The Derivative - WTF is this market? - with Vineer Bhansali of LongTail Alpha

Episode Date: April 11, 2025

In this emergency pod edition, Jeff Malec is joined by Vineer Bhansali, Founder and CIO at LongTail Alpha, LLC, to break down the market's wild rollercoaster ride that demanded immediate attention. When markets hit new lows only to rocket back with a stunning 10% rally, we knew it was time for another "WTF episode" – our signature emergency broadcasts reserved for the financial world's most shocking moments.Together, Jeff and Vineer dissect the tariff chaos sending shockwaves through global markets, with Vineer providing insights on the critical liquidity crisis unfolding across stocks, bonds (especially long-term), and their derivatives. This episode delivers the expert analysis and perspective you need when markets go haywire – just like when we talked crude oil's negative plunge and the GameStop rebellion that took down a hedge fund in years past. No scripted talking points, no scheduled interviews – just raw, unfiltered market commentary when you need it most. The world's financial markets just had a moment... and so did we. SEND IT!Chapters:00:00-00:49 = Intro00:50-11:08 = Market Volatility and Liquidity: The New Trading Ecosystem11:09-18:02 = Hedging Strategies in Uncertain Markets: 0DTE Options, straddles and strangles, and Tail Risk18:03-30:56 = Global Asset Shifts: Bond duration, Basis Trades, Gold, and the Erosion of American Financial Exceptionalism30:57-43:41 = Tail Hedging Economics: Getting out of the money43:42-54:32 = Market Resilience and picking up steam: Is there hope for Trend Following?From the episode:Relationship Between Trend-Following and Options (whitepaper) Previous episode with Vineer:Taming the Tails with LongTail Alpha's Vineer Bhansali Follow along with Vineer on LinkedIn and @longtailalpha on X.com and be sure to check out LongTail Alpha's website for more information!Don't forget to subscribe to⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠The Derivative⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠, follow us on Twitter at⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠@rcmAlts⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ and our host Jeff at⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠@AttainCap2⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠, or⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠LinkedIn⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ , and⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠Facebook⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠, and⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠sign-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, visit⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠www.rcmalternatives.com/disclaimer⁠

Seriously, after what happened yesterday, I mean, you got a reprieve. You got the VIX dropping from 50 to 30 overnight. You got the stock market going up from, you know, a thousand points on the S&P and whatever, it was 2200 points on the NASDAQ, if you came in this morning and you were not hedged and you knew you had to hedge, there's absolutely no excuse. Welcome to the derivative by RCM Alternatives.

Send it. Everyone, we got Veneer Bansali here, Long Tail Alpha. It's a Masters opening Thursday. I've been watching the Masters all day. I think that slowed down the volatility a little bit today. Everyone said enough. Let me watch some gold. But it's been a crazy week. So wanted to have you come on and tell us what you're seeing from the front lines. You're

just telling us off camera here you haven't slept much. Not because you're nervous, but because there's things to do, right? Absolutely. You know, so for a person in the long ball field, I think space, you space, we build positions, obviously. When vol is low, markets are rallying, you have to be countercyclical. And you build them patiently with investors who understand that the best time to buy protection is when protection is extremely cheap, which it got to incredibly cheap levels. And I wrote about three or four pieces in the last two weeks saying, basically, what's up with Vol? Why isn't it going up with what's going on?

And then of course, April 1st, it all kind of started to happen and move and Vol basically tripled. So yeah, we built positions when Vol is low, markets are up. And then when these events happen, which tend to happen more frequently and the bigger frequency now, we'll talk about that why we believe things are faster and deeper. And what we're doing is effectively monetizing because we have a plan in terms of where we're going to take some of the hedges off. So we can either provide the liquidity to our investors or the hedges off. So we can either provide the liquidity to our investors or redeploy them into lower strike options or into other asset classes which might not have moved or

going from short-dated options to long-dated options, basically in all the active management levers of option trading. And yeah, so we've been up pretty much every night because the index options markets and some of the futures options markets are actually open way, way, way before the official S&P 500 starts trading. Yeah, you were saying they open at midnight and it's pretty good liquidity and volume in there? Yeah, California time at midnight. Yeah, you know, it's not as great as well. Let's talk about liquidity in a minute here. It's not great as the rest of the day, but you can get enough done. You just have to be very careful because obviously there aren't too much of the retail crowd out there and too many of the large market makers participating, but you can do enough and size attracts size because it's usually professional traders around the world who are involved there. Now on this topic of liquidity, I guess I can address.

