The Derivative - Volatility (LIVE IN VEGAS) panel discussion

Episode Date: June 29, 2023

We're doubling down on the knowledge and taking you through the high-stakes world of Volatility with a special "Derivative Podcast" straight from the world's entertainment capital, Las Vegas. Join host Jeff Malec and our panel industry heavyweights Cem Karsan, Luke Rahbari, and Zed Francis as they delve into the intriguing market dynamics and risk management world. From the role of Volatility as an asset class to the impact of retail platforms like Robinhood and TikTok, our panelists explore the ever-evolving trading landscape. Discover the power of probabilistic decisions in options trading, uncover the significance of liquidity, and gain insights into the art of positioning for success. These experts also shed light on the challenges of managing risk in an unbalanced options market, examine the role of market makers, and analyze the implications of the Federal Reserve's actions.  This episode provides a jackpot of insight surrounding the fascinating interplay between Volatility and macroeconomics, providing valuable perspectives on inflation, fiscal policy, and market trends — SEND IT! Chapters: 00:00-01:23=Intro 01:24-12:57= Approach to Volatility & its role in a portfolio 12:58-27:32= Playing the game & options liquidity 27:33-45:32= OTDE Options, hedging your risk, & who blows out in this market? 45:33-01:05:12= Art or Science? Systematizing a strategy / Effects of hedging Vol & short-term Vol in the markets 01:05:13-01:27:13 = Opening up for questions: Constraints on the Fed, Protection on the tails, Are the giants (large funds) in control? Follow along on Twitter with Cem Karsan @jam_croissant, and Luke Rahbari @luke_rahbari for all their updates and for more information visit kaivolatility.com, equityarmorinvestments.com, & convexitas.com Don't forget to subscribe to ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠The Derivative⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠, follow us on Twitter at ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠@rcmAlts⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ and our host Jeff at ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠@AttainCap2⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠, or ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠LinkedIn⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ , and ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠Facebook⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠, and ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠sign-up for our blog digest⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. Disclaimer: This podcast is provided for informational purposes only and should not be relied upon as legal, business, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations, nor reference past or potential profits. And listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. For more information, visit ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠www.rcmalternatives.com/disclaimer

Welcome to The Derivative by RCM Alternatives, where we dive into what makes alternative investments go, analyze the strategies of unique hedge fund managers, and chat with interesting guests from across the investment world. Hello there, and hello from Greece, which caused us to skip last week as my travel to this lovely country threw a wrench in the works. Sorry about that. But we're back with a banger of a pod for you today, and then we'll take next week off for the 4th of July festivities before resuming the full schedule till the end of the year holidays. On to this episode, which is a recording of our recent

volatility panel in Vegas, where I got to sit down with Jim Carson of Chi Volatility, Luke Rabiri of Equity Armor, and Zed Francis of Convexitas to talk through all that's going on in the volatility space from zero DTE to the Fed to vol sellers returning and more. Send it! This episode is brought to you by RCM's VIX and volatility specialists and its Managed Futures Group. We've been helping investors access volatility traders like the ones we talked to in this episode for years and can help you make sense of this volatile space. Check out our VIX and volatile white paper

at rcmalls.com under the education menu and white papers link. And now back to the show. First up, we'll introduce everyone here. First up, we have Luke Rubari, CEO of Equity Armor Investments, which sub-advises on the rational equity armor fund, as well as run managed accounts for investors. Blending long equity exposure with their own volatility index. Next up, but not in order here,

Zed Francis, CIO and co-founder of Convexitas, which runs a unique tail and convexity option overlay strategy in equity accounts, as well as offer two programs in the futures-based managed account space. And last but not least, the croissant baker himself, Jim Croissant, CIO and founder and senior managing partner of kai volatility advisors welcome guys thanks for having us thank you um let's dive right into it hear from each of you why you think it's so important to have a piece of the portfolio

that trades in and around volatility it spikes its reversals and everything in between sprinkling in some of what makes your approach different and special as it approaches the 3D chess game that is volatility. Luke, let's start with you. All right. You have to have some volatility in your portfolio, and whether you know it or not, you're all trading volatility, you own some volatility, you've bought volatility. If you have a car, if you have a home, you're buying puts, you've been sold those puts by some institutions, and you've bought some volatility, or you're trying to hedge your risk

using that volatility. Obviously, almost every asset class, to me anyway, has volatility embedded in it. And this is my line that I've phrased here so no one else use it, but volatility from one asset class will always bleed into another asset class. Always. The only question is how much and how fast. So you need to be aware of volatility. Volatility is not like other asset classes. It's mean reverting.

Stocks are not necessarily mean reverting or commodities or currencies. So it's something you've got to keep an eye on. It's something that you can take advantage of. It's something you can use as a hedge. And it's something you've definitely got to be aware of, no matter what type of portfolio you're trading. I'm going to have a question on it always bleeds in in a second but we'll leave that for now and go over to you Zed. All right I'll go fast so you don't forget your question. How we

really think about volatility is utilizing it as a portfolio tool to allow you to take more risk today and have liquidity during the drawdown events to potentially accumulate additional assets, accumulate additional things, accumulate additional stuff when the market is down and potentially things are more attractive. So very much view it as a portfolio level tool that needs to be potentially constructed and write operational framework to make it easy to utilize and easy to access that capital during those drawdown events. But again, more of a portfolio construction theme, rather than relying upon correlations,

something that allows you to go to work aggressively today and have excess capital, excess liquidity during those nasty events to be proactive rather than reactive. All right, Jim, throwing it to you. I'm going to be a little bit more long-winded as I'm prone to be. Not you. I think both of these guys are talking about primarily long ball, right, and its role in a portfolio. I don't really look at volatility as an asset class. It's the underlying distribution, right?

It's the options that underlie every asset class. The world has been managing long or short every asset since time incarnate. And you've been seeing a secular move towards a more flexible and robust way to express direction and probability. I think that's what underpins ultimately the increasing demand for options broadly and for volatility. Options are, in my view, the underlying. They are the full distribution both in terms of moneyness and time of the probability distribution of every asset class. I think the market is heading towards that direction because it's a more, again, flexible, robust way to express information. You can do that with long vol.

You can do that with short vol. You can do that with put spreads, call spreads, all kinds of different probabilistic trades, but it more accurately expresses that direction. And so for me, that's what vol is. We have a long vol product. We have a vol neutral product. We have products that take advantage of the positioning and the distribution, what that means for the distribution itself. But at the end of the day, vol is probability. It's the shape of the distribution, not just the direction. I think that's the important takeaway. So would you say it's kind of everyone's been trading in 2D and vol services give you 3D

or options in particular? Yeah. An asset is the expected, the value of the asset is the expected return of the distribution. I could give you two assets with exactly the same industry, same market cap, and if you didn't put a label on them, you would think they were the same asset unless you looked under the hood at the distribution. They could have the same exact expected value. One could be very flat left tail.

One could be very flat right tail. The reality is their personalities, the actual underlying personality of that asset is expressed in the distribution it is simply a summary when you're looking at the asset value and so do you think like robin hood all these retail platforms the growth and options i'll throw this out to everyone like is that uh which cause which which is the chicken which is the egg right are people getting pushed into options and then saying, okay, this is cool. I have more optionality for not a very creative term.

I think of options involved broadly as a technology. It's a superior way to express the information that people get. And at the end of the day, that doesn't mean it's going to be adopted day one. You need network effects, right? You need more different types of options, like we're getting micros and nanos and every day and every hour, you know, that is building out the assets, I mean, the actual product. You need more access. That's the Robin Hoods, the TD Ameritrade, so whatnot. You need more education. You need more volume. And the volume begets volume because it brings money in, brings different technologies to adopt it in. And at the end of the day, that's

what we're seeing. And that's why we're not seeing this in a linear way. It's really happening kind of hockey stick, right? We're really hitting that tipping point, which you hear about a lot with technology. And I really do believe 10, 20 years forward, this is going to be central finance. I don't think people realize that people still talk about it as an asset class. We're still talking about, oh, 2%, 5% allocations. It's not about an allocation.

