S&P volatility and long something else. It might have been long single name volatility in like a dispersion context. It might have been long European volatility or Asian index volatility, you know, where there wasn't that

persistent bid for, you know, and where there was some structured product selling flow on the other side. And those trades did quite well, you know, for an extended period of time for good reasons. You know, they were sensible trades. Then what you started to see was, you know, that persistent bid for S&P start to fade. A lot of the pension funds, participation and tail risk funds drop off after so much money got evaporated, trying to hedge at very expensive levels over the five years after the credit crisis. And then you saw more and more selling flows and eventually S&P index volatility,, further out the curve, it got very cheap. But I think there were quite a lot of folks that, again, for so long, it was a good trade to buy

European vols, sell S&P vol or buy anything and sell S&P vol that many people kind of got stuck in that as like a that's a good trade, because it's just always a good trade. And they came up with narratives about why it was always a good trade and kind of overstating a little bit of the structured products impact and, you know, all these other kinds of things. And you saw, I think a lot of people stay in those kinds of trades, you know, for years when they stopped working and then when they started losing money and still stay in them and then get totally crushed on them in 2020. And, you know, it comes again from, you know, habit formation, right? When something just every time you click the mouse,

it works. After a while, you stop thinking about why it works and you just expect it to pay you. Taleb's turkey, right? He's every day until that thousandth and oneth day, one thousand oneth day, one thousandst day. How do I say that? Cool. Let's go into, we'll finish up with some of your favorites. We can go quick fire here. Favorite Bay Area restaurant. Oh, geez, that's tough. I mean, the uninventive one would be spruce which is i think the best restaurant kind of you know high quality restaurant in san francisco i'll buy a long shot really uh really love that place the best um you know out of the blue uh you know thing probably rangoon ruby and in palo alto outstanding burmese food cheap uh yeah and i see some of your

tweets you're like in some places that look like they have no walls. There's just like outside. It looks nice. I actually got engaged in a sushi restaurant in Palo Alto. I can't remember the name of it. My wife was a consultant out there

and I was surprised. Nice. I'll have to look that up. Yeah. Gin Show is one of the good sushi restaurants in Palo Alto. Steve Jobs used to go there all the time back before he died.

That may have been it. Favorite FinTwit follow? Oh, man. Favorite FinTwit follow. I'm going to have to think about that for a second. All right, we'll skip over that one. You can come back to that one. Favorite investment book? Favorite investment book. I would say, actually, it's probably only loosely an investment book? Favorite investment book? I would say actually, it's probably only loosely an investment book. But the House of Morgan is, you know, really a chronicle of, you know, the of the Morgan family and dynasty and the businesses that grew out of that going way back to like the 1700s and a story about the evolution of the financial system globally over that process. And I think you just learn a tremendous amount from it.

Does it have when the US came to him for money, right? Wasn't he? Yeah, absolutely. Today's dollars, was he a trillionaire? You think of, yeah, you think of, it's funny, right? Because you'll get a lot of people who are very anti-central banks. But, you know, Jacob Morgan was basically the central bank before that, right? You know, it was just a more informal process. Right. Would you rather have this single guy be the central bank? Yeah, exactly. Or have some kind of government process for it.

And are you a california wine guy had jason buck on here said he lives in napa i said favorite napa wine he's like i don't like napa wines you're gonna get in trouble but so no a are you a california wine guy yeah i'm absolutely a california so some of your favorite uh labels out there totally i mean so there's your classic stuff like you know silver oak is fantastic you don't find a lot of people who disagree with that, but I'll give you some, again, less known stuff. So I really like California's Infandels. I think, you know, it's a strong comparative advantage. And, you know, there's a shop called Matsuko that just does a fantastic job, has some of the best Infphondels that you'll ever get.

But a somewhat recent discovery that's funny and has been chatted about a bit on Twitter is convexity, right? Like some of the old LTCM guys actually have a wine label, and it's actually decent. I expected it to be very overpriced for kind of the

kitsch value of the story, but it's actually halfway decent, too. I got a case of that the other day. I saw the i didn't realize they were ltcm guys yeah yeah it's uh merriweather himself a couple of the other guys that's a book someone needs to write i don't think he's there like squishing the grapes or anything right but someone needs to write the follow-up of those guys still left with some pretty good chunk of change right oh yeah after they almost blew up the world but that's story for another day uh favorite kid activity favorite kid activities your kids when you were a kid but you can tell me when you were a kid either totally favorite kid activity is probably riding bikes with uh with the kids um you know in part because there

you get to have like a fun kid activity that's a daddy and son or daddy and daughter thing, but you get to get a little bit of exercise from lose a little bit of the dad bod in the, in the process. So the kids, you know, we started out with, you know, the six month old in the front seat and then graduated to like the rear seat thing. And now Thomas is five. He's almost a little bit too big for the rear seat. And we're going to have to move to like the, the, you you know the kind of tandem trailer type of uh of bike they are like some of these dutch designs where they've got all the crazy stuff uh when they get a little older this summer we took my

son out to uh we're in snowmass and you do the down the ski hill with the jumps and the bank turns and everything oh yeah that was epic uh last question then we'll let you go. Favorite Star Wars character? Favorite Star Wars character? God, I mean, it's so uninventive to say Han Solo, but yeah, he's a legend. And you just sometimes, you know, you just got to be the decisive action in the heat of the moment.

Like you can't overthink stuff. You just gotta, you know, if you got a plan, whatever, but you just gotta be, you know, decisive and respond. And, you know, certainly through markets like March, you know, again, you have your, you know, you have your process, but there's ultimately you're gonna be stressed in every way. And you just gotta, you just gotta show up and, you know,

show up and let the adrenaline flow and get it done. That could be the new QVR motto. Never tell me the odds. Never tell me the odds. There you go. All right. Did you think of your fin twit guy? We'll let that one go.

I don't want to have you make any enemies. Oh, God. I'm like scroll. The problem is that there's just a lot of really good and really funny people. I would, I mean, it's too hard to pick one. All right. there's just a lot of really good and really funny people um i would i mean it's too hard to pick one all right we'll leave it alone uh and then and then i'll get and then i'll have like 10 people being yeah what the hell i thought i was your favorite exactly uh awesome well this has been fun sorry we went a little over but hopefully it was worthwhile no worries

absolutely no and when things open back up, we'll be sure to come out and visit in San Fran. Sounds great. Looking forward to it. All right. Thanks. Take care. You've been listening to The Derivative.

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