The Derivative - Vol Persistence, The Unholy Trinity of Risk, and the (100 yr) Dragon Portfolio for our 100th episode with Chris Cole

Episode Date: March 10, 2022

Picture this...Downtown Chicago...December 2019 B.C. (Before COVID)...The RCM crew is venturing out to a small studio ready to record the first episode of The Derivative, with no video or clue what we were doing! Who would have thought we would be crossing the 100th episode mark just two short years later!? And, we couldn't celebrate this special milestone without a one-of-kind guest. Chris Cole, founder and CIO of Artemis Capital Management, is taking it up 100%, as he tells us about his very own journey within the industry. From his days of convincing people that they need some long vol – to too many people trying to own long vol and bidding up the cost of that protection — and everything else in between. But the fun doesn't stop there! We're talking Chris's unique research pieces over the years, digging into his pet dragon (portfolio), George Lucas Star Wars as a long vol metaphor, and his could have been should have been Pulitzer material paper on Dennis Rodman — because who doesn't love the '90s Bulls?! Plus, we're bringing back a favorite fan closer from seasons 1 and 2. Stay tuned, sit back, and enjoy the show! Chapters: 00:00-02:05 = Intro 02:06-16:38 = The Wide World of Vol, Sticky Strike Regime & Inflation 16:39-45:12 = Unholy Trinity of Risk, Hyper-active Central Banks & Power Law Distributions 45:13-01:08:21 = The 100 yr Dragon Portfolio, Corporate Debt & Gold vs Crypto 01:08:22-01:22:51 = George Lucas' Optionality & Long Vol Rodman 01:22:52-01:31:43 = Hottest Take: Debt Crisis  From the episode: WHAT WOULD YOU PUT IN A 100-YEAR PORTFOLIO? Follow along with Chris on Twitter @vol_christopher and visit artemiscm.com for more information on Chris and Artemis Capital Management. Don't forget to subscribe to The Derivative, and follow us on Twitter at @rcmAlts and our host Jeff at @AttainCap2, or LinkedIn , and Facebook, and sign-up for our blog digest. Disclaimer: This podcast is provided for informational purposes only and should not be relied upon as legal, business, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations, nor reference past or potential profits. And listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. For more information, visit www.rcmalternatives.com/disclaimer

Welcome to the Derivative by RCM Alternatives, where we dive into what makes alternative investments go, analyze the strategies of unique hedge fund managers, and chat with interesting guests from across the investment world. Happy 100th episode, everyone. I remember episode one like it was yesterday. Sat down with Wayne Himmelsheim in a small studio across from our office in Chicago, December of 2019. We had an audio tech in the room, me, Wayne, our marketing head, and our graphic designer. No video and really no idea what I was doing.

Not sure I know any better now, but we've had such great guests on the show that they've made it pretty easy for me to play along and try and keep up. And somehow we're here 100 episodes later. Thanks for listening and being part of the journey. We've got a great one for you this special 100th episode, finally getting Chris Cole to come chat. In addition, we splurging got some new equipment to celebrate the milestone with a better mic and HD camera. Take us through the next 100 shows. So apologies for those watching on YouTube and not used to seeing me in HD. On to the show, Chris Cole is the founder and CIO of Artemis Capital Management, who focused on providing institutional investors volatility exposure. And he's the author of some tremendous research pieces over the years. This was a great chat where we dig into Chris's pet dragon. George

Lucas' Star Wars is a long ball metaphor and his could have been and should have been Pulitzer material paper on Dennis Rodman. And of course, all things ball.

Send it! This episode brought to you by RCM Alternatives who've been great in supporting the show and helping us access all these great guests, many of whom are clients of RCM.

So go check out what they do for managers at www.rcmalts.com. And while you're there to go along with today's show, go download the newly updated VIX and volatility white paper. And now back to the show. Welcome, Chris. Haven't spoke to you in a while. I think since the Texas ice storm last year. So how are things? It's great. How are you doing?

I'm great. Thanks for being on. Thank you for having me. And you're there in the office in Austin? I'm here in Austin, Texas. Beautiful Austin, which goes between 70 to 30 degrees. 70 to 30. Yeah. It's like, it's like literally, yeah. It's like, it's, it's almost like volatility itself.

And how is it getting too crowded down there? All the Chicagoans moving to avoid their taxes. It's a lot of, a lot of people from California actually. It's tremendous. I I hope Austin can stay weird. That's what I really hope because I think there's more VCs now than there are musicians, but there's plenty of room for people. So, you know, to, to embrace the culture down here. Didn't they have a little campaign like stay weird Austin or stay,

stay something weird is the, the official slogan for, for as long as, as long as anyone can remember. Keep awesome. Love it. So let's jump right in and talk what is happening in the wild world of vol trading. We had VIX hitting 36 today. We're just talking offline here. Nickel was up 100%. Bond sort of sold off.

So what's jumping off the page for you? What are you thinking about today? Well, I mean, obviously the big vol is in the commodity space. I mean, that's been absolutely incredible. And we're seeing kind of a repeat of the 1970s. Now, I think which I think we spoke about and was talked about, you know, in my 2019 paper about how you can get that right tail risk. But what's interesting about equity vol is that it's been a very measured downturn in the S&P.

And I think that's been what has been most striking. In fact, vol has kind of underperformed to the upside in the S&P and outperformed to the downside. And to that extent, even though optically VIX is over 30, and people would say that is high ball and it is high ball. But what we've seen, very similar to January of 2016, S&P ball has followed sticky strike regime almost to a T. And that has occurred until this last week. It all changed this last week. So, you know, what does that mean? Yeah, I'll push you on.

Tell us what sticky strike regime means. Sticky strike regime. Well- Sounds like something you need a cream for or something. Yeah, I know. I know, right? So I mean, if you think about implied vol, think about it like this for people who are more familiar with traditional equity analysis. If you're a growth investor, what you're seeking to do is you're seeking to buy companies that are going to exceed the expectation of earnings that are already embedded in the market. So to that extent, I think we all know that with a growth stock, sometimes it will report

earnings and match what the earnings expectation of the street are, and the stock will actually go down. So if you're a growth stock investor, you are buying the stock expecting it to exceed the earnings expectations already embedded in the market. And volatility is no different. If you're owning long ball, if you're a long ball shop like Artemis is, what you're looking to do is buy volatility and have that ball exceed the expectations that are already built in the market. So in many ways, the skew of the S&P or the implied volatility by strike price represents that linear expectation. And the market will gradually move down or up the skew curve, and the VIX will track that skew curve. But when there is what I call the unholy trinity of risk, which is really the combination of illiquidity, solvency risk leading to volatility, you will see jumps in that skew

curve. The skew curve will jump up vertically. And that's what happened in March of 2020. It's what happened in August of 2015. It's what happened in October of 2008. Well, what's interesting is that volatility throughout this year, from January to February, perfectly followed the expectations embedded in the skew, in the perfect linear way. And that occurred really until last week, starting March 1st. We finally saw that jump in the skew curve. And it's interesting, why did that happen? I think for the first time, people looked at this Ukraine crisis and said, wow, this could go nuclear. It could go nuclear. It was right at that point where Putin began to threaten that option. And it also coincided with a number of new sanctions by Western democracies targeting the Russian banking system, SWIFT, which I think led to some liquidity stress.

So I think, you know, first and foremost, you know, the situation in Ukraine is very sad. It's extremely sad. And I think John Steinbeck once said that, you know, in effect, it's, you know, war is a failure of, of man's intellect. That, that is exactly what this is. It is, it is an unneeded war and people are suffering. So I always want to hold that. And I always want to think about that when analyzing ball in this environment, you don't want to be making money at the expense of people's, at people's lives and their liberty. But that being said, our goal as fiduciaries is to help our investors take risk responsibly.