It's not an asset class. It is a way to express every asset class. And I think that's what's important. I think trading often begets more trading. And so we've definitely seen that over the last handful of years. I think what's interesting from our seats is a lot of the folks that have come into this marketplace, that's institutional in terms of product building, individuals, are really strike buyers and sellers and not necessarily volatility traders.

And so because of that, they're looking more so at payoff diagrams than necessarily fair value of any sort of options, which, you know, in our seat hopefully gives us a little bit of edge. We welcome those folks entering the space holistically. But I think a lot of it's trading because we're trading. A lot of people are buying and selling things based on, you know, ad expiration payoff diagrams rather than a fair value. I agree with that.

But that doesn't mean they're not naturally thinking about probability. We all, when we make a decision, whether we put probabilities on it in our mind or not, are making probabilistic decisions, right? And so if somebody decides to bet on an outcome, right, it's because, oh, I don't like this and I like this because I don't think this is worth what it should be and this is what it is. And I think that's the important kind of thing. Isn't that where retail gets themselves in a little bit of trouble of like, oh, I think Tesla is going to go down to $400.

I don't even know what it's trading at, but it's going to go down to this strike price. So they buy that put, not realizing whatsoever that they've lost a lot of value in buying that put. It needs more than just the price to get done. To be clear, it's early days, right? You know, you plug a cord into the wall. You don't understand fully how the electricity gets there, but we've all gotten used to it. I think there will be a lot of infrastructure built

to make it easier for people to express the information that they believe, right? And as it relates to options specifically. So I'm optimistic with time, right? That we are building out the infrastructure to make it more easier for retail, individual investors, asset managers, broad RIAs, everybody to do this. But to really express what's in their head more specifically to what the distribution itself says. And I think Jeff probably bring it up is when you're possibly trading things based on the payoff diagram at expiration you're kind

of ignoring how much the risk changes between today and that point in time so that person that bought the Tesla put on that view they were originally short ten thousand dollars of Tesla and now it000 of Tesla, and now it's $100,000, and now it's a million. And they were in the correct view, but they didn't adjust along the path. And now the random walk gets them on that random day at expiration rather than having any sort of risk controls or trading risk-focused rather than that payoff diagram. A few newcomers in the audience, I forgot to use my joke before if you made it to this room that's way more complicated than this volatility stuff so congrats you're smart enough to get here and to figure out the volatility stuff

uh and quick luke rubari equity armor jim carson kai volatility and zed francis of convexitas thank you um and we're just zed uh jim was just comparing Thank you. And we're just, Jem was just comparing options to electricity. So we're getting into it. Luke, you got any thoughts there? Yeah, I think I understand what these guys are saying. As far as the

retail goes, so just to bring it down a level, volatility is calculated like volatility indices like the spikes are calculated off prices of options off the spiders, right? So if there's a lot of retail coming in, and I think the retail paper coming in is using options for leverage. They're saying, hey, if I put up $800 and the stock gets to this price, I'm going to make this type of return. 300% return, 80% return, whatever it is in this short period of time. So that's what they're doing.

Now, it doesn't really matter to me why they're coming in or how or whatever. But they're coming in and this retail flow that tends to be in the front month or the front week or whatever, right? It changes the calculation or it changes your expectations of volatility for that week, for that stock, for longer term volatility, et cetera. So knowing the flows, knowing how things are calculated, knowing how people are trading options is all a part of it, obviously. I'm thinking of the Oakland A's who are going to come to Las Vegas here, and they have like 200 people in their stadium instead of the game. So where I'm going with this is if everyone's trading the options,

if that becomes the new thing, there's nobody watching the actual game. You're just trading like you're like betting on the game and trading around the game and there's no one actually watching the game does that matter do we still need to play the actual game to get the derivative of the game so I think I'm just gonna jump in here the the liquidity hasn't been enough in the options market because it is complicated there's are only a few players who really get it and that dominate the market making in those products. But that means as volume increases because these are a better technology,

a better way to express that liquidity and the effects of it have to be pressured out into where the liquidity exists. Which generally speaking is in the underlying still. Distributed across products in the underlying or correlation trade. But that is why it has become so important now to the bigger picture is because the majority of the world is still playing this game over here. They don't understand necessarily the effects of the distribution,

but it's increasingly the tail wagging the dog. And you've heard a lot of talking about that, but it is just again an expression of direction at the end of the day, whether it's direction up or down or direction and change in the distribution or the shape. But that has effects on either volatility or direction that ultimately has to find liquidity to absorb it. And so part of me is here thinking, like, okay, but what does this do for my portfolio? It's complex. Everyone's complicated.

It's the new technology. I don't want the new technology. I just want to own Apple. I just want to own IBM. What's it do for me? Well, a couple of things about options. You can get a piece of software that says what an option is worth and what you should do. But what's really important to understand the liquidity, as Chum said, and the pricing and the flow of the options. When I used to be a market maker on the

CBOE, if a call was at $2 and I was short it, right? I've sold a lot of it. And people were trying to buy it at $2. I would offer out at $1.90. And then I would offer out at $1.80. And then I would continue to pound it because I was the biggest trader and I had the most money. And it didn't matter if the calls were worth $2.25 or what. The biggest player says the call is worth $1.90 or $1.80. It doesn't matter what your software says. Right, right. It doesn't matter what your software says. Some of this is happening in retail now. They're just coming after options. It doesn't matter. They're looking at a binary event or they're just trying to get the leverage. So that's starting to skew stuff a little bit. And how do you use it in a portfolio?

It really depends, but I would think that the best way to use it in a portfolio is to find someone, I know I'm talking my book, or some of these guys that actually have traded it or watching it all day because this is not a passive game. It's not that type of thing. We marry volatility with being long assets, both on the long and short side, depending on what we're doing. We're long on our funds. We're short when we're doing structured products, and we look at it holistically. Where does this asset class, where does this strategy fit in my entire portfolio? So when we do our OCIO services,

it's a combination of being long volatility, short volatility, and depends on the kind of asset class and the type of volatility you're short. But I think you need to own some. It's a cornerstone, I would think, of any portfolio. You own volatility now on your car, on your house. Most people's stock portfolio or the stock for an RIA that they're managing is pretty big. You don't need to have your entire portfolio in there, but a portion of that needs to be protected, needs to have it in a non-mean reverting asset in combination with risk assets. And then you get into the other stuff that you want to do, whether it's fixed income and other things. As I said, Jeff, ultimately derivatives are a risk transfer tool,

like at the heart of them. And so what's important is to first understand what structural things are in place that create imbalances in the pricing of that risk transfer tool and now you can utilize that knowledge base to create a absolute return relative value hedge fund type of allocation or I can in our seat we basically are saying we want to use that tool and what we see is edge within the pricing of the derivatives from the imbalances and those structural flows to deliver something that is negatively correlated, unfunded, and liquid during drawdown events to allow folks to take that liquidity and

redeploy capital. But likely the fundamental edge that we're seeing within the instruments themselves is probably pretty similar, but you can utilize that in many different formats. I'm going to get another weird metaphor now. So it's kind of like, okay, we've discovered colored paints. Is that a thing? Right? Ink, colored ink, right?