Yeah, dive in. Yeah, there's a few metrics, right? And the biggest one at the most superficial level, the highest level is you look at the depth of the E-mini futures contract stack, the order book, and it's basically evaporated. So the easiest way I can say that is there is no liquidity. So if you think you can get anything done in the futures market of any size, you're just fooling yourself because even now, during the all day today and all day yesterday and maybe last week, you could see in the depth monitor,

maybe about 100, 250 total contracts. That's the whole stack of all the bids and offers that you can see. Versus normally 500 to 1000, maybe 1500. It can get very deep, especially near closing time and opening time. So you're running at one-tenth, maybe even less than that. But yeah, that's a symptom in the equity market. If you go deeper into the layers, for me, the hierarchy in my brain is the most liquid thing is obviously cash. There's nothing more liquid than cash. Then you have T-bills. Then you move out the duration spectrum to the treasury bond market is a good metric of how liquidity scales with just duration risk. And the 30-year bond, as we all know, has no liquidity right now. It's moving 30, 40 basis points a day. And that then sort of gets absorbed into asset

classes that rely on that risk-free asset or discounting. So what are equities? Equities are very long cash flow instruments. You have to discount that back on the long bond or 30 or 50 or 100 year bond. So there's no liquidity in the 30 year treasury by extension you can say the thing that you're going to discount those cash flows on equities will have very little liquidity So given that there's so little liquidity in the Treasury bond market I'm actually surprised that there's any liquidity at all in the equity market right now, right?

Yeah, and do you think that is that a function of actual liquidity of the people? I mean, I guess this is a philosophical question of what is liquidity. But right. Is it in my brain? It's because people are scared to death, not normal investor people, just the market makers of like, I'm not putting my neck out there. It's going to get chopped up, right? And there's, I can't make it wide enough for it to be profitable for me. If we can rally 200 points in the S and P in a matter of six minutes, whatever it was, like where, where can I put my marks in order

for it to be safe as a market maker? Well, yeah, I mean, not 600 or 200, by the way. I mean, sorry, I know you and I have come from 200 was big, 800 points, right? The NASDAQ was up close to about 1800 points yesterday, right? The NASDAQ futures, 1800 points, 10%. So yeah, so and in a matter of a few seconds from that, you know, tweet that came out, whatever you found these days, not the tweet. Yeah, so to your point. Truth social. Yeah, the point is that, yeah, so over the last few years, the ecosystem has changed,

and I've talked about this before, I think even in your last podcast I came on. And human beings have been replaced with automated trading bots because they never sleep, they never get tired. And they're basically making that bid offer spread continuously. And what happens in these kinds of episodes is the algorithms or algorithm makers are very smart. They calculate what they need to clear a certain volume and they just say, well, we'd rather shut it down and let somebody else do it than step up and try to make markets when the S&P futures is jumping five points between bid and ask. So the market makers, for the most part, the electronic market makers are just out. So what you're seeing here is probably boutique people or maybe humans. So it comes back to

COVID or a COVID type of episode, you know, I call it as mono on mono trading. It's human against human. And humans are extremely risk averse when it comes to providing liquidity, right? If you remember in the old days, when there was a bond futures pit and floor, there were one or two guys like Tommy Baldwin and others, who would be at the bottom of the pit and the whole pit would basically stop when this guy would show his hand because it stopped with him. He could turn markets around. Yeah, he'd bid 5,000 contracts. He'd bid 5,000, he'd take it and he would like, boom, the market would reverse and go

the other way. It doesn't happen anymore because that person does not exist because nobody wants to be a hero. And electronic market makers are exactly the anti-hero. They basically say, oh, wait a minute, this tsunami is coming. Instead of stepping in front of it and saying, I'm the man, I'm gonna actually join the tsunami and run with it. So I think that's the ecosystem is very different right now.