And the best thing that we can do in this environment is analyze it and to perform and to work within that context. So everything I talk about with Ukraine and Russia is with that in mind. But I think for the first time in the imagination of investors, we saw this risk come into play and tail risk began to get bid really for the first time this year, above the expectations that were already built into the market. And consequently, I think you have begun to see a rebound in many of the long vol and tailors funds as a result of that. It's another way to say all that, right? We've been talking in January and February up until those last days that yes, VIX is higher, but fixed strike vol has declined, right? Or the

vols come in on these fixed strikes. Is that another way to say your sticky strike regime? Yeah, that's exactly right. That's another way to kind of describe that. So, you know, meaning sticky strike, you know, the market has been following, and what we mean by sticky strike has been following that strike regime almost perfectly, implied vols moving up the skew curve along by strike, but then they jumped up very recently. And that is very interesting. And that represents a fundamental rebid of risk in the marketplace. And that's really when long vol and tail risk funds can begin to make more money. It's really when the Vega component begins to pay off, um, rather than just the, the Delta component, um, or the negative Delta or the gamma component. Uh, which we should dig into that in a second. Cause right. We've had some other guys on who have looked the other way of like, it's too expensive. It's too,

you have to wait too long for the Vega component to kick in. Why not have the Delta component and gamma hedge and flip back and forth? So let's ask you your thoughts on that. Why is that not a great idea in your opinion? Well, it's not a bad idea, but I wouldn't poo-poo that idea. But I think at the end of the day, it's Vega that's going to jump if there is a fundamental risk event and a geopolitical mishap. It will be more convex. It will be more convex. That's right.

So to that extent, I think it depends on what your objective is. There's a lot of different ways to play volatility, a lot of different objectives. But if you're interested in that type of convexity within that framework, that's what you're buying. You're buying Vegas, you're buying Bama. And that's what will protect a portfolio to some degree. Of course, if there's thermonuclear war, nothing will protect anyone. Let's hope that's not the case. Let's back up for a second. And on those, do you believe we had too much protection in the near term, like with JP Morgan, Hedge Debt, these types of programs, buffered notes, knock-ins, all this stuff?

Was that compressing the small part of the curve there and making those strikes sticky? What are your thoughts, Sam? You know, what's interesting is that what we see, at least in terms of net put delta, is actually that there's not that much. The street is actually a little bit under hedged. Across the curve? Yeah, yeah. across the curve or yeah yeah and that that's that's one of the things that we've been seeing and that if anything people have been monetizing hedges that already exist rather than adding on risk and that that has been that way for the for the majority of this year until this last week

that's that's that's what changed this fundamentally changed this last week and that's what's that's what's pretty interesting about that. And where do you see that getting bid? How far out of the money are you seeing it getting bid across the spectrum? So this really depends, I think, in terms of how much this will get bid up. I think that really depends on how this resolves. But the major factor here, which is really interesting, is that this ties in with a lot of the monetary and fiscal policy risk. Because at this point, so one of the things that sort of made me a little bit upset, I thought it was a little bit sloppy analysis.

Because I'm sure you got this across the street where people have come in and said, well, war is a reason to buy stocks. Preston Pyshko Yeah, definitely a few tweets of like, here's the S&P performance on every armed conflict over the last 100 years. And it was net positive. Jim Collison Besides being in poor taste, I mean, I think it's right. I mean, I think Wall Street needs to kind of wake up and be like, hey, people are suffering. I know people are giving investment advice, but beyond that poor taste of that type of dialogue, I also think it's sloppy analysis. Because if you go back and looking at that framework, people are looking at

the Gulf War, the war in Iraq, the war in Afghanistan, maybe even going back to the Vietnam War, inflation is super low in all these environments. For the last 20 years, we've seen inflation be very, very low throughout the Gulf War, Afghanistan. There was room for monetary policy. Even during the beginning part of Vietnam, there was relatively benign and low interest rate, relatively low interest rates, but room to cut in relatively benign inflation during the first part of that war, not towards the latter part. But if you go back and you look at the beginning of World War II, when Hitler invaded Poland, inflation was at, I think, over 8% at that point in time. So that's more of an interesting comp to some degree, not a fair comparison, not a fair comparison by all means. But from an inflation standpoint, that was the last time we

saw a major war break out with respect to that type of inflation, where there's a threat to Western democracies. And to this extent, you saw markets drop tremendously when that broke out. It was a tremendous decline in markets and a lot of volatility at that point in time, And there was not an immediate rebound. So I think some of this dialogue is a little bit myopic with respect to the regime that we're in and the fact that the Fed has its hands tied with inflation where it is. Naturally, you know, naturally, too, like war, you know, war can be a war can be an inflation buffer, you know, when you're using fiscal stimulus to, say, buy tanks, and then those tanks are blown up. And then that's not inflationary. Well,

we're not fighting this war yet. So at this point, rather than being disinflationary with fiscal spending, the only thing we're getting out of it so far is inflation, compare it to the Gulf War. That's not a fair comparison when you're trying to evaluate what this means for markets. And I'm speaking about markets here. That's what I'm only speaking about. And I think it also ignores the binary nature of it too, right? There's a non-zero chance that there's nuclear war here. Any analysis that says, hey, you average X percent after each war ignores the threat of losing all your money, right? Yeah.

So that's the key. Kind of besides that, Mrs. Lincoln, how was the play? Yeah, exactly. And so to this extent, I'm a little bit surprised that we haven't seen more of a jump, like a true jump in vols in that sense. But it also speaks a little bit to the liquidity regime and the dynamic with respect to the number of shortfall players

and the way vol might change going forward. And I think that's a really interesting thing to kind of evaluate and something that's really greatly understated by people. So your unholy trinity before was, name the three again. It's illiquidity, credit solvency, and leading to volatility. And that's the unholy trinity. So where are we at on the first two? Liquidity has been okay. But it's getting worse. Yeah. That is actually beginning to show signs of stress, whether that's premium or premium

discounts to net asset value in some major bond ETFs, whether that's interbank lending stress. We are beginning to see liquidity stress seep into the market just now. And obviously, credit spreads have been rising as well. And that is something that's pretty, we can come back to that in a second. But you go back to my 2017 paper, the Ouroboros paper,

it's making its own tale. And we talked about the over $3 trillion of implicit and explicit short volatility. And I wrote in 2017, in October, 2017, that VIX would touch all-time highs and all-time lows and all-time highs within two years. And that's exactly what happened. That December, it hit all-time lows in December 2019. And obviously we hit all-time highs in March of 2020. Not counting 1987 with

the S&P 100 fall. I'm looking at VIX, but certainly- And you're not even counting Feb 18 when you almost nailed it there too, right? Well, yeah, that's correct too. That's interesting, but it didn't hit all-time highs. Got it, got it. So at this point, you had a shakeout of the irresponsible vol players. Many of the people irresponsibly shorting volatility were shaken out and utterly destroyed by that. And you're not just saying retail there and the Zbixi short, but the institutional short sellers as well?

Yeah, that involves XIV, but it also involves a number of hedge funds that are no longer in existence that were shorting convexity in various forms. And I think, so if you look at vol modeling, right? You have all of these different vol models and vol surface models you can fit. And everyone thinks about the absolute level of vol, but one of the major elements there is vol of vol, correlation of vol of vol to vol, and vol persistence. So vol persistence is very interesting. In a regime where there is liquidity and there is none, you get the gaps up in vol, and vol collapses back down. So in that regime, vol persistence is very,

very low and vol of vol is very, very high. And that's due to the forced unwind of many of these short vol players. So that is the Ouroboros eating its own tail until it dies. Got it. Well, now we- Do you think that's from others coming in and selling the ball when it spikes too, or not, it's going through them. It's eating there. That too. Yeah. That's, that's a fair point as well. And so consequently what happens is everyone calibrates their ball models to this high vol of all low vol persistence reality. And then, you know, in, you know, 2020, everyone's talking about how quickly you have to sell your tail insurance. Oh, well, obviously, vol spikes, you have to sell it. You have to sell it. You're an

idiot if you keep it. Unless you sold it at 35 and went to 80, right? Yes. Yeah. Well, to this point, though, it's very interesting. This high vol of vol, low vol persistence, is a very modern phenomenon. It's not something that we've seen historically. I mean, you go back to 2008, and vol stayed elevated over 30 for almost a year. If you go back to the late 1990s, you saw very high vol persistence all the way between 1998 to 2002. Very high vol persistence, meaning vol- In a rising market for most of it. In a rising and falling market. Now, we don't know what vol would have been like, what implied vol would have been like in the 1970s or 1930s, but it's very, very interesting that you can look and see something mental during those periods by analyzing realized volatility.