And before we were all drawing in black and white and we're up here, me and others on podcasts saying, okay, you should invest in colored paints and colored ink. We're like, no, it's not the thing. It's not that they they're colored it's what you can do with it it's what you can paint with it's just like if you think something maybe has a fair value of of 10 bucks and it's like not guaranteed or anything but like and that's probably what it is but there's a decent amount of folks that are structurally selling that thing so instead of trading at 10 bucks it trades at nine and a half so you're like, there's multiple things you can do with that. You could go long, short, and just say, I want to capture

that $0.50. I think that is a reasonable way to express value is just capturing that mispricing due to the fact that there's a significant amount of flows altering what probably the fair price should be. Or you can say, I actually wanna take a directional position and it seems cheaper to me to just buy the nine and a half dollar thing because it should be 10 versus something else. So let's see, there's a little bit of edge driven by a decent amount of structural flows

from various products and such that have been created and you can utilize that edge in multiple different ways. Here on the live pod we have a butterfly in the room. Go ahead. Yeah, so I just want to add to that. So if you have any piece of information about a stock, everybody has their own edge. They have some piece of information maybe that they know better than somebody else. But just expressing based on that information whether a stock's value should be higher or lower is incredibly inefficient because you're dealing with all these other participants

and all the other information that they have, which you may not have. Why try and bet on whether a stock should go up and down based on some piece of information you have? What you should bet on is the probabilistic reality, the effect on the distribution that that has, right? That is a much easier, more precise way to express the information that you have. And I think that's where its truest best value is.

There are other things here right understanding that distribution understanding the positioning as luke mentioned is critical because uh it's a part of market microstructure it's just like understanding short interest but much more detailed understanding of if the price goes to here it's likely to face supply or demand um So there's a place for that. It also is incredibly valuable because most of us are long in our lives. We sleep, eat, sleep, breathe, right? And the reality is the tail, right, is the part of the distribution that is the least linear, that is the most convex. And so having something that improves your geometric

returns it allows you to take those other bets and do other things um is incredibly valuable in the portfolio but i think that's part of a broader conversation i think it's part of that this bigger picture which is you know you're expressing a part of the distribution which is which is so so if i can i'll i'll try to uh that was eloquent, but I'm going to dumb it down to, it took me six and a half years to get my undergrad degree, so I'll dumb it down for people. Man wilder. Right. So the way we look at volatility is the S&P is going to have the same volatility, whether it's 10,000 points higher or 10,000 points

lower on a normalized day. So average volatility, if you say to yourself, is, I don't know, somewhere between 18 to 22, okay? That's going to stay constant. So how do you take advantage of that? You say to yourself, the S&P normally moves this much at around these levels. What's its volatility? How much is it expected to move? Given that expected move, you look at a price of an option and you say, wait a minute, the S&P's expected move over the next month is supposed to be 100 points and this call is trading $30 lower. I'm using extremes, $30 lower than its normalized volatility, what should I do? Well, you should buy that call because it's probably going to realize that volatility. Or if it's trading at 140, wait, what's going on? So the best way to do that is look at a stock that you follow or you trade options on the week of earnings. You'll see that it's not trading at its normalized volatility, long-term volatility. It might be trading at its normalized volatility for earnings, which is much higher because you don't know what's going to happen, right? And then that's where you get into the building, the position, and what you

want to do and what you expect. And I think that's where the public gets in and says, you know, NVIDIA's got earnings this week. I think it's going to be up 40 bucks. The 330 call is $3. Man, that looks like a buy. And they buy it and they come in and they rush in. And then that changes some of the front month curvature and what it does. I think that's what you were saying.

That was simple. Or should I go sit in the audience and listen? No, no, it's related, right? It's part of, like, at the end of the day, let's take it to the kind of YOLO call crowd, right? Why they're not thinking necessarily about explicit probabilities or implied volatility, but what they are thinking about is two things, which we've mentioned.

One, that the probability, the payout is significant relative. Right. They're definitely looking at the payout. The probability of that is higher, and it is a very fat tail. They also related, and this is kind of reflexive, is that the more they buy it right the more they control liquidity there the more they can force a fat tail and so yes at the end of the day they are they are thinking explicitly about what i'm saying but that is the reality of of what's happening and and more and more options are wagging the tail particularly on the parts of

the distribution that are liquid and fat right i think the banks recently is a great example it's not just uh you know all these regional banks it it is it's reflexive not only in that they're squeezing the market down you then force a tail that forces liquidation in the bank itself, right? And pulling out of deposits. So it's so important to market structure right now because the liquidity is weakest on the tail. You can dominate liquidity in these illiquid places in the market and really force major outcomes that can have macro effects. What do we think about that?

Like, as you were saying, the meme stock guys were like, hey, we can make these things go up. Have they figured out we can make these things go down or was it? So two years ago or a year and a half ago during the meme stock craze, one of the things I was very, you know, I was talking very vocally about is just wait until they figure out the puts. Everybody's fine with the call side, right? Call side, yeah, you can have a couple of congressional meetings. People are like, what's going on?

Nobody really cares. But when you start forcing liquidation in all regional banks, that's a little bit different, right? And it's the same thing and it's actually much more dangerous because liquidity on the left tail is worse than the liquidity on the right tail and then not to go too far down the rabbit hole do you think hedge funds and others are like the first step in that to push it into the retail crowd and then the retail crowd takes it and then they finish it off I think it's the other way I think so this whole idea of like diamond hands right this idea

that retail comes in and does the same thing and will hold on and will do it regardless is an incredibly powerful thing because what it does is it signals to a Citadel or to a Kai volatility or to whoever that these guys are gonna be in buying tomorrow morning too you You better not be short it. Actually, you better be long it because they're going to buy it from you tomorrow. And the more and more you have a consistent buyer, the more and more it forces the whole, it's a signal, right? It's a cascade. It forces essentially speculators, the infrastructure, the market makers to start pushing the whole thing in that direction which begets victories for the retail which makes it more consistent which drives a whole. It's supply and demand not math, not

options pricing. Supply and demand will drive that up or down. It has nothing to do with where you think volatility is or where it should be or what it's worth. So they really learned that from me in the 90s. They should be calling that the Luke trade. The Luke trade. I should pen that too. So while we're on the meme stock craziness, let's move on to the next bit of craziness, which is zero

DTE options, which have rocketed up in growth. I can't remember what I said here. We're going to just have quick one word answer or one phrase answer for each of you. Zero DTE, is it A, irrelevant noise, B, a big deal, really affecting vol markets, or C, somewhere in between? Luke? Somewhere in between because it depends on the stock and the index they're in or whatever. But it's, you know, all right, A, it's a big deal. No, that's B. Then B.

So for A, B, it's a big deal. Come back to me. Zed. I'm more on the A camp. I think it's pretty irrelevant. All right, Jim, I think it's a big deal. Big deal. All right, we got two big deals, one irrelevant.

Let's get into it. We'll let Zed go first, why it's irrelevant, and then these guys can come over the top. I mean, anybody trading one-day options why it's irrelevant and then these guys can come over the top i mean i anybody trading one day options as a market maker understands that it's a essentially a binary option it's one day risk it's you know yes or no and so the only way you hedge your portfolio is to trade another binary option.

And those types of folks are essentially posting on both sides, creating a portfolio of all these binary options. Obviously, you have risk controls. If they get too imbalanced one side or the other, turn off the machine. But once you have a bunch of binary options it kind of turns into something that's pretty benign and linear and easy to hedge so ultimately you know I think it's the folks that are mostly providing liquidity in those you know zero DTE options are pretty darn good risk managers and it's not a linear instrument that you utilize to hedge that risk, it's another binary option, another 0DTE option.