Sidebar rumor, I've heard Baldwin actually went and tried to do Nasdaq stocks on the screen and lost a fair amount of money because he couldn't be that guy in the Nasdaq market, which you'd think the bond market's bigger, but there was the physical, as you're saying, the physical human nature of it. Let him do that. But right, like that's a weird thing to me because liquidity to me means, oh, there's not trades on both sides versus the market. I don't know if there's a question in there, but right, it's a little nebulous of what does that mean exactly? Like, there's plenty of people wanting to buy and sell, but the market makers aren't there so that

we just can't, you can't match them up, I guess. Yeah. And also, you know, we have to also admit and agree that there's a lot of retail participation. I just spoke with somebody recently who basically has been selling naked zero-DT options, right? So just like literally just selling it and collecting the binary daily payoff is like, it goes up through my strike or down through my strike. I'll lose money, but if it doesn't, then I'll collect.

So what has happened is because in the ecosystem, there's a lot of retail traders who want to trade, but they are not necessarily hedging with futures or with SPY or anything else. They're just literally running naked positions. You are finding that with these kind of moves, many of these positions are just losing money. So they're losing money. So they're backing off, right? So one of the key structural underpinnings of the markets recently has been to buy the dip mentality because retail comes in and buys it

because they can get the liquidity at the end of the day to sell it. Right now there isn't there. So retail has just stepped back because they're just not there. Maybe margin calls, maybe too much losses. They're not stepping up and providing the buy the dip liquidity

because they must have gotten hit pretty badly over the last week or so. Except for yesterday, right? They thought they'd won. No, buy the dip worked again. Well, it's interesting you say that because I actually had to go and get just the routine physical done.

So I went to my doctor's office and my doctor came in and he was clearly, he was a great guy. I've known him for a long time. But he was a little, you know, impatient. He was like, basically what he said was, you know, I could have bought that dip if I wasn't here to, you know, to give you a physical when the news came out and I could have made a few bucks just by, you know, pushing my phone. You should have been like, well, if you invested with me over here, you wouldn't have to worry

about buying the dip. Let's make a trade. But even the dip reversed today, right? Because we know half of it reversed, so we don't know what comes next. Speaking of the Zero DT, have you heard any, right, I think when this first started to become a thing and that volume started to take over, I think, what's it been, 60 or 70% or more of the option volume? Right?

A few things were, one, this is overtaking the VIX. The VIX is not useful anymore because of all this zero DTE was a theory. Two, there's going to be some huge blow up when these types of moves happen. One of the primes or market makers is going to go out of business. So dismiss either of those or both of those. I haven't heard anything of any big firms going under because of zero DTE. Not yet. I mean, I hope not yet. Yeah, but you know, you never know, right? Somebody's under capitalized and overexposed. And, you know, maybe preemptively, a lot of people were a lot of firms who might be allowing that kind of speculation and probably not allowing that.

But I don't anecdotally, we don't traffic in those markets. But, you know, again, zero DTE is somewhat maligned. I do think there was an economic rationale during the COVID era and other times when people kind of had to take out their gambling instincts in the index options market. But right now there's very little rationale to speculate on short dated options. Because again, coming back to liquidity, there isn't really much you can do unless you're willing to do a coin flip trade every single day. Nobody's gone out of business yet. Most of the retail is selling them, do you believe? Yeah. Yeah. So in this scenario, maybe they should be buying them.