And there was exceptionally high vol persistence of realized vol across the 1970s and across the 1930s. In fact, realized volatility would have averaged about 37 to 39 over the entire decade of the 1930s. In fact, realized volatility would have averaged about 37 to 39 over the entire decade of the 1930s. A long vol would have been a positive carry strategy, or arguably would have been a possible carry strategy in the 1930s for a decade. So this is very interesting. So there's one element, which is like you have all these short vol players that get washed out. And as a result, they're not shorting every vol spike. Or they're not getting washed out in every vol spike. And that reduces the decline in vol. And it reduces vol persistence and vol of vol.

Or excuse me, it reduces vol persistence and increases vol of all. Yeah. But there's another factor that comes into play, which is the monetary reaction function. That's another really interesting factor. So in this environment, we've had hyperreactive central banks. Every single time there's a crisis, they cut rates or they do QE or they do whatever, or they inventory corporate debt. Japan, they buy actual stocks and ETFs, right? Yeah, they buy stocks and ETFs. Well, I mean, hell, the Fed, and I would argue illegally,

my friend Daniel DiMartino Booth has said that it's against their charter as well. I would agree with her, spent some time with her and Lacey Hunt in our offices here. But like they sat back and I mean, you think about that. They invent like they gave out loans to a special purpose vehicle funded by the Treasury to buy corporate debt. Right. Well, it's a little weird. Why didn't they invest in Artemis or why? Right. Like how come those companies got the benefit? I guess I'm not politically corrected enough. Exactly. Connected enough. So if we look at this, though, they are constrained in their ability to respond.

You can't flood the market with liquidity, or maybe you can. I never say never with them. They can't flood the market with liquidity when inflation is at 7.5% and wholesale prices are at 9%. So this is very similar to what was happening in the 1970s. And it has a fundamental effect on the behavior of volatility. So at this point, dampening. I would say not dampening it. It doesn't dampen it. What it means is vol can still rise. In fact, it has a higher average. What it does is it extends out the distribution. You have less peak, but you have less extreme tails and more persistent vol. You can have these situations where vol stays over 30 for a long time

but how doesn't that hurt guys like you it's harder is that a harder game to play when it's over when it's long for a long time instead of you'd rather have the spikes there's different ways to play that uh-huh yeah yeah there's different ways to play that dynamic so it does yeah i mean you know it presents interesting opportunities because when the, when the, like definitely when absolute level of vol is higher and we only think about it linearly that way, then that definitely you're buying expensive vol. But when the market is wrong about vol persistence, that produces interesting opportunities to play forward fall.

Got it. Right. So people are expecting six months out, nine months out, 12 months out for it to have been coming in already when it doesn't stays up. Yeah. So, and that's, that's, that's quite, that's quite interesting. And so it's, it's not just, it's not just so, I mean, I, there's a lot of people that have kind of talked about, you know, the, I mean, I talked about the impact of shortfall in 2017. People have talked a lot about that institutional shortfall selling. There's a lot of talk about dealer gamma, dealer Vanna charm. And I think all of this is very relevant. It's all very relevant. And I don't poo-poo the people who talk about these things, That makes a good podcast though. Come on. It does make a good podcast. And I mean,

that analysis is extremely important as part of the mosaic of understanding markets. Do you guys use it? Absolutely. We do use it. It's extremely important in the mosaic of understanding markets. But my problem sometimes comes when, my problem sometimes comes when, you know, if you're a hammer, everything's a nail. Yeah. And there's sometimes a view that that is the only thing that matters, the only thing that matters. And to that extent, we somewhat forget that maybe looking at a different monetary and fiscal regime that has changed radically with a very different inflationary regime, that vol fundamentally is not going to behave the way that it's behaved the last 10 years. And that is something I think that kind of laser focus only on things like

flows misses. Yeah. But what does that do for those market makers, right? Because they still have to cover those strikes. So are you saying that's going to still exist? Yeah. There'll be new flow. It's still relevant. Yeah, new flow will come in to meet the new regime. That'll dwarf that dealer hedging flow. It's still relevant, but in effect, it's still a relevant part of the mosaic of understanding the markets, but it becomes less dominant as a factor than some other factors, other fundamental factors. So let me give an example on this, right? Love it. In 2020, we reached all-time lows in autocorrelation of equity prices.

So what that means is that by the dip, never paid off more, ever. Post-pandemic? Post-pandemic. That's right. And that represented a 20-year trend downward in autocorrelation. So what does that mean in English? It simply means that buying the dip pays off. If yesterday was down, today is likely to be up. Well, that was not always the case in markets. In fact, that strategy of buying the dip, which is a part of a synthetic replication of the variance swap, would have gone bankrupt if you had done it between 1919 and 1970. But something fundamentally changed in the early 70s. And take a wild guess what fundamentally changed.

I was born, but that's probably not it. It wasn't Star Wars. It wasn't Star Wars coming out. It was not Star Wars. Close second. Something to do with gold, perhaps? Yeah, it was a delink. Exactly.

It was a delinking, the Nixon shock, the delinking of gold. Right. And at that point, at that point began the regime of central bank reactionary function where central banks suddenly, and of course, interest rates peaked out. And then what began was a dynamic where every single market crisis, you could rely on a central bank to save the day. Introduce the Fed put, essentially. Introduce the Fed put, exactly, over 40 years. So here we are all the way down.

And now the real question at the end of the day, and it's worth asking, is that Fed put valid? Or is it capable in the event that inflation remains at 7.5% or the event that continued supply chain disruptions happen with oil prices expanding in Russia? And you have to imagine it's a matter of time before China tries to take Taiwan. And what does this mean for the change in the post-World War II global order of trade. But what it means at the end of the day is it will fundamentally change the vol regime. The idea that you don't have a central bank that's able to quickly respond to every market crisis because inflation is raging fundamentally changes the way that prices behave. It accentuates the right tail on commodities, and it tremendously ruins the

mean reversionary characteristics of equity markets, which by proxy fundamentally changes the vol regime. And suddenly your dynamic of extremely high vol that comes back just as fast with high vol of vol and low vol persistence goes out the door. So one of the things that I've really enjoyed to do is you can plot the magnitude of equity and vol price movements on a power law distribution. So it's fun to do this with realized volatility or the VIX. It's really fun to do this with VIX. And if you plot this on a power law distribution- Fun for some. The listeners probably included. Yeah. Yeah. So what does it mean? A lot of things, a lot of natural systems can be plotted on a power law distribution, which is exponential in nature. And what that means is that these natural systems will follow kind of an exponential growth curve.

And this one example is wars, the death count in wars. The average skirmish will perfectly follow along this power law distribution. But World War II or the Chinese-Japanese War, where there's millions upon millions of deaths, suddenly exceeds the power law distribution. So when something exceeds the power law distribution, it represents a reflexivity that pushes something even more extreme than an exponential growth curve. Right. So it's like more exponential, exponential. Yeah, more exponential. Exactly. Yeah. So if we look at this, you know, obviously wars follow this proxy. Earthquakes follow this proxy, earthquakes follow this proxy. The average tremors, and then you have your massive earthquakes, the San Francisco quake in the early 20th century. City sizes will follow this power law distribution, and in some cities like Tokyo violate it. And of course, your favorite thing, movies follow power law distributions. Your average movie comes out, it fits the power law line, but Star Wars and Avatar and Titanic exceed the power law distribution in terms of their,

in the revenue they generate. So VIX moves will neatly follow a power law distribution, except some of the VIX moves will exceed the power law distribution, both on the upside and the downside. Over 70% of the top moves, violations in power law distributions in VIX have occurred in the last three years alone. Whoa. Really? Both up and down. It's not just up. It's also down. And what do we mean by that?