How does that work without them losing money? So if I'm, right, S&P is at 4,000, I'm selling 4010 calls to retail, so what are they using to hedge that? Did I get that right yeah retails buying 4010 0 DDE calls saying they think it's gonna close there today well I mean they're likely getting decent to a flow and they're building out an entire book of various different strikes and if they get a little unbalanced they're probably cleaning it up by you know actually not just sitting on bid ask and utilizing a one day option to hedge some of that risk

because utilizing a linear instrument is not very effective in something that has a zero deal. Right, but I'm saying the only one to really use would be the exact one you sold and then you're just buying it. So you go another strike out or another five or 10 strikes out. That's reasonably inconsequential.

You're just five handle differential in the S&P 500. Three more. Okay. Jim? So the problem with options is when things become very unbalanced, right? This is what happened, again, with AMC, GME. If you can't hedge it out well enough because the market is not liquid enough, if it's in a point of the distribution, an asset kind of on the tail, that's where

the risk happens. And when you push something either to the furthest part of the distribution on the tail or to the most forward shortest time, the impact of that because of the gamma effects is that much more dramatic. You can have per dollar spent per positioning that much more impact. So moving 45% of the liquidity from 30 days to zero days to expiration has much more impact. Not just because of the amount of gamma that can be expressed. If it's unbalanced, to Zed's point, if it's balanced, it doesn't matter. If the market makers are taking both sides, no big deal.

But if everybody starts going in the same direction, which will invariably happen, that's what we do. We crowd into trades, crowd out. It will have more impact, and it's on the part of the distribution is very hard to hedge it is very hard to get enough gamma in the portfolio with anything other than zero zero DTE then with zero DT and that's why it matters same reason that you know bank stocks crash because they can have an outsized impact same reason that they AMC and GameStop names kind of do with it. Going to zero

DT just has a greater impact. It has more convexity and it's less liquid ultimately to the market maker. That's what matters. You were somewhere in between. What do you got to say on both those? I think it's really difficult to risk manage, first of all. Something that's got a one delta, trying to delta hedge it when it goes to 100, within an hour is a bit difficult. Because you're not the only one trying to hedge. You're not the only player in the market. I think when we've done it, we've been buyers, because the least you can lose is

your premium and sometimes what happens is if you're in early enough some of the strikes that are further out you can spread off very I mean it puts it becomes a great trade but who knows I think they are important I think sooner or later someone will blow out as it's bound to happen they won't be able to manage their deltas they won't they won't be able to manage their deltas they won't they won't be able to manage the exposure whether it's on the short side or long side there's a whole bunch of other stuff that goes with it whether you can find a borrow on these stocks what someone wants to do after hours trading all sorts of things so i think

i think it does matter depending on the instrument and And it's not something that we play in a lot at all. Although you say you've traded some. We've bought. We've bought. We would never. Have you guys traded them? I don't think we've entered any positions inside of a day. We'll do it more reflexively if we feel like it's happening, but more on the long

side. And so who blows up in that scenario though? The market maker? Yeah. Who's at risk of it all unwinding? Well, always the seller of the option, especially obviously on the call side, on the put side too if something happens because something that was one delta or five delta five minutes ago can go to a hundred what do you it's a binary option right it goes through your strength most of the flow is basically one day covered call rating yeah so i mean the dealer would right this is uh but the question is who's the dealer let's talk let's go to gamestop who who blew out melvin did why did melvin blow out because they were not the sophisticated dealer they were warehousing risk they didn't understand why so who blows out not Citadel they're the ones buying because

they know it's coming they're getting in front of it they're pushing it it's gonna be the warehouse or probably a bank or a fund that has an opinion about something that doesn't understand. French bank. I'm definitely, in my comments, focused very much on index. You know, I'm sure a $5 billion sub-single name can have more interesting things happen. But at an index level, I think it's pretty benign, ultimately. And, you know, I think when you look at SIBO revenue per contract it's down why is that well it's because it's mostly market makers participating and getting paid to sit on you know bid ask to participate in this markets like

if pension comes in and trades 10,000 contracts XYZ my guess is there's a follow-through of 30 40,000 contracts as essentially market makers laying risk off onto each other. So it's showing a little bit of an outsized influence on how big the market really is. And then just to make one other point, so to edge the one zero DT, they might have to do five at a further strike. No, it's not even the ratio. It's more just laying off risk across. But you're saying they go to another zero DTE at greater size.

Or even the same strike. But yeah, like they're laying off the risk to each other if somebody gets imbalanced and they're willing to pay each other for it, you know, to get their book right-sized. But one trade probably causes a much bigger number in terms of volumes and it's kind of realistic risk sitting in the market. Jim you were... So a couple of interesting things just to like everybody talks about zero DTE like just generally but like what's actually happening the play-by-play is last year the you know Vega any vol in the equity world did not work right so you had a massive exodus from

anything that was implied vol related the market went down vol got compressed it didn't work so people but what did work for some entities was buying realized vol equivalents like zero DT so there was a lot of volume that started moving to that because it was working it was an alternative hedge most of the volume was buying zero dt early that is in line with the general kind of non-vol specific trader being like betting on a direction betting on puts okay we're going to go down today i'm worried about it or call but guess what once 45 of volume goes there happens? That doesn't work anymore either. So vol has gotten massively compressed on a realized basis as well.

And a lot of that is because there was so much volume in that zero DTE gamma stuff. But now, not only are people not hedging in vega, people aren't hedging in gamma either. And there's a lot more sellers now. It's actually on balance much more sellers of zero DTE because that's what's been working. That's what people do. So I think the big takeaway here is not just what's happening in zero DTE, why is there so much volume? It's where are we in this dealer positioning progression? And what is that likely to mean for the next outcome. Luke, you want to say something? No. No. Which, but interesting, you know, I've noticed it seemed to coincide roughly with the saving of SVB, the bank, of that floor that's been in place in vol since COVID really. Finally, we broke through that and

got, I don't know, you guys. Right, you got the bottoms up, right, kind of vol effect, but then you have the top down Fed coming in, underpinning, selling puts, right? Right. So when you have those two things together, that can be pretty powerful for a while, but then that encourages excess risk taking, all kinds of other issues. But do you think it is, for your strategies in particular, is that a good thing or a bad thing? Is it more of a two-way market now than it was through most of 21 and 22?

Like that you have upside and downside? I don't know if these guys can jump in. I don't think it's a real two-way market until the Fed completely gets out of the way. They shouldn't have come in and saved Silicon Valley Bank. I don't care if someone was going to lose $15 million and that was all they ever had. Maybe they should have been a little more careful and spread their money around, and the Fed should have allowed people like myself and some others that are more disciplined to come in and buy the assets of people that take unreasonable risk

or they're blind to the kind of risk they have in whatever institution they're in instead of coming in and saving them with my tax dollars how do you really feel well that's how i feel so we've got a couple california guys here they might have been at risk well maybe i should have owned one of their homes um the the fed has been in the market and the fed has been the fed put saying everything's going to be okay we're not going to let the market and the Fed has been the Fed put saying everything's going to be okay. We're not going to let the market float the way it really should be for the last 10 years has been a huge mistake. It seemed to me the Fed put was sort of gone and then they came up with a new one. Right. The minute something goes wrong, yeah, they give more methadone to the addict.

A little bit different course. I would say you should be wary of purely systematized strategies in the derivative space. Because as you think you're kind of alluding to, Jeff, things change quite rapidly and dramatically and often kind of obviously and a system of tie strategy is not going to have the ability to do that transfer and how they operate when those inflection points happen so i think it's more so you know you know is there edge better worse you know i think we have certain edge and certain things at all points in time and other things it's changing often you got to monitor it and adjust with it but i think the main takeaway is just purely systematized implementation of derivative strategies is problematic because things change rapidly i'll

just add one thing to what chen was saying as the market went down last year vol got crushed because people are thinking well the fed's going to raising, which means it'll be good for the market, right? It's not, it didn't make sense, but that's what people thought. So I think the Fed has been fully in there. It hasn't let the markets flow the way they have. Capital's gone to a lot of wrong places. And now that's starting to be problematic, like hold to maturity securities. If you bought the 10-year when it was a 2.5, it's a problem right now. But why not? The Fed is going to be there, 2.5, whatever. So the Fed has put people at risk by its behavior. It's encouraged bad behavior.