But which leads me to my naively and I was talking with some guy who does some options stuff. He's like, why don't you just buy the straddle every day? Right. And the market's going to be up or down five percent. I'm like, well, because I think the straddle is priced in for it to move

even more than that. So, right. What what have you seen with that of what's working in terms of straddles and strangles or that's everything's just the price is blown out That's a short dated. Absolutely correct. So short-dated implies are trading I mean you can go look at your screen right now at the money 5300 S&P puts you probably get 40 points on a put

And I call 80 points right for a one-day option. I mean, that's huge, right? So so when you get paid whatever percent or a half or 2% for just a daily options, it's very tempting that you can get that kind of premium. But to your person's point, you just don't know when you're gonna get a 5% move or a 9% move like we had yesterday. So 1% premium earned in a 9% move is a very bad thing to earn.

So realized is realizing 200% and implied is 60% or whatever the number is. So short-dated options in my view are coin flip trade, right? So volatility as a metric should not be used for short-dated options. And that's the change in the ecosystem. Full stop or right now? Well, we don't know, right?

So if, here it is, right? I mean, I was kind of jokingly talking to somebody yesterday that, you know, I'm a quant by training and I do financial modeling to figure out what's good and what's bad. And right now on my screen, I just basically put a feed from truth socialists because any analytical model I can come up with will get overwhelmed with what that signal comes out.

For good or bad, I don't really know, but really, you know, modeling doesn't make, for sure, dated options. Any sense. You can come up with your best quantitative model. And like, you know, the person you were relaying the information from. So yes, market's moving 5% today, but you could come in tomorrow and make moves 0%. In which case, your 5% premium is completely decayed because of it. Yeah, kaput, right? So, but having said all of that, if you go longer dated, and I wrote a piece just recently

on why longer dated volatility is still quite subdued, it's moved a little bit, but it hasn't moved very much. Credit default swap spreads have moved, it hasn't moved very much. Credit default swap spreads have moved, but it hasn't moved very much. And again, credit default swap spreads are like extremely long volatility. And I think the reason really is fundamentally people believe that what has happened over the last few years

is going to happen again, where either the Fed's going to ease or we're gonna get a pivot from the administration and the markets will just stabilize. So that belief is what I think is holding longer dated volatility still at very low levels. And again, I'm not making a forecast here, but the view is that if what we're seeing today, and this is this whole game theoretic formulation for me right now of what's going on in the world is multiple people, multiple agents playing multiple games. We don't know what the games are. We don't know what their strategies are.

We don't know what their payoffs are. We don't even know what norms they're following. The tails of the distributions are very fat and flat, as people say, right? So you can have movements in the market that actually start taking their own life. So something happened in the market that creates reactions, like maybe what we saw yesterday, that then results in a completely new set of reactions. This path dependency could result in longer volatility for longer, a higher volatility for longer,

in which case what we're looking at in the long-date space right now might just be extremely cheap. And define what we're talking about here with short-term and long-term. Just put some numbers on it. We're talking about... That three months in, I would call short-term. And then anything year or longer or nine months or longer, I'd go long term. And then three to five years, I call extra long, that you can't really

buy a lot of index options there because that's not a liquid market, but you can do CDS and credit default swaps and things like that. And then just to on my other point, so when you were saying short term is like a coin flip, you were saying right now, not a year ago or not in normal times, you can model out some short term. Of course, yes. In the short term, right, exactly. In the short term, in a normal time, if you saw a implied volatility,

I mean, again, volatility is not a good measure for long, but assuming you take this simple coin flip binomial model and you translate it to an implied volatility using black-Scholes which people do, you'll get an implied volatility of 60 percent. In the old days, if you got paid 60 percent implied volatility, i.e. 80 S&P points, or a at-the-money straddle for one day,

you would take it all day long. But right now, why isn't everybody selling it? It's because the dangers are that you move 300 points either side before you get to do anything. Yeah. Right. Because no one's willing to buy it. So you've mentioned credit default swaps.