Daily moves or the prints themselves? Daily moves. Okay, so if it lost 16% in a day or whatever, we're saying that might violate the power move on the downside. Yeah, exactly. Yeah, huge moves up and down. Huge moves up and down. And the majority of the top ranked ones have occurred in the last three years alone. I mean, so to put that in perspective for a second,

like we just think about that perspective. That's like you take the last three years, that is like Titanic, Harry Potter, Star Wars, Avengers endgame, all coming out in the last three years. And simultaneously, every major box office bomb, Ishtar, Heaven's Gate, John Carter of Mars, All those bombs also coming out in the last three years. To me, that is anomalous. Something smells, right? So you see the same thing. So that fundamentally, whoa, when you look at that, it pops out to you saying, this is bizarre. This is really bizarre. And why is that happening? It's because of the dominance of flows. Flows are a big part of that. The dominance of short ball, implicit and explicit strategies and the hyper reactivity of central banks that force people into these risk premium strategies that all blow up at the same time. And then the Fed comes in and rescues and creating more and more hazards so it can rinse and repeat over and over and over

again. Well, what has fundamentally changed? Many of those short ball risk premium strategies have been blown out and people are less inclined to put on that risk, whether that's a day trader sitting in Houston or whether that's a Canadian pension system. And you mean they're forced into those by the central banks by the rates being zero and they have to search for a yield elsewhere? They have to search for a yield. Yeah. So on one factor, you've seen a lot of those implicit and explicit short ball trades go away because of what has occurred. The second factor is you can't have the reactivity of central banks. The reactivity of central banks is constrained greatly by what is occurring with inflation and what is occurring in the commodity

markets right now and how the average American is going to be paying more in gas prices and food prices. For God's sakes, my parents couldn't find cat food the other day. They went to four stores looking for cat food. In Austin? No, no, in Michigan. Got it. For cat food. So when they found a store that had cat food-

They bought it all. Yeah. Right. They bought all the cat food they could find. I think of it as like the little kid comes up to his dad, he's like, dad, my ice cream fell. And the dad's like, not now, kid, the house is on fire. So asset prices are the kid with the ice cream. The Fed has this dual mandate, which they, in theory, only have the single mandate. So now we're putting rubber to the road here. Now's

the test. What do they care more about, asset prices or inflation? And so that I think is very, very important distinction. And I don't think you can just isolate that because if that changes, fundamentally, that is going to have fundamental changes to the way the equity ball behaves. Absolute fundamental changes to the way equity vol behaves. And you think that's just mentally with traders or that's also actually physically, there's not people coming in and selling the wings and selling all this vol? It'll be forced. It will absolutely be forced because A, because there will be more vol persistence. So what happens in that, much like we we saw in the seventies ball goes to 30 and it

just stays there for a long time. There's ball persistence and it stays there on average, right? Is it that you have an absolute higher ball regime? Got it. Yeah. And a higher vault, higher, lower ball persistence there or no higher ball, higher ball persistence, but also higher vol. Yeah. Higher vol persistence and a higher vol regime. So, I mean, that's, that's, I mean, it's, it's a, it's a fascinating dynamic and that is a fundamental shift about the way vol will behave that will fundamentally change the way that people will need to look at, at different

strategies. If that is, if that is the case. So part of that is just to wash out a short ball traders in that framework. And part of that will be the actual reaction function of central banks and how that impacts the realized volatility of equity prices. I mean, equity centric, obviously. I mean, commodity vol is a different thing. There'll be more realized vol on the right tail of commodities in this framework. But I think you can kind of see how that all comes into play. Definitely. Part of my theory is the risk departments are infinitely better at their jobs than they were five years ago, 10 years ago, 25 years ago, right? So you used to have these big hidden risks inside a bank and they blew up and it caused vol.

Now that's, hey, Chris, three strikes and you're out, right? You didn't close out that position. You went over your bar limit today. We're liquidating your, right? The computer systems and all that have kind of tightened up the ship on an institutional level a little bit. Let's think about it for a second. Is it the risk departments or is it the quant models themselves? Because if there's persistently higher vol

across asset classes, as there was in the 1970s, back when inflation where it is today, we have the highest inflation since early 80s, 70s, as was in the 1930s. If there's persistently higher vol, many of these strategies de-lever with vol. So in many ways, the strategies will be forced to deliver simply by the fact that vol persistence will be higher. Right. They'll still give their investors 17 vol or whatever, but by de-levering to meet the new vol regime. Yeah. If you're targeting 15 vol and vol is at 30, you're going to have to run persistently at 30. And commodity vol is at a gazillion. You're going to have to pull back your positions.

Right. Commodity. And risk parity will have to do it too. And all of these quant strategies will be doing it. So in many ways, it might not even be the risk department doing anything. The natural order of the markets will de-lever. But that can also lead to more volatility, right? As they're de-levering into a sell-lever. But that can also lead to more volatility, right? As they're de-levering into a sell-off.

And that naturally leads to more persistent vol as well. It once again becomes, so it's vol persistence. Everyone thinks in terms of vol level. Is there a fancy Greek for that or no? I guess no, right? Right. There should be. Yeah. But you can fit it. I mean, it's one of the fit parameters for many of these vol surface models. So that's kind of fun. Maybe those vol surface models become a little less academic and you can actually pull something out of that. You can pull that whole persistence out. How do you guys think about it? In your programs, you also look at proxies as I call them, right?

Of like, hey, if index falls too expensive, maybe we go into rates fall or gold or whatnot. Explain to us how you think about that, how that works and what you're seeing right now with rates fall going through the roof. I think I saw it's been at its highest in a few years. Well, you know, I'm a believer at the end of the day that, that it's, it's a combination of different conditions because, uh, what appears to be high, uh, what appears to be high may only be high by looking in the rear view mirror. So of course that can lead you to trouble too. Yeah, let me give an example. I'm not saying we're going to go into hyperinflation. Please don't infer that from this. But if you looked at the German hyperinflation, bankers would come out and they'd be like, okay, we're going to lend you money to buy this thing

at 2%. And they're like, oh, okay, now rates are higher. We're going to lend it to you at 5%. And people were like, oh, rates are, rates are high. And we'll lend it to you at 8%. It's like, okay, well, rates are high. We'll lend it to you at, um, lend it to you at, uh, uh, 20%. And then, oh my God, it raised a really high. And then they just stopped lending and any interest was at a thousand percent. So to the same fashion- That exceeded the power law there as well, probably. Yeah. So for a long time, people would say that 27 vol is high. But 27 is exactly where vol averaged in the late 90s. That was average vol in the late 90s. And someone might go back and say 30 vol is

expensive. But vol averaged 37 to 39 on a realized basis in the 1930s. So I don't think you can necessarily divorce volatility of any asset from the macro environment. The vol of oil is fundamentally different today, given what's happening geopolitically, than it was six months ago. So in that sense, it's an analysis of all, whether it's quantitative or qualitative, requires not only an understanding of dealer flows. I think that work is incredibly important. And I respect the people who do that work. But it's not only a basis of looking at flows, but it's also a basis of looking at things like everything from monetary, fiscal policy, geopolitics, and trying to quantify each of those factors in some sort of a way that can be repeatable and unusable. Definitely flow is one of the things that's most data-driven and one of the easiest things to kind of look at. But to this extent, liquidity and credit stress, I think, are paramount to equity vol. And I would argue just as important in many conditions. And there's

a lot of good data that one can observe to those effects to understand ball persistence. So what is, what is high or low ball is really dependent on the specifics of a cross section of data analysis across these factors. And as we spoke about earlier on, it depends what people are expecting and what actually happens is even more important, right? Yeah, that's it. That's exactly right. So, but as you guys are using those tools, how do you think about that? You're, it's a Vega play in rates and in gold as well, or more of a Delta play in those? I mean, you can, you could be a Vega play or you can, you could tilt it as well in a direction. So, but I, I think to some extent, um, uh, to some, clients may have a preference in one way. Clients may have an objective to that extent.