Jim? The reason the market didn't go down last year in my opinion is because in the short term referencing kind of what you were saying the thing that matters most is positioning because it is the ultimate biggest driver arguably to supply and demand. SKU was at record levels and hedging was at record levels in early 22 because everybody knew the Fed was going to be raising rates. So when the market did decline, which was partially because the Fed raised rates, but also because the Russia Ukraine thing happened. It became vol compression drove, realized vol compression drove.

Everybody's long 110% stocks and has a 10 delta put as a hedge. Guess what? If you drop down to that 10 delta put, everybody's got to monetize that put. And if it starts losing money for them them they're not only down 110% now they're losing on the vol side that's what happened that's what happened saw it plain as day underneath the surface skew there you collapsed the all the put buyers liquidated and and the realities that doesn't change the macro realities the reality is that interest rate hike doesn't hit the economy for 18 months.

And now we're in a very different position. The market is structured differently. So you really got to look top down and understand what's happening underneath the surface to liquidity and to flows, but to also understand what's happening from the bottom up and what's that positioning like and what does that mean this is why often we get a first move where it is slow where it is managed where people do expect it and then markets rally back everybody's like oh crisis is over we've averted things and then bad right it's a matter of shaking shorts shaking that structured ball positioning and ultimately those two things are generally squeezed that positioning is squeezed either by a counter trend move which changes the narrative or time which bleeds out decay

anybody who's trying to hedge this is the only thing i want to chime in there is i agree that the most interesting thing for 2022 in the fall arena was skew and like skew which i think you're trying to lead to is just you know puts relative calls, if you will. So steep skew means puts are more expensive to calls from implied volatility. Flat skew means calls and puts volatility about the same. And pre-2008, skew was reasonably flat, especially in comparison post-2008, because essentially banks could warehouse that downside risk without really any capital charges associated with it. 2008 happens rule

change that was pretty difficult to warehouse a lot of out of the money uh risk on the put side thus right thus skew has now been pretty habitually steeper since 2008 and that was you know even excessively so into the case leading into 2022 because not only do you have that regulatory regime that's kind of forcing steep skew but you also had a decent amount of folks with an opinion that were shifting things even more so and so the extreme flattening of skew not only through the you know extreme steep levels to like normalized steep levels but like truly flat skew surface in 2022 is probably the most interesting piece in the vol surface which again i think is related to positioning that you know

people are still always long the market but they're probably less long than their benchmark thus their ultimate risk once the market started moving lower was actually a snap recovery not a continued fall and then i want to pull on a thread there that you were mentioning it's tough to systematize this stuff but that seems counter to me of like this is a new technology it's super complex you need 3d ball surfaces you need all this stuff, right? You need super complex models just to understand it, but then you're also kind of saying, well, it's more art than science. So help me understand that. Which is in control, art or science? I think the science is, we'll call it imputing fair value of something, but the art's more

important for any sort of thematic moves. So if you're purely the quote-unquote scientist they put you in the category of a really strong market maker which involves a likely pretty extensive technology budget to make sure that your quote-unquote science is at the pinnacle of the industry but if you're having something that's a little bit more you know know, not just straight up market making, then you've got to move out of that pure science. You've got to understand fair value of things and have the correct tools in place, but it's more important to be able to adjust to thematic changes than being a pure market maker. I think the way to

systematize it is not to just fit a volatility surface and say this is high or this is low or this is high relative to this or this is low it is to understand that this is not tornado insurance that the contracts themselves have a reflexive effect on the underlying so to systematize a strategy you have to generally understand where the positioning is in the market. That can drive a real edge in a systematic way. Understanding what that means for the probabilities. Yes, understanding what's high and what's low, those are absolute and they matter.

But if you think that because something is high, it's less likely to happen, you're missing the whole part about actually modeling the distribution itself. And I think that's an important piece that a lot of market makers didn't do for the longest time but that more and more they're using the information embedded um you know in in in the distribution in the the market to understand supply and demand i'm going to use your tornado insurance theory right so the whole concept of gamma and everything happening with the market makers is as the tornado is getting closer to that house that doesn't have the insurance, the tornado is getting stronger. And the more houses it knocks down, the stronger and stronger it gets, right? Which doesn't happen in real world phenomena, but. Correct. Correct.

You know, it's the contracts themselves are reinforced reflexively affecting the distribution. So that is a really unique thing about market insurance, and it's important to understand that. That liquidity that's being put into the market and that part of the distribution ultimately needs to be driven out, and that itself reflexively affects the distribution. So we can't just throw VIX prices into chat GPT and say, make me a great model on this? Not yet. Not yet.

What Jim's saying is it's really a tool to focus on distribution rather than necessarily direct price movement. And that distribution tool might influence price movement in certain scenarios. I think a simple one is especially you know the conference happening through the wall is a bunch of allocators that really want mailbox money. So you have a lot of people that would love to just earn their you know so for plus 150 basis points like clockwork and the only way to get something that looks like that kind of return is you got to ignore the extreme left tail because that's too expensive so you build a bunch of products that look like hey we're just going to give you that mailbox money and then when everybody's like well what happens if this happens like oh well that's going to be the end of the world and

guns and gold and whatever so just ignore that because that's too expensive and then you wouldn't like the yield that i'm going to give you in the mailbox money. So it's affecting the pricing of the distribution within options and that allows you to potentially take the other side of some of that positioning on a pretty habitual basis but then when the market moves you probably have to move with it because people are starting to enter a different piece of the distribution of those actual products that they own. I just want to add one thing. When we're talking about market volatility, there's different markets, right? There's the Dow, the S&P, and the NASDAQ. And there's some

of my NASDAQ friends here. So in 2018, I did a hit with the NASDAQ and we were looking at where the market returns are coming from. So we keep talking about market volatility, and this is what the S&P is doing, whatever. I think right now in our calculation estimation, the S&P is over 55% NASDAQ. And so far this year, I think roughly 50% of the market gains have come from three stocks. So when you're talking about and what are those Microsoft, Apple, and Nvidia I think. So when you're talking about the market and you're talking about indices and you're talking about which big indices, you have to know what's making up that indices,

what's driving the moves. Apple right now, again read this, I haven't done the calculation, I think is worth more than the stocks in the Russell 2000. I saw that. I think that's crazy. Right. So even if a stock is, let's say, 18% or something of any index, does it really drive? What's the beta of the index to the stock and vice versa? You know, is it really driving it more and more? What's making up the volatility of that particular index? So it's gotten to a point where, I mean, I'm old enough to remember when there was a real difference between S&P and NASDAQ and the Russell. Now I'm, you know, is there a difference between S&P and NASDAQ? Maybe yes, maybe no.

So I'm going to take this thread a little bit and talk about something that broadly happens. Some people here may have heard me talk about this, but I think it's important that everybody understands. The reflexive effects here are not just directional or, you know know affecting distribution if the hedging or the majority of all supply is in something like the index right and yet you're having a macro effect where the majority of the market is getting hit because the single stock that's not those aren't ball centers they're actually experiencing idiosyncratic risk. By definition, because the index itself is pinned, some things have to go up. And what we're seeing, and often what you see when breadth gets out of whack like this, is exactly that. That's part of why it's a poor indicator for future performance.

That's why breadth is such a good signal. It's because usually it means something is happening in market microstructure that's holding the market in place. And it's generally vol in the S&P or other kind of centers that are not in step with what's actually happening underneath the hood. And so right now that's what we're seeing. Right now there's lots of sellers in less liquid non-vol centers because those are places of risk and they're expressing macro liquidity concerns. And the index is pinned because volatility is very well supplied. And that has to be expressed somewhere else in the market to balance that out.