Talk a little bit about what else is in your right outside of index options, what else is in your toolbox in terms of all these different path dependencies and how you kind of view that side of tail hedging. Yeah, so we think in terms of what it's been doing during all this. Yeah, yeah, absolutely. And, you know, when we think about hedging, we think, again, kind of given the engineers and quants we are here, in terms of the trade-off between reliability or dependency or how much you can trust is and cost.

The most reliable thing, obviously, to hedge, I mean, other than just selling all your equities and just going into cash, the most reliable thing that you can do is buy a contractual option, like we're just talking about like, you know, index options and so on against your beta and the portfolio. As you become, allow for less reliability, you can do cross market trades, right? So instead of hedging equity options with equity options, you can hedge it with CDX, credit default swaps. We talked about that briefly. Then you start moving into the spectrum and you start thinking about things that respond possibly slower. But if this continues, they should respond.

And the thing I'm thinking about there is duration. So you can buy bonds in your portfolio. Now, unfortunately, in the most recent episode, bonds have been dismal for good reasons, because as equity markets have fallen, people have started romancing, and these tariff issues have escalated. People are romancing, basically an escalated tit for tat game

in which foreigners who subsidize our treasury bond purchases might not buy them or maybe even sell them. So treasuries in long-term duration has not done very well at all recently at least. And then you go into strategies like trend following and so on, which people do in various forms intraday trend all the way to long-term trend again hasn't done very well so far. Trend following is actually net-net was down last week and it's been down for the year.

So in the spectrum, we think we're not attached to just tail hedging. We just think about where is the reliability highest and where is the pricing the highest. So on the spectrum right now, tail hedging is longer term tail hedging is using options is still the cheapest in my view because it's the most reliable. But other things will start kicking in as and if this market continues to move in one direction, trend following, duration, and other things. So data on the radar screen is just that we're not overly allocated to them right now because basically from my calculation, I still believe long-dated volatility is actually quite cheap. So short-dated options have become expensive in the short run, or maybe fairly priced one would say, but long-dated is still pretty low. And what are your thoughts on the

bond duration trade? If that's just a blip, it sounded like you were thinking that still works long term. Yeah, was it the basis trade blowing out like all the headlines were saying or what what are your thoughts on what happened yesterday? Right? What was that last track of time? Wednesday night when it was down? Yeah, five points in the long bond. Yeah, I was there awake in the middle of the night when you were up 30 base 25 30 basis points intra at night on yeah around midnight. so then he came back okay so what's going on there right so again having been a professional bond trader for you know PIMCO and others for such a long time now that's kind of where I you know cut my teeth I guess in trading

yeah so the bond market I think has a few things not going for it right now. And the basis trade I'll talk about in a second that obviously is technical. I think it's more of a technicality that requires a little bit more explanation. But at the highest macro level, I think it's just inflation coming from tariffs, right? The tariffs are a tax and the market is basically saying in the short run, And the market is basically saying in the short run, maybe the value of having a treasury, T-bill call it or a two-year treasury, overwhelms the inflation risk because short-run inflation might spike,

but at least you're not locking it in for multiple years. But in the long run, if inflation goes up and duration should obviously not do well if inflation goes up because yields will be higher. There's really no reason to justify buying a long bond at 475 or 480 or 5, whatever the number is right now. So that's number one. That's the macro reason. Number two is that it's extremely illiquid and bond volatility has gone up a lot. So equity volatility, of course, has spiked to 50, but also

what people look at is the move index for rates volatility or swaps in volatility and so on. Interest rate volatility is extremely high. So if you think about what the risk in a bond is, the bond's risk is effectively the duration of that bond, 30-year bond is the duration, call it for 28 or 29 years, times interest rate volatility. So if interest rate volatility goes up a lot like it has recently, the total price risk of a bond is very high. So if you could have justified holding a bond maybe a year ago with the same duration at a lower volatility today, you cannot because interest rate volatility is about 30% higher. The move index has moved,

I think, from 100 to 130 or something like that. Where's that from a historic level, like historic highs above COVID? I don't think so. I think during one of the big European crash, let me just put it up here. Yeah, sorry, put you on the spot. No, I can put it up here because, yeah, if I remember in 2008 during the financial crisis, it got to 200. No, I can put it up here because yeah, if I remember in 2008 during the financial crisis, it got to 200 basis points annualized. That's the move index. The whole curve moves differently. And right now, if you think about it, 130.