And so you're seeking to meet that objective. So it depends. Are you looking at it on an overlay basis as a means to protect a particular portfolio? You know, what type of pain points does a client have? And how can you address those pain points by your exposure to vega, gamma, deltas, and higher order Greeks like Vama, for example. Let's change subject here for a minute. so you're known as the ball guy but your newest pet so to speak is the dragon portfolio um so i first got to ask you what's with all the animal names you've got the aurora borealis the dragon the serpent the hawk um does that come out of your

brain or what's with all the animal names i guess guess it just comes out of my brain. I don't know. That's a good question. Right. Artemis itself, right? The dragon came out of, it was kind of an accident because I wrote that paper, Allegory of the Hawk and Serpent. And I looked back over a hundred years backtesting all these different quantitative strategies. And they're all out there. And the thing about the Allegory of the Hawk and Serpent paper is that the appendix is actually longer than the paper. That's not easy to do, especially with volatility, right? Yeah, exactly.

There are a lot of interesting assumptions, I think valid assumptions. But to that extent, I always looked at that analogy. The serpent represents a regime of secular growth and moral hazard and reflexivity. And in the Iliad, a hawk comes down and kills the serpent. And the hawk in this case represents secular change. It represents either inflation or deflation. You know, the right wing of the hawk represents inflation and the left wing of the hawk represents deflation. So you end up having a hawk come over and disrupt the corrupt Ouroboros of the snake eating its own tail. And of course, what the dragon represents is the combination of a hawk and serpent.

And that's, you get a dragon. And the dragon portfolio, the 100-year portfolio diversifies. It's really meant to be a competitor to a 60-40 portfolio, a competitor to a risk parity portfolio, because the vision of the Dragon portfolio is to diversify based on thematic regimes of markets and not by asset classes. And so to this extent, the Dragon portfolio combines assets that perform during periods of inflation and stagflation. Of course, that would be fiat alternatives like gold, silver, and commodities, and then commodity trend advisors. Commodity trend advisors are a big component. Obviously, then you have assets that perform in deflation. That would be volatility and fixed

income. And then you have assets that perform in periods of secular growth. And that would be assets like stocks, equity. And so you combine all of these assets together, not predicting what regime you're going to be in. And you apply some degree of leverage to reach your volatility target. And when tested over 100 years, I think quite credibly, as outlined in that paper, that is a portfolio that outperforms and more importantly, outperforms almost every single systematic trading strategy, and importantly, performs in every single regime. It performed during the Great Depression, you would have gotten huge returns in long vol and commodity trend and fixed income. During the sagflation of the 70s, you would have gotten huge returns from CTAs and fiat alternatives like gold.

During periods during the last secular boom, the last 30 years, we've had a big performance out of both fixed income and obviously stocks and real estate, the secular growth. So the Dragon portfolio diversifies based on thematic exposure, not by asset class. And it does not rebalance. It, excuse me, it rebalances, but it maintains a constant weighting of these thematic asset classes, not trying to predict and not using volatility as a metric to rebalance or correlations the way risk parity does. So different from risk parity in that it's not levering up bonds 4x to equal equity vol. Yeah, everything, all of these asset classes are held in about one fifth exposure and they are all levered equally together to that extent to hit the ball target. And so, you know, why the animal names and that particular product? Well, because it combines the

hawk and the serpent, that is the dragon. And the dragon is a universal symbol of prosperity and strength. And was it that paper or another one that had the news clipping of, was it in Montana, where there was the forest fire and that they found the hawk crisped up that was holding the snake? Oh yeah, that was in that paper. Yeah, that was in the appendix. Yeah, I read it. You really read it.

Yeah. Well, like what? That was a great find. You must, I read it. You really read it. Yeah. I'm like, what? That was a great find. You must have been digging deep for that one. Yeah, you know, you're like, you know, you spend a lot of time looking at hawks and serpents and like, oh, look at this. Maybe the power line fried it. It went down, but then a dragon launched.

There's a dragon flying out there. It was reborn as a Phoenix. Exactly. But just to put a finer point on that. So risk parity would say, hey, I made 20% in S&P. I made 5% in fixed income. I'm going to lever the fixed income up 4X. So I made 20% in both.

In that same scenario, if you make 20% in stocks, 5% bonds, that's all you get. You're getting the 20 and the five, adding them together. That's right. Generally what happens is that one or two of the asset classes are outperforming by a large margin. And that's what we've seen this month. You know, in Dragon, we actually have seen, you know, this particular month, equities are hurting,

but fiat alternatives, CTAs obviously are ripping it. And vols returns have been good, but muted, you know, um, you know, I, I think we were talking a little bit about that before coming on is, is what we talked about with the fixed strike and, uh, and some of the dynamics there, but overall like that, you know, so this month fixed income has not been doing well or that well, It's kind of been flattish and stocks have obviously not been doing well. But these other asset classes have been so well that it's led to positive returns. So I think that's what you see. But take that same idea and extend it over a decade.

Right. I was going to ask that. If you think like the CTA returns, it feels like a decade compressed into the last three weeks. But that's the idea. If you usually wouldn't see inflation or have you in your testing, do you see it in like such a short period of time? Oh yeah, definitely. Yeah, absolutely. So, you know, the 1970s saw a huge ramp up of inflation, very similarly. So this is the thing, when they say, oh, inflation's transitory. And okay, maybe, maybe it is. I don't know. I'm not an economist, but I am a student of financial history and inflation is rarely-

Right. You're as close as it gets. I guess in the dull science, but inflation is rarely transitory. When inflation gets moving, it's rarely transitory. And I think that's a made up word. I don't think they had that word back, right, in the 70s. They like to make up words, don't they? Quantitative easing. And how do you think, and I'm going to know the answer, but how do you think about the bonds?

Like who in their right mind would want to own bonds right now at the zero bound? And like, why not just time it and say, Hey, I'm going to get back in bonds when rates are good and when I don't have the duration risk or whatever. Yeah. I mean, it's a good point. You know, I think certainly you might move around where you are on the yield curve, but you know, one of the things I always say is, you know, prepare. Why would you want to own bonds? Well, let me give a shocking idea here. What might actually cause us to tip back into a massive deflationary crisis? Well, I presented a chart at this event in Austin. I was very gracious of Steve Drobny to invite me to speak at it. And it generated a good degree of debate among, I had this visual image and the image was like, just imagine the global economy as a global economy as an armada of ships. And those ships are sailing through a narrow strait. On one end of that strait is the waterfall of deflation. So no one wants any of the economies

and their ships to follow this waterfall of deflation. But on the other side of that straight of water is the hellfire of inflation. So if you get too far close to that, you're going to burn up. If you try to swing from one to the other, you can run into big problems. Well, there is a narrow straight right now. There is a narrow straight. And it's directly related to my unholy trinity of volatility. And that straight represents the amount that interest rates can rise before we have massive corporate defaults. This was the chart? Yeah, this was the chart.