And that's why we're seeing it and guess what where the ball is not pinned and NVIDIA where people are massively buying calls right and other names that are big enough to counterbalance and this was the dispersion trade that was tough and all you know about it last year it's all year about equity you know yeah global EQD and it continues to work because the hedging is happening and the structured products are broadly in the S&P. Now, the reverse side of that is when things become unbalanced,

like we're talking about. Now that starts to go the opposite way. And that's what happened in Feb, March 2020. That's why the S&P started the decline the day after the Feb OpEx. That's why it ended the day after March OpEx. And that's why the majority of the day after march op ex and that's why the majority of the pain in the the performance was in the s p not in the constituents it's because when it starts to reverse that goes exactly the opposite way and guess what correlation goes

to one and now i'm going to bring it back to my question of your first thing a ball always bleeds through but we didn't see the bond ball bleed through the s p in 22 or did we you can correct me i think i think i think we did i think we did and we saw it in um we saw it in some of the stocks that are related to that or some of the products right uh mortgage-backed securities agencies the, the dollar, the move in the dollar, the move in currencies. I think you started to see it. Now, is it fully done? Is it as violent as it was in the fixed income market? Not yet, but I think you saw the first tier, which are banks that bought hold-to-maturity securities,

and all of a sudden they're going from saying, as a tre treasurer i have zero risk because i own hold the maturity securities dude dude you're down like you know 180 because you bought the stuff on leverage as well right so you saw that in the banks that's happening it's it's happening now if the fed hadn't stepped in it would have have been much, much worse. But the Fed stepped in. So, I mean, that's the way, you can't cry about it. That's how the market works. But the Fed has been keeping volatility dampened, especially if they let these banks go, you

know, it would have been a mess. And to what Cem was saying earlier about what the market structure was talking about, to translate it, he totally agreed with me. So, Jeff, the spread between treasury volatility and equity volatility makes a lot of sense because equities are kind of floating instruments right like their revenues are probably somewhat tied to inflation which was what was driving rates and thus their you know free cash flows were probably going up somewhat aligned with that inflation number so it's a you know a floating instrument and you know yes you know you should discount things, possibly more aggressively with higher rates,

especially with a tech-heavy indicee, but ultimately it's a floating rate instrument versus a fixed rate instrument, and when interest rates move that much, they're gonna ding and have more violent moves with the fixed rate. But you also have to, I agree with it, but you also have to remember, 20 years ago, but you also have to remember 20 years ago, if you

were a commodities trader or a FX trader, you didn't know an equity trader. You only knew equity traders and you were in your own little silo. Now with structured products, with ETFs that give you access to all sorts of different things, to REITs, you know, it's getting more and more because big funds and managers are all owning different things. So when they get in trouble or when things go well, correlations go to one, right? Because their entire book, they're starting to get hit on other stuff too. So, you know, and another Blackstone or whatever, is it Blackstone or Blackrock, whatever that $65 billion REIT. Yeah.

Right. You just can't get your money out. Right. Everything's fine, but we just put up gates. Everything's fine. Right. You can't get your money out. Then Starwood did the same thing.

And then the banks, you know, that really started it, was that. And then people started to look at commercial real estate. And they're like, man, these, you know, really started it was that and then people started looking at commercial real estate and they're like man these you know hold to maturity security and then boom boom boom boom boom it it bled down i think there's a wilson phillips song just hold on i said it bled down not hold on so i have a couple of thoughts uh one a hundred percent luke in the short term when there's not enough liquidity in the tail to absorb the amount of people trying to get out. So that's part of why, again, correlation goes to one. And it does eventually, in those scenarios, bleed through to almost every asset class. But that's often short term, and it's a function of liquidity. I think a common theme here that we've been talking about is the importance of liquidity,

importance of how the positioning is and what that means for structured liquidity in different products and different parts of the distribution. We're in a different time. The part of the, you know, the frustration on your end, I hear you, is the Fed has been selling puts. And they've been selling it not just for 10 years, Luke. They've been selling them for 40 years. And they are the bully in the room. And they always can underpin the market, is the psychology, and has been for 40 years. This is a bit of a macro turn. But the reality is they could do that because we had two mandates, price stability and maximum employment.

And those two things were in line because we were in a secular deflationary period. The reality is for the first time in 40 years, we have a more inflationary period. Now, the big question on everybody's mind, is that going to continue or is that not? We can go into a whole other hour here talking about why we see that being the case. I had a $28 avocado toast this morning. I think it's going up. But there are secular themes under, you know, populism, you know, deglobalization, all these things are connected. I won't, again, I'd love to give the whole thing but we don't have the time for all of it. But if we are truly in a secularly inflationary period, which I believe we are, that really puts the Fed in a box.

And that's a very different thing than we've seen the last 40 years. The Fed has a very difficult decision to make in a stagflationary environment. That means they have a loss of power, a loss of strength. They are no longer the bully necessarily in the room they are they're vulnerable and they're not just vulnerable within the u.s they're the cross the cross national forces come into play the last time we saw this 68 to 82 right the last inflationary time we go look at that data, and what you begin to see is not volatility increasing across assets. You see it increasing in certain types of assets, and dramatically so.

And actually, ironically, being dampened in other assets. We see an increase in FX, in interest rates, in currencies, right? All this makes sense. We're dealing with cross-national kind of rotations you see in precious metals which are also kind of a currency type situation but ironically in commodities particularly industrial commodities energy precious i mean not industrial metals you actually see massive vol dampening why is that because now there's a new source of power. Now, OPEC or, you know, name your country with, you know, Chile with copper or whoever, right, has their own put.

They can underpin the market like we've seen with OPEC recently. They can really drive a floor because they have more power. And during inflationary periods, that's what we see. So it's kind of an interesting little side note. Not everything always moves secularly together in vol. During short periods, yes, the tail goes to one. But if we are truly entering a different regime and the Fed put is weakening, which I believe it is, that changes the calculus for equity vol, changes the calculus for rates and FX and anything tied to that. But it also changes oppositely the calculus for vol and other products. So there's a really... We're going to open it up to questions. One minute, go ahead.

All right. So the important point for me is that for the last 12 years, 10, 12 years, the Fed has been lowering rates while the markets have been going up, which is just, I don't understand it. I mean, Janet Yellen- Or did the market go up because they were lowering rates? As the market was going up and the economy was strengthening, they refused to increase rates. And I have some of, I tweet every once in a while. I'm hugely popular.

I've got like 17 followers, I think. But the good thing about Twitter is that there's a time stamp of what you said and when you said it. Janet Yellen, I said that inflation is a great equalizer. And then all the other stuff with, oh, it's going to be gone in a couple of months, et cetera, et cetera. So that's one big mistake the Fed made. And the other thing is, I agree with you that the Fed is going to be in trouble and they're not going to have the power they used to. But from the fixed income markets, I truly believe that the strength of a fixed income market for any country is the power of the military. Okay, because if you remember, when Iraq went into Kuwait, Kuwait had the number one credit

ranking of any country. Two and a half million people like number four in oil reserves, right? Credit rating, currency the strongest. Iraq, totally bankrupt and broke, but they had a couple more tanks, right. Two days later, credit rating of Kuwait. Kuwait wasn't even a country. They started to try to start printing new money. So as long as the military power is there, the Fed has more power than just what it really should as far as supply, demand, macro, etc.

But this is what you're seeing with China trying to change that, China trying to say our currency is the one, etc. But I do think the Fed is going to be in trouble. I do think we're going to see inflation, and I do think that there's a lot of legacy assets that people have bought, and there's been a lot of capital in the wrong places, and they have to come down. That's all there is to it. Ted, finish the question.