So it's only about a half. But if you look at the long-term charts, it is getting to the point around, actually, I'm sorry, it's exceeded COVID. COVID, my peak shows about only 110. So we're trading above COVID for sure. So think about it from the portfolio construction metrics of somebody who follows like a risk parity portfolio, stocks plus bonds. But the risk parity has done really badly too, because both bonds have gone down and stocks have gone down. If you're following, risk parity has done really badly too, because both bonds have gone down and stocks have gone down.

If you're following a risk parity framework and your bond volatility goes up, you have to proportionately de-risk your bond allocation, because the way risk parity works is you have a total volatility budget. And add to your stock account. Well, exactly. On margin, you add to the stock, but your total volatility has gone up. So you're basically saying de-risk stocks and de-risk bonds at the same time, because risk parity portfolios run with a total ball target, let's say 10% total volatility, and that's allocated proportionately

to stocks and bonds and other things based on their own volatility. So stock volatility goes from 20 to 50, usually disparity looks at historical volatility, 20 to 30 or 20 to 40, you're going to de-risk your stocks. Bond volatility goes from, call it, 100 basis points annualized to 130 annualized, you're going to de-risk it also. So you're de-risking everything. So that leads to this kind of correlated thing. So that's number two. And that kind of is related to, you know, illiquidity in the bond market. Number three is just this fear,

and as an existential fear for the market, is that if the Fed doesn't come in and does QE, who is going to fund this massive deficit that we've got, right? I mean, we got whatever, you know, today there was a $ whatever, you know, today there was a 20, $30 billion 30 year bond issue. It went through okay today, but can we keep doing this

if the people who buy our bonds are not going to subsidize or maybe, you know, not provide that funding? So that's number three. And then number four, we can talk about the technicals, the basis trade, which kind of, you know, basis trades blow up frequently but the one that is blown up this time is the bond versus interest rate swap. If you're interested I can talk about the technical. Yeah, I'll go back to number three for a second because this is interesting to me, right, of like the, and this

is true in the stock market too, of like have we lost American exceptionalism right what's our USP is 20 the rest of the world's 15 I'm just throwing random numbers out there maybe they're 10 but whatever so if we both lose a billion dollars in earnings our market's going to go down a lot more than the people who are trying to right if we try and make it fair it's going to hurt the US a lot more than the rest of us but that's a side argument but if we're right is that fair, it's going to hurt the US a lot more than the rest of us. But that's a side argument. But if we're right, is that the argument of like, we're losing American exceptionalism, we don't deserve to have a premium on our bonds, on our stock market, on everything, which is why you're seeing both sides sell off?

Yeah, I think that could be true. And I don't really know how it's going to play out in the long run. Maybe it'll play out just fine. But in the short run, you're exactly right. It's like the dollar has been sold, not bought. Right. Which in other words, saying people are losing trust that we're going to do what we normally do. Right. And think about this, right? Gold, we've been, again, reluctantly so because I'm definitely not a gold bug, but I wrote a paper three years saying, I don't have a choice right now because I've done the analytical exercise.

And it all says, and here's the top 10 reasons I wrote a paper with top 10 reasons why there is an alternative and I call it GITA, gold is the alternative. And it was like three years ago, GITA, right? It's because I don't think there's a choice. So what basically is going on right now for people is if you de-risk out of the US dollar,

what other market can take it? A European bond markets can take it, but they've got their own problems Some money is gonna go to European bond market somebody's gonna get some money's gonna go to European equities And a lot of it is just gonna go to precious metals and maybe base metals. So gold's been a Macbair and again I'm not making a forecast here But I would not be surprised if we see like another 20 to 30% move in gold up in like a flash in like a month and people will say what happened here and that's the power of you know what you were referring to is like the secular reallocation of assets from one block to another block.

If there's a mass exit out of dollars, it's probably gonna end up in other currencies and then gold in particular. And then, but was one of the craziest things. When gold was down 3% or whatever it was the other day. So then, right, inside of all this are these moves that make sense and then moves that make absolutely zero sense. That was the same day the gold was going down. So that day made me feel like there were mass liquidations. Yes. Right? Of just people, I have to sell everything in my portfolio because I need to meet X,

Y, Z margin call. I haven't read much that that was actually happening, but that's what that felt like to me when gold was selling off at the same time. Yeah. I think you might have read, there was a couple of articles. I think they are believable that the thinking was that everything would get tariffed including metals, but then precious metals were excluded and all the people who did the geographical arbitrage where they flew in bars of gold on private jets from London to save them from tariffs, right? So they figured out kind

of what the approximate tariff rate was and they said if gold is trading inside of that value, then we're gonna put them on a plane, bring them to the US and when the tariffs come in, we can sell it inside of tariffs because they're already inside the US. But precious metals. I miss that, Argo.

So people were like flying them on Monday in private jets. Absolutely. I gotta go back and look at the flight aware if there was like a huge stream of jets. That's a great article. I think I probably dig it up for you. It said there were a lot charter flight and then the whole trade data was distorted because of the gold that was actually has to be obviously disclosed because you can't smuggle it in. It was disclosed and that we brought this in and it actually skewed the

trade flow data because of the amount of gold that actually came in. Wow, right. Like a billion dollars worth of gold. A few billion. But then people found that these bars were actually not going to get tariffed or there was no benefit to future gold purchases, they were not going to get there. So that premium just evaporated and that resulted in the sell-off. That's kind of one of the stories I heard. My favorite gold one was Jim Cramer. On Monday, saying he buys it on his Costco,

I guess you can buy gold bars at Costco, on his Costco credit card and gets 3% cash back. That's incredible. I'm like, I'm sure their gold bars have at least a 3% markup. So you're probably just about even, but it sounded good. So three, yeah, who knows what happens there. But so you and then for you were talking about this basis trade. So yeah, we don't need to go too far in the weeds.

But is it the same similar to long term capital management where they're doing on the run versus off the run? Yeah, it's a little bit different in this case. So this is treasuries versus interest rate swaps, right? So the one of the biggest anomalies that is out there, which is everybody to see and everybody can trade and people did trade on it, is that the 30-year bond, let's say, is at $4.95, whatever, typical number. A 30-year interest rate swap where you receive fixed, effectively replicate that bond coupon and pay floating rate interest using the SOFR rate. That rate is about 3, I call it 4% round number, 95 basis points lower. So you scratch your end and you say,

why is it that the treasury yield is at, call it 4.95 and the swap yield is at 4? They're effectively the same duration instrument and all that. By the way, the treasury is full faith and credit of the US government. The interest rate swap is basically a contract, fully collateralized,

but contract between banks and banks. So what am I going to do? Well, I'm going to buy a bunch of treasuries, and then I am going to receive a bunch of swaps, basically buy the swap or the swap coupon, and sell the treasury. Because it's floating right? Yeah, I said backwards the first time, sorry. You might have edited this out, my brain. I'm gonna buy the treasury because I'm getting a 495 yield. I'm gonna pay fixed on the swaps.

So my duration is head. I said it right the first time there. Okay, I'm receiving a treasury, buying a treasury at 495 and I'm funding it, but I am now paying fixed on the swap at 4%. I'm keeping that 90 basis point spread and I have no interest rate risk. Sounds like a great trade, doesn't it? Yeah, that's good. And the reason, and every year, by the way, 90 basis points.

But leverage. But yeah, 90 basis points, you leverage five times, you can make 4.5% a year, right? Just from no duration risk. So that's a very classic basis trade just like the LPCM trade you talked about or the futures versus cash bond trade that is very popular. The problem is that when a lot of people do it and something is levered, something kind of goes awry here, in this case, funding rates or treasury volatility, then some people get tapped out and they have to liquidate. Even though this is a great trade in the long term, you cannot

hold it if you're running at 5X and 10X leverage because every 10 basis points is a big market hit and you might get shut down on it. And how do you buy a treasury? You buy a treasury, but you have to fund it using a repo contract. Anyway, so the bottom line here is that because of the treasury volatility, illiquidity, et cetera, people basically, I think, got forced out. Margin call. Margin calls on the treasury side. And then they effectively had to liquidate both edges of it. But for somebody who's got capital, who wants to enter it now, it's a better level. I don't know if it's done but it's a better level now. But do you think that was enough to make that full Wednesday night move or

that just once it started building on itself people just were flooding in? Exactly and there's no liquidity because if you know there's a lot of sellers foreigners are sellers. I've tried these basis traders are sellers and there's very little buyers and there's two auctions coming, which we had two auctions this week. The question is, do you want to step in front of that trade and try to buy more bonds? And people will say, no, I don't want to. Yeah. So. What do you think this does for a lot of What do you think this does for a lot of tail hedging type stuff where like, oh, the index falls too high.

I want to go take, which I would call basis, but not as we just talked about, but take some basis risk, right? And I'm going to gold options or bond options or some other cheaper ways to get that sort of tail risk. You think that breaks that for a while and people move out of that space? No, I think you can. I mean, we call them indirect hedges. That's one of our, I guess, tools in the trade, so to speak. But volatility is very cheap as it was about a month ago or two

months ago and VIX was at 15. We were saying, look, don't take basis risk, just be buying straight options, take no contractual indirect correlation risk, etc. But now that volatility in the short end of the curve, three months and a, is kind of high, you want to take more basis risk there. You want to do things like foot spreads, perhaps. You want to do indirect hedges and other asset classes, right? Because here's one speculative thought that if this thing continues, perhaps the Fed actually gets forced to cut. So one typical indirect hedge that people will start looking at is just so for call options. So can

you buy call options on the short end of the, you know, used to be the euro dollar curve, but now it's a so for curve. The more far field you move, like gold calls or currency options or you know, HYG high yield and so on, the more basis risk you're taking but it becomes a trade-off between yeah between how much basis risk you're taking and how much kind of cheapness you're gonna get. So it is very attractive but you kind of have to be able to evaluate the relative value of all of them. And hard to note like in this example right like we should have all bought Swiss franc calls right? What's been up like 30% in two days or something or not 30% but it's been up huge in two days. But how do you know which one? That's the risk, right? That's the basis

risk. How do we know which of these other items are going to hit? Yeah and I think you know what people typically do there is they run some sort of correlation analysis, right? So they say, what are traditionally the flight to repatriation, flight to quality, right? So if everybody's going to buy gold, where is most of the gold of the world kept? Switzerland. So you're going to have to somehow get into Switzerland so let's just buy Swiss franc. So Swiss franc is still quote unquote a very reliable tail hedge. Because of that reason, it gets a premium, I think, and

interest rates are kept very low there. The yen used to be like that in the old days when the yen was the reserve currency of savers. People would flock into the yen. And you can see the yen has moved, but it hasn't moved that much. It hasn't moved 30% for sure. And the reason is because Japan's got its own problems

and they've got their own problems. Yeah, so where do you go? So you can go to gold. Natural gas. Natural gas, yeah, exactly. It's so low, it can't go any lower. Yeah, where do you go? So if I'm calling you on that Wednesday morning, we're down making new lows, what do I do? Right? That's, well, it's too late then? Or you start to walk through these other items? Like, okay, well,

this is somewhat cheap. This is still somewhat reasonable. Yeah. Yeah. And I know it comes back. My first question is, you know, what is your pain threshold? So it's down, how much are you willing to lose by doing nothing? And at that point, people can calibrate