So right now, corporate debt. Now, why is this related to derivatives? Well, credit solvency is volatility. If you take a chart of OAS spreads and overlay it on top of the VIX, you will see what I'm talking about. And define OAS for the listeners. Option adjusted spread. So we terms of credit risk. So if you take that chart of the investor appetite for credit and overlay it on top of the VIX, they are one in the same. So right now we have the highest corporate debt to GDP in American history. It's about 47%. It's huge. It's a very scary chart, extremely scary chart. Never before have there been more corporate debt, but not really a big deal because interest

coverage is fine. Corporations have no problem servicing that debt because what they've done is they've went out and they refied or they rolled all that debt at super low levels as rates came down. And they extended their duration to the maximum duration now. It's about five years. OK, great. So no big deal. Well, at some point, those corporations are going to have to roll that debt. And there's the largest tranche of corporate debt at the lowest grade of investment grade. I think it's over 2 trillion right now. And the junk bond market is only 800 billion,

I think. And those numbers might be dated, but it's approximately that level. But out of the 47% of GDP, we're saying the biggest chunk of that 47% is in junk bonds? Is investment grade, but just above junk. Got it. So if those bonds get downgraded, they will overwhelm the junk bond market. Right, right, right. Overwhelm it. Like quadruple its size. Yeah.

And so what's going to happen then? What's going to happen to junk bond yields? They're going to explode. And then a lot of companies that could get financing are not going to be able to get financing and they're going to go under. Well, it's fine as long as rates stay low. Right. Well, so what this chart shows is it shows how much can rates rise before corporations are going to be back to where they were in 2007. U.S. corporations will be forced to pay anywhere between 25 to 50 percent of their profits to servicing that debt. If rates rise back to where they were in the 1970s, 100% of corporate profits will go back to servicing the interest on that debt. So you can look at this like an arm. You know how the arms that caused the housing crisis back in the day? This is a big problem.

Adjustable rate mortgage. Adjustable rate mortgage. So it's fine as long as rates stay low, but this is a massive volatility trigger. It is a deflationary time bomb. And as my friend, Mike Green told me when I sat down and talked to him about this, he's like, Chris, you're an optimist. And I'm like, what do you mean, Mike? He's like, you're assuming these companies will be able to roll their debt. Many of them won't be able to roll their debt. So to this point, the Fed can't raise rates that high, but they can't let corporate yields go that high because it will be a collapse of corporate profits, which of course will be a massive collapse in the S&P and a massive collapse or massive increase in volatility. So the inflation could lead to a deflationary crisis of epic proportions. And that just looks like, I can't roll that debt.

I can't service the debt. I'm just going to stop taking on the debt and stop building my business. Right. Yeah. Deflationary. And you may see this rampant rise in commodity prices is craziness until at some point. 50% of corporate earnings now have to go to servicing debt and the junk bond market is now $2 trillion and we are thrust back into a violent deflationary reality. And I'm just not

smart enough to know when that might happen, how it might happen. So to that extent, it's a matter of just not predicting and holding that. Because, and you know, it's interesting. One of the things people don't realize is that, you know, even something like a bear flattener has actually performed really well. Yeah. I mean, the long end of the curve is going up, but it's not going up as much as the short end has. So you could actually put on a long duration trade and make money. Right. And for the dragon, if you're thinking in a hundred year terms or even 10 year terms, if you can hold out the duration, you're going to get your money back with whatever interest, right? Yeah. But to this point, we're not trying to predict what regime we're going to go into.

We just want to hold an asset class that will perform in whatever regime we need it to be. And so if you take your fixed income down to zero, you're naturally making a huge prediction on the thematic regime. And we actually see that as a violation of the ethos of what the dragon represents and is intended to do. And then how do you, like CTAs, and I'm a card-carrying member of the CTA fan club, but it seems like there's the most basis risk there, right? Of like, they'll perform in inflation, they'll perform in deflation, they'll perform in a crisis period, right? They're not necessarily structurally set up to do so,

which you could argue me on that. But just how do you think about that, that risk of the CTA, the commodity trend in the portfolio? Right. Like their mandates not to capture inflation. I'm a huge fan of CTAs. And I credibly have. I mean, I guess it's trendy to now, but I mean, credibly, you can go look at my writing back in 2019 before all this started. And, you know, I think I've made that case. So, but I believe CTA should be the same as long ball funds. There's basis risks in long ball funds. You know, you can be in a tail risk fund that bleeds and bleeds and bleeds and bleeds and then makes money, but it's not an alpha, you know, it's not an alpha product. But so that's the only basis certainty you can get is a tail risk fund that bleeds and bleeds and bleeds.

Those guys who- Naive put buying, essentially. Yeah, naive put buying. The guys who sit back and say they made 1,000% in March of 2020, and they're quoting on their option premium, and they've lost 100% for the last 10 years prior. I mean, it's comical in that sense. But, and I would say even unethical to quote performance in that way. Yeah, we've covered that on here before. Like, yeah, you lost, you made 6,000%, you lost 6,000% the last five years before that.

Yeah, exactly. Like, you know, it's, but to the basis risk concept, you know, if you are, if you're a long ball trader, you're trying to find in smart ways to carry long ball affordably. And some bleed is expected to that said, if you can carry neutrally or positive, you're a hero if you're performing in those, in those down periods. Similarly, CTAs, you know, you're going to have basis risks because there's some CTAs that are going to be holding for two weeks. Some CTAs are going to be holding for two months. Some CTAs that are intraday, as you know, and probably know much better than I do. So my view on all this is that you do not want a silver bullet. You don't want to invest in one CTA. You don't want to invest in one long ball fund. You want a mosaic approach. And I think that's incredibly important

to building that aggregated portfolio. And so to that extent, it's almost a commercial for what you do. A great leading question. Not intended to be,, I really believe that. And I think that's, that's how a lot of our smart clients look at it. Right. Right. My worries. And when, even when we're putting clients in CTAs and I'm like, okay, there could be some inflation environment where it's all driven by oil and everything else is going down and the CTA is flat, right? There could be some environment where it doesn't catch it just so everyone's aware of that unlikely but it could happen that's right yeah that's absolutely right um and then gold we talked a little bit about um i've had a love hate relationship with gold over the years like i was proven right up until the last 20 years i guess or 10 years right

it's gone on a tear but how do you think about gold? Is that for the dollar debasement, right? Is it a fiat hedge, so to speak? Yeah, it's a fiat hedge. That's the way I look at it. And which environment? That's the inflationary environment or not necessarily? Oh, it's a very simple environment.

Gold does well when real rates are trending negative. It's the most misunderstood asset. It's not necessarily an inflation hedge. It's a hedge against negative real interest rates. And so that's when gold is performing. When real rates are trending lower or when the expectation of real rates are trending lower, gold does well. And that's naturally what's happening here. Why is gold doing well? It's no mystery, right? Inflation's at 8.5%. And bond yields are going up, but not enough to match the inflation rate.

So the real rate's still negative. Negative. Real rates are getting more negative. And guess what's going to perform? Gold. Gold. It's that simple. And what about crypto?

You know, I spent a lot of time at this conference talking to some interesting crypto people. And I own personally some crypto. And I said in the paper, you know, I even said in the paper, it's valid to kind of put, you know, anywhere from 25 basis points to 1% of your portfolio in crypto because it's either going to go to 100 or it's going to go to zero, right? And I'm not smart enough to know. So it's very controversial dynamic. I think crypto has shown elements of being a hedge like gold. So sometimes it behaves that way. And sometimes it just behaves like a tech stock. Right. A risk, total risk on risk off. Yeah. So I am open-minded to it. I personally own it. I do think that there is a asteroid coming for the crypto space in the form of regulation. I look at some of these DeFi shops and they look like bucket shops from the 1920s. I've had interesting conversations with very smart people in that space who are doing very

interesting things. And I think there's a lot of opportunity. So I'm not bashing crypto, but I think there is a regulatory KYC asteroid coming and some crypto firms will be mammals and some crypto firms will be dinosaurs. And I'm just not smart enough to know who's who. But there's a lot of people out there who would design Dragon and say, forget the gold, we're going to use crypto instead, right? We're going to use Bitcoin

instead as the fiat hedge. Yeah. And I, you know, I... You'd prefer the thing that's been around for 10,000 years? Yeah. Gold's got a 2,000 year history, right? Yeah. Prices, like literally they were right, right? Yeah. I mean, literally you can get gold prices going back to twelve hundred., I would not think that's responsible. Right. Well, if you started in a year ago, you'd have some bruises to prove it. Yeah. So I love momentum trading crypto. Crypto kind of looks like commodity markets in the 80s or now. You can momentum trade it.