I would say 30 seconds on inflation is, you know, I think you should think about things as there's fixed costs and variable costs. And variable costs will say a cost of financing and labor and fixed costs are generally assets or things that are associated with assets. And it's easier for the Fed to attempt to reduce the variable costs by increasing costs of financing and hopefully slowing down labor. But they're failing at that, obviously, thus far. And the question is, do they actually care about inflation?

Are they going to do something that could break the fixed cost side, i.e. bring assets down? Or do they not actually care about inflation? They won't have a choice, unfortunately, because the problem for the Fed, the biggest problem is if long-term inflation expectations go higher. Because reflexively, that creates a pull of demand forward, as we all kind of know. And importantly, it also allows, if real rates are negative, people to borrow for cheap and buy assets that ultimately go up, which creates more inflation as well.

So there's like a reflexive effect there that they won't have a choice. You'll get runaway inflation unless they respond. And that's what puts the threat in the box. All right. Let's look at the box. All right, let's have it. John. How should we be thinking about the actual constraints on the Federal Reserve, though? I mean, do we think of them as a unit with the Treasury? It's about how much debt you can take on as the United States. I mean, how do you actually translate, you know,

inflation as something unpopular into policy that's made specifically? Like, I just want to understand this better. It's a big question, right? And I don't, there's a couple of things. One, the Fed was created with a legal mandate to use one tool, monetary policy, to address two specific things. Maximum employment and price stability. Now, those two things were aligned forever. They could just print money all day long, send money to capital, create a deflationary environment. And at the end of the day, in the last 40 years. That distribution eventually makes people angry at the bottom. People say, two generations, my dad did better than I did. I did, you know, and he did worse than his father. That's the type of thing that

creates a loss of status and political appeal. And what we're seeing in all of this is a score that we see whether it's right or left and the moving of populism whether it's rusted out cities in middle America or you know Bernie and AOC on the left, it's all a function of that at the end of the day. And that political swell, that desire by the populace for a more fair and just, when I say the populace, primarily millennials on down to the world labor, the bottom of the distribution, is what is driving secular inflation. The Fed can't fix that. The Fed can't come in and raise interest rates. They can affect cyclical inflation, but they can't affect secular inflation. And the Treasury can affect it, but the more they do that, try to fix inequality, the more inflationary it is.

I was only gonna just chime in that the fiscal and monetary side were on the same team for a long time that's probably unlikely to be the case going forward even even the last three months the fiscal side obviously is not overly happy and the fed probably is high-fiving themselves they're like look at this inflation's coming down unemployment's still a three handle like they're very much on different teams for the first time the problem is once this cycle gets started, the populism, you drive inflation and as you mentioned it's a flat tax. Who does it hurt most of all? It hurts the poor and ultimately that then drives more populism discord like the system's broken, it's not working for me, etc. Which leads to a new form of fiscal which tends to be price controls or tax gas, gas tax holidays or first-time homebuyer tax for things that are still fiscal student they're more directed towards the inflation

itself this is the cycle that we're when we're just and for Karen does anyone listen to smart list podcast no all right for Karen can fiscal verse monetary once I want to explain that in 10 seconds or less. Fiscal versus monetary? Yeah. Monetary is using interest rates or QEQT to affect the flow of capital to those who borrow. The quantity of capital out there. And fiscal is sending it to the people. Like we saw in Coke. Whether taking it or sending it to them.

Adjusting essentially the distribution of income where the money goes the power of the purse string belongs exclusively to the treasury the fist the the fed cannot control that all it can do is flush money into capital called a planet palo alto sending money to corporations or wealthy individuals people who borrow to stimulate. Policy versus interest rates. And SBB was the Treasury guarantee? That was the Treasury underpinning. So that was a little... But the point here is not whether it's Fed or Treasury. The point here is where is the money going?

And the money's been going to the top for 40 years. And people are saying enough is enough we want to fix this unfair they believe is an unjust situation that's a political problem if we decide as a populist by our votes that that is the case that is inflationary and that's a problem that puts the Fed in the box and they can no longer come sell the put anymore. Darryl. Yeah, Darryl. Darryl, I was going to brag that I've memorized everyone in the crowd's name. So talking about like the path dependency of all, right, and the history of all and, you know, where we've seen these cycles go with you know

skew being really high and then coming down now and then you're talking about this structural pull forward with ball coming to zero DTE so you know just going forward do you think the trajectory, the path dependency that vol has been on currently lends itself to a situation where we would want to protect those fat tails on the downside? My opinion is yes, we're getting there. Dealer positioning is a function of trend of some kind so the more something is profitable people crowd in people who are on the other side get out and eventually it gets heavy 85 percent of scenarios and our models show dealer position be quite strong and they're also going to be some type of trend doesn't mean trend up or down necessarily. It can be trend down at all like we saw in 2017.

It could be a massive rotation growth to value and people getting crowded, right? But those trend situations create heavy positioning and those ultimately tend to be more dangerous situations for what the opposite of that positioning is. Imbalance. Imbalance. And we are heading to a point of bigger imbalance, particularly from the short side, whereas we were on the other side last year. I mean, we're like Volk, I mean, very different things too.

So it's like, you know, one day, one week, one month option. That's basically implied versus realized. Are we going to move more over the next, you know, one day, one week, one month than the distributions currently implying where you know two-year options is kind of more of illiquidity you know stance on the marketplace it's less dependent on the realized movement and much more when there's an event where people need to reach for some sort of liquidity mechanism.

The dangerous part is when that positioning aligns with macro for us. And I think that's the thing that worries me most is that we're getting that lag on liquidity, all those things right as people are giving up on them. Is the exciting part a little bit that it's getting cheaper? So just when it might be crowding on the short side, it's getting cheaper to play the other side of it. Yeah, I mean it's not that

it's cheap that excites me, it's that the positioning is getting off sides. Anyone else? Say you were an allocator that allocated to some of the people up here. Would you have any questions for them at all you mentioned the point earlier about the fact that seems like beta is just you know across all different asset classes there's just no everything

eventually the beta goes to one and everything like I said if you get into that, like, you know, the issue with COVID, SPV. And a lot of it has to do with these larger funds, these giant funds that just have their hands essentially into everything. Do you see, like, that changing going forward? Or do you just think it's going to become an even bigger issue or problem that just continues to affect volatility? And do you see ways to maybe take advantage of that, kind of being like a smaller, more nimble type of fund, like what your strategies are? I'm just going to repeat the question for the recording of, if I can remember, that the betas, as Luke mentioned before, are all seemingly as one in bonds and stocks at some point. And a lot of that because these large funds are doing a lot of different things in different

asset classes. Is that a good thing? Is that a bad thing? Will it change? Is that fair? And do you see opportunities to kind of take advantage of that? You know, being if you're in, say, like a small or more nimble fund or strategy, or do you see strategies that are more take advantage of that, you know, being if you're in, say, like a smaller, more nimble fund or strategy, or do you see a strategy to say,

well, we're going to take advantage of that? Right. And do you see opportunities in that that you could take advantage of as, I'm not going to call anyone up here small, but as mid-sized managers? Well, I guess you can look at it from the good side, is if something big happens in commodities or something, since it's going to bleed down if you have some volatility, you'll get some benefit from that. I don't think the funds are going to, unless they have some blowout of some of the funds

or whatever, I don't think they're getting any smaller. I think they want to attract more money. So what do you do? You have to come up with a new strategy. You have to come up with something new, which means the entire fund is now got six different risk managers that report to one guy, right? Commodities, fixed income, whatever. Obviously, there are some specialist funds, but I don't think that's going to change. And I think as far as volatility is concerned you know it's for us we look at it as our we have a long exposure to volatility at all times because we have we run it with long risk assets so we're always net long vega but what we try to do is try to buy cheap volatility relative to what we

think is expensive volatility right and also depends on what kind of regime you're in for example if if I told you volatility is at 50 today right or the spikes index or the VIX index is at 50 today I think most people would say that's high but is that in relation to yesterday when it was at 100? Or yesterday when it was at 20? So today matters the least. Tomorrow matters, obviously, and yesterday was important. But today where volatility is matters the least to us.

So we're always trying to look forward, say what's it coming out of, where is it been, what are the expected moves mathematically, what you're paying for volatility, are you going to realize that move? And then we always try to marry it with a risk asset, having no choice but believing that over the long term the market's going to go up, but there is going to be some downturns and it's more important to control the downturns because if you start at $100, let's say $100, and you lose 10%, you're at 90. If you gain 10%, you're at 99. So to us, it's more important to control the downturns rather than be always fully invested

and try to get in every penny on the upside. And again, that's just a small part of the portfolio, having some volatility, having some volatility management, taking advantage of volatility, whether you're selling it, whether you're trading it, whether you're marrying it with risk assets. I think it needs to be a part of your portfolio. As I said, our strategy in isolation is meant to do well during bouts of illiquidity when correlations are likely drifting towards one across the portfolio.

And in that specific event, there's likely larger disconnects due to the fact that the market is less efficient than it was at other points in time, which hopefully continues to drive the ability to take advantage of that specific opportunity, even though we're positioned to do well to go into that. I think what's almost more important is the portfolio construction on the allocator, asset holder side of the fence, which is, in my opinion, don't rely upon correlations because they are likely what's going to drive you into some problems when they all kind of go towards one. And if you're not relying upon those correlations, think about your asset allocation process of what you actually believe is going to deliver returns rather than be a quote unquote

hedging asset that does rely upon correlations. So I think, you know, our strategies are probably meant to do well in that environment and probably provide additional opportunities during that environment. But I think it's even more of a portfolio construction question at the end of the day. Beware of relying upon correlations and those asset classes that you're assuming are going to do well during those environments. So we have like two engines, I agree with you. We have an RV, like a relative value market maker framework, right?

Where we see what's high, what's low, not just within each product, but across asset. The other one is dealing with positioning, right? Looking at where the positions are, what that's likely to mean as a function of liquidity, right? Those are two sources of edge. When does each one matter? The RV piece, generally speaking, things come back to correlating to one matter the RV piece generally speaking things come back to correlating to one on the tail so when you get into a tail situation what you want to own is what was cheap ultimately but in the majority of other

scenarios which is the overwhelming majority you want to be where the positioning is on your side as a function of how much liquidity there is and those are the two things you have to put together when you're modeling what type of position do I want to have, what's the most probable win versus risk scenario. But that's kind of the way we look at it, is really kind of putting those two sources of edge together. I've got an answer here for you that you see, not with what these guys do, but more in the trend-following space,

that the last year and a half has really seen more bets become active right in the past when the fed was doing all this stuff it was really just one big bet all these different assets were moving together now that rates are going now that different countries have different views on whether they should be cutting or raising you've really seen a lot more dispersion it's not the right word but you've seen things split a lot more and trend followers love that because they're placing 75 different bets right so the more long or short so the more each of those 75 bets moves independently the better it is for them yeah so I have a

follow-up question on the trend following So... We've jumped the shark. Sorry, guys. Yeah. So March, right? You see the Six Sigma event in treasury options on the futures. Basically kneecapping all of these trend followers in the span of a week, right? Two days. Two days, yeah. So I haven't seen that bleed anywhere else right I haven't

seen that event essentially work itself out through other parts of the market yet and if I you know looking at some of these strategies and the relative value and you know different index or products that are traded, is that just like a one-off esoteric event that, you know, has no, you know, volatility bleed throughs later? Or, you know, are we going to see a convergence between, you know, the big bet that rates are going to be cut and the fact that rates haven't been cut yet. I don't know if that answers my question. Yeah, I would give a quick answer, which is sometimes when things get really wild, like the metals exchange in London, it just closed down for three or four days.

I would argue that putting up gates on $100 billion worth of REITs is closing down exchange. So you haven't seen it follow through because they haven't let it follow through. But it did then, that kind of, as water found its way to people that are holding legacy assets in the banks and et cetera, and you saw people started to look at that and their commercial loans, et cetera. So I think you've seen it. It has bled down, but then the Fed came in. So obviously, they came in for a reason. They saved that bank for a reason.

They didn't save it because they didn't have anything else to do or they weren't worried about what was going to happen. They came in for a reason because they saw what could happen. The dam could break. Ultimately, I agree. Ultimately, the way these things break, to see everything come into line, to go correlation one,

really see a massive fall of that, two things have to happen. We're talking about an 08 type thing, right? Or a 2001, you know, you have to, or February, March of 2020, you have to have some major liquidity issue. It has to be something that comes from the top, from a macro perspective. But you also have to have weak positioning. And that can happen in several different ways. It can be a part of the distribution that's so heavy and so big

that it can have ripple effects that blow everything up. Or it could be at the center or at the core of the positioning, like it was during Fed March of 2020. The macro was big enough, the positioning in the center was unbalanced enough to cause a bigger issue. So the answer is yes, eventually, if the positioning continues to go off sides, which it tends to gravitate towards

because people are greedy, right? You know, that's part of, they have an incentive to be. And then you pair that with what we believe is a macro liquidity issue, that eventually we will get there. And, you know, my view is that it's real well on our way now, a year and a half or so into this. But it always takes a bit longer than you think because of the reflexive effects, because people are positioning for it.

They have to give up. They have to be shaken of their conviction. Or the move is counter-trend. You get some type of blow-off, right, that forces that positioning as well. But the positioning needs to weaken, and you need to have that macro thing. And we believe the macro issue is in place.

It's just this kind of reflexive positioning issue that has yet to unpin kind of the rest of the assets. Yeah, it definitely wasn't healthy, but mostly assets you own are long-duration assets, so like 10-year-plus stuff. And that part of the curve, unsurprisingly, was not nearly as violent. So it's like you weren't moving an asset based on discount

from treasuries moving around much. And then the other side of the coin is financing. Financing outside of fixed financing, which, you know, takes longer to have problems, is floating, which is going to be Fed funds or SOFR or something along those lines, plus. And that obviously didn't change either. You know, spot rates didn't move.

So it's like your snap problem vehicles of either duration moved dramatically and guess what all my assets have a lot of duration or my financing cost changed overnight well that didn't change either because it was spot it was kind of you know not even this you know front end it was kind of two-year driven but you know it was isolated for now to that you know spot on the treasury curve but it's definitely healthy, but it's probably why it didn't cause a decent amount of ripple effects and other things immediately.

All right, we're gonna leave it there. Unless someone has a really burning question they wanna ask. All right, we'll leave it there. Our future's up, right? Yeah. A couple more. On the screen, I've been watching. I can't help myself, I've been like watching them a little bit.

Thank you everyone. There's drinks and some food next door. Enough for 50 people so go help yourself and eat it all. And thank you all. Thanks guys. Thanks. Okay that's it for the pod. Thanks to Jim. Thanks to Zed. Thanks to Luke. Thanks to RCM for supporting. Thanks to Jeff Berger for producing. We'll see you the second week of July. Have a fun 4th.

Don't blow off any fingers or eat too many hot dogs. Peace. You've been listening to The Derivative. Links from this episode will be in the episode description of this channel. Follow us on Twitter at RCM Alts and visit our website to read our blog or subscribe to our newsletter at rcmalts.com. If you liked our show, introduce a friend and show them how to subscribe. And be sure to leave comments. We'd love to hear from you. This podcast is provided for informational purposes only and should not be relied upon

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