And that's kind of fun. That's my new favorite line. I don't do that in my fund. I do that personally. Right, right. My new favorite line, like commodities in the 80s or now. Yeah, or now. But it's super fun to kind of trend trade crypto.

But I'm definitely not the right person to be talking about it other than those views. And before we let you go, I'm a big Star Wars fan, as you know. So you had a great piece all the way back in 2016, explaining how George Lucas's real brilliance wasn't Yoda or Han Solo, but his optionality. So people can go read the piece i'm just gonna ask you because it happened after the piece where he sold out to disney for two billion right yeah did he become did he shift off his optionality brilliance to um cashing in it did he go short ball instead of long ball hey it's how you sell something for a billion dollars i think you know he got a billion in stock and a billion in cash i think he definitely sold it cheap i i thought that was interesting you know um because disney had they were flipped right the roles got flipped

they had huge optionality on that and it's paid off in spades huge optionality on it like they they they were able to unlock things you know maybe george lucas is looking at a different type of life optionality right now you know at his dynamic you reach a point maybe maybe george lucas's optionality is spending more time with his grandkids or something like that i can't i can't theorize but but the original paper the original star wars paper which was super fun, you know, that was all about like finding like Lucas way back in the 1970s. He was coming hot off American graffiti. He was a big, big time young director. And he was offered a I think it was a million dollars to direct Star Wars.

And he said, hey, why don't you only pay me $500,000 and I want to buy the licensing and sequel rights to this movie. And, you know, the Fox executives laughed at him. They laughed at him. And the reason being

is because at that point they had tried merchandising with a movie called Dr. Doolittle, not the one with, not the Eddie Murphy one or the Robert Downey Jr. one. This is way back. I don't think Eddie Murphy did one. It was a disaster critically and commercially. They actually bribed people to get it into the Oscars.

So I think it did get nominated for an Oscar Based on bribes alone But They were left Fox was left with like two million dollars In the 1960s Of like worthless llama merchandise From their Dr. Dooley

Right and you got a picture of it in the paper Yeah that's right So they're like This George Lucas fool What's he going to do with the merchandising and sequel rights? Of course, what Lucas did from an optionality standpoint is that he sold the middle of the return distribution. So he was getting, he had a carry, he had carry, but he sold off some of that carry

in order to buy left and right tail optionality. Right. That paid off tremendously. So that, that $500,000 option he bought actually became a multi-billion dollar payout, huge payout. You know, analogous today, like, you know, people will sell the middle of the return distribution by tails. They might sell term structure roll down, but by tails. You know, Star Wars, if Star Wars was a modest hit, that would not have paid off. But because Star Wars was a power law distribution hit, it was a massive convex payout. So to this extent, you look at that as a proxy for both trading and life. But I think maybe hopefully I'm at a point in my life one day where you trade in the optionality you get from trading for a different type of life optionality. Yeah. And we have no idea what type of life optionality George Lucas might've gotten.

Well, I was, I was upset when they, they screwed up, Chicago screwed up. They were going to have the museum here and the, the friends of the park pushed it away. Cause it was going to turn out, turn everyone's a tailgating spot outside soldier field into a museum. God forbid. So you're going to have a star Wars museum. We lost it. I was going to go.

I was knocking on the park with that, with that, uh, the mural of all I don't remember what a star Wars character. I know the posters are coming. We're sending you some posts. Now, were you upset? We made you Anakin. Were you upset? Cause he, he turns to the dark side?

I wasn't trying to say he turned to the dark side. No, I loved it. I loved Anakin. I love being Darth Vader. I love it. I think it was Carl Jung who said, your roots have to reach to hell so your branches can go to heaven. I like it.

I like Anakin. Whenever you're playing Left Tail of All, you're definitely on the dark side. He comes around in the end. He becomes one of those ghosts. He was a force ghost when they did the uh the re redistributed or whatever hopefully i can become one of those ghost people one day and just guess what you're gonna be on this art because usually when we do our pot art there's

like a little glow around the uh the guest's head so you'll be a forced ghost on this potter yeah i love i love it So I absolutely love it. And then I got to mention my second favorite paper, cause you have two papers on my two favorite things, Star Wars and the nineties bulls. So you tried to explain why people need this negatively performing long ball thing by saying Rodman was a great fit on the bulls. Yeah, no, I mean, that's, that's that's that's that says it all right there

it's so simple the robin thing because you know robin um so dennis robin lowest scoring inductee in the basketball hall of fame uh guy really didn't have never averaged only averaged over 10 points one time in his entire career and in fact fact, he was so bad at scoring. You would put them on the court and you wouldn't have to guard him. You know, he was, he was that bad. But Rodman was so good at one thing and he was, in fact, he was so good at it. He was six standard deviations above the norm in rebounding the basketball. So, you know, what does that, what does that mean exactly well what happened is when you put rodman

on the court and they only knew this by doing advanced statistics later on today you put rodman on the court the offensive efficiency of his teams went through the roof so even though the guy couldn't score every single time he was on the court, his team did massively better at scoring. Right. The guys who could score got second, third, fourth chances. They got second, third, fourth chances. Exactly right. So, you know, you get Michael Jordan misses a shot, Dennis Rodman gets the rebound. Jordan's not going to miss the shot again. You know, Isaiah Thomas, Joe Dumars, they miss a shot.

Rodman gets the rebound. He's going to be able to get – they're going to score again. We don't talk about them on the Detroit teams, just the Bulls. I was a Detroit guy. We were like enemies back then with the rivalry. In that sense, Rodman is like long ball. He's like CTAs in that sense, Rodman is like long ball, is like CTAs in that sense. So when the rest of your portfolio is missing, volatility gives you the opportunity to take a second shot.

Via rebalancing. Take those profits, put it back into the offense. So Rodman's wins above replacement value, which means like how many extra wins did Rodman get his team, was one of the highest in NBA history. The guy truly represents maybe a top 20 player in the NBA across time. This is something that's really interesting because we came out with a paper last year, which looked at a metric called wins above replacement portfolio. It's wins above replacement player for the investment portfolio. It's a metric that allows people to substitute in. It's a better metric than Sharpe ratios. So what's fascinating is like Dennis Rodman got overlooked. He was a second round draft pick.

I think the Bulls got him by trading Will Purdue. With respect to Will Purdue, it was just a backup center. So people didn't respect Rodman. He's a better announcer these days. Yeah, that's right. With respect to Will Purdue. Rodman, his value was not seen. It's the same way for long ball. It's the same

way for CTAs. People sit back and they say, why do I want this thing that bleeds? And what does it do? You know? And the reality is the question is, does it help your team win? And you can measure that quantitatively using this metric we developed called C-WARP. And what C-WARP does is you assume you borrow capital and you invest in a hedge fund strategy and you layer that strategy on top of equities or whatever your portfolio is. And then the question is, does that asset layered on top of your portfolio increase your sortino ratio and return to drawdown ratio? And if it does, it has a positive C-WARP. It's like it's saying that asset gets your portfolio extra wins.

Preston Pyshko, Added Winners, yeah. Jeff Ross, And as it turns out, 70% of hedge funds have negative C-WARPs, even if they have, so they negatively impact your portfolio simply because they're replicating the same exposures you have in stocks or bonds. Only 30% of hedge funds have positive wins above replacement portfolios. And guess what is the number one? Long ball. Yeah. Long ball, relative value ball, and CTAs are right at the top. So, you know, it speaks to this idea about their value in the portfolio

to hedge against inflation, to hedge against stagflation, to hedge against deflation. And I think a lot of the institutions haven't woken up to that fact. Go onto our website if you're interested in this, if you're interested in seeing the CWARP metric, we have the paper, the calculations either, and we even have a GitHub repository where you can download code to implement that. And I think that's, and in fact, there's a website called Allocator that is a hedge fund database that actually is now using CWARP as part of their process. So, and I will say this much, if you use CWARP in an iterative process, you get better results than a Markowitz Portfolio Optimizer. Do you think over time, are you still trying to explain this to people?

Like, right over since 2008, you're still trying to explain even to institutional investors that still don't get it? Why don't they get it yet? Are they new? Have they turned over and these are the new guys you have to convince? I think most institutions don't get it, sadly. Look, there's a number of very smart this. And that's understandable. If you're the Norway sovereign wealth fund, you own everything. You own every asset and whatever happens, happens. Exactly. And if a drawdown happens, it's going to happen. So that's pretty valid. And I understand that. But if you're a $3 billion endowment or a $1 billion family office or a $500 million family office, this is very important to understand. there's a number of different institutions that do get it. The ones that get it really get it.

But sadly, I think most don't. And I think you see people chasing performance. You know, a long ball fund is super popular after a spike, but it's sorry, that's, you know, that's not the best time. And they're super unpopular after a long period of low performance. So, and bleed. Um, so I think it's, it's kind of the equivalent of saying that like, Hey, we're on a, we're on a scoring streak. We haven't missed a shot. Let's pull Rodman out. Right. Yeah. I mean that we're left in a, you know, we're up three, three goals to nothing on the soccer field. Let's pull our goalie. What could go wrong? What could go wrong? And then, yeah. So I, I think, you know, and then it's like, Oh no, the other team has scored five goals. Let's put our goalie back in or, or what they, what they do is like, okay,

let's, Oh no, we're now down 30 points. Let's put in three Robins. Right. Right. So. But I think it's also line item problems, right? Like they just see it as a line item and get sick of it. If it was combined from the start, right, then they never see the bad.

They just see the good. They just see the blended performance that works out better. The blended performance. I think this is something that this is why, quite credibly, it's most effective to do this as an overlay framework. That's the beauty of derivatives, is that you can overlay derivatives on top of different equity exposures or whatever exposures, credit or whatever, and not have a massive outlay of additional capital. That's the most efficient way to run these strategies. That's how most of our strategies are run. I imagine that's how most

of your strategies are run. Sadly, it's difficult for smaller investors to access that. I think people, smart people like Mike Green and Paul Kim at Simplify are trying to solve that problem. But it's the overlay and it has to be blended. But people have a lot of problems just buying the asset by itself. Just like someone would look at Dennis Robbins and say, this guy doesn't score. Why do we want him on the team? Yeah, why do we want him on the team? Last segment here before we let you go. Your hottest take, what nobody's talking about, what everyone's talking about, but gets wrong. Get yourself in some trouble. Oh, man. Look, I'm going to go back because I think that's so powerful.

So powerful, that idea. If rates go back to where they were in 2007, corporate America will go and solve it. Which is what's that number? That number is like, if we have a renormalization of rates to 5% and corporate credit yields go up to 7% to 8%, it's over. Yeah. Not to mention mortgage consumers and everyone who can't afford that also. Yeah. It's over. Yeah. So in that sense, let's think about what the Fed did in March of 2020. They backstopped the entire corporate credit market, specifically Fallen Angels. They had this plan in advance. They knew that if that lowest tranche of investment debt got downgraded,

that it would be game over. Which brings up an interesting point. They're smarter than they look, right? So they're sitting there thinking of ways to not let these things happen. Yes, yeah. So the question we have to pose, and I actually pose this to some very smart people,

including one of the individuals who was profiled in the Big Short. What could they do? Does his name rhyme with furry? Actually, not him. But I was like, what could they do? I posed that question to Lacey Hunt and Daniel DiMartino Booth. Because one of the things they could do is-

Do the same thing again, you know, at that, I mean, one of the things they could do is do the same thing again, but then, yeah, but then, you know, under a democratic, so keep in mind, the Fed did not buy the corporate bonds. They didn't buy the ETFs. They were giving loans to a special purpose vehicle that was owned by the treasury to buy those. So that means you and I were buying them using loans from the Fed. I didn't get my check. Did you get your check? Yeah, yeah, I didn't. So it's interesting, like in a polarized world where there's massive income disparity and people suffering, will the government, the U.S. Treasury, meaning you, me and every other taxpayer, be able to inventory trillions of dollars of corporate debt? Will people be okay with that,

especially when that debt was used for share buybacks? But especially if they just add some zeros in the system and buy those, right? Like MMT and say, well, it doesn't really matter. They're just fictitious digital zeros that we bought this stuff with. Yeah. This is where I'm not smart enough to know, but here's the thing that's interesting. If you can get 5% inflation a year, steady, then you lower your debt problem by a third in five years. You can inflate it away. So that's the straight. If you can keep inflation at 5%, you're in the middle of the straight. If inflation goes to 10%, you are in trouble. You're on fire. And if you go off the waterfall on the other side, you're in the depths of despair. That's right. Yeah. So it's a difficult, it is a conundrum. And the point being is that that will impact the vol environment. You are likely to have stagflationary high persistent vol until

maybe that happens. And then we're back into deflationary sucker punch. This is forth turning stuff. And the other way out of a debt crisis is a global war. Preston Pyshko, MD debt crisis is a global war. Or a global reset. I've been pushing for the global reset, right? Why don't, doesn't the G7 just get together and be like, hey, all of our bonds between each other are gone. We'll make, we'll make whole the like investor class, but. I mean, that'd be, I'm not smart enough to know.

I think that would be very, very inflationary. So, but I mean, you know, in the past we got out of these crises by a global war. And I'm not advocating that, of course, but, you know without destroying everything so uh so it is it is interesting stakes at this juncture so i do like this i do like this moody chiaroscuro lighting here it's awesome it goes well with my dark maiden anakin um so that's my last question on our 100th episode here we got away from it this season but we used to ask every guest their favorite star wars characters so you've already done anna admiral akbar admiral akbar love it yeah i could have brought my t-shirt i got a nice t-shirt of him uh with the chinese finger trap right it's a trap so you have to know you have to get the humor and

the line to know the t-shirt adm Admiral Ackbar definitely is my favorite 100%. Brilliant. And he didn't have that much screen time. No, no. They should have fleshed him out a little bit more. Maybe Disney will do like an Admiral Ackbar mini series. An Ackbar series. I'd watch it. In the books. So I read all those that have since been disowned when Disney rebooted. But in all those books, the extended universe they call it expanded universe he has whole books about him he was he was a character oh wow i didn't realize they did flesh him so there isn't there is material there's material they can grab and uh i have hope for an admiral akbar miniseries i'm very excited about it the uh yeah i'll write i'll

write into disney i'll be like guys did you watch the mandalorian and the book of boba fett and all that i i watched mandalorian some of the episodes of it i really so it's super cool because they've done this thing where um you have an ability to uh they they have a framework where the virtual set will move with the camera so i have a background in cinematography i was always very upset about how cinematography has died because they just flatly light everything. I am not flatly lit right now, but if I was in front of a green screen, you're layering so many elements on top of it, they just light everything flat. So like any interesting lighting has just died but um but uh what has what this tool allows you to do is allows you to put a character in a virtual set but actually like them the way that people used to be lit and as they're

turning and whatnot yeah exactly and if you ever see the they have some behind the scenes video on this it's super cool um and it's so exciting. Cause you're like, wow, cinematography is back. That's awesome. But super fun, super fun series too. Did you watch Dune? They had great cinematography in that new Dune movie. I have not watched that yet. Just for the cinematography I'd recommend. Yeah. I was, I was done by the same guy i think you did uh uh the blade runner uh the new blade runner which i didn't like that much but i love the

cinematography yeah this is brighter than that one but it has good all right chris this has been fun thanks so much for joining us thank you we'll see you next time down there in austin super fun drop on by sometime. Awesome. Thanks. Have a great one. You've been listening to The Derivative. Links from this episode will be in the episode description of this channel.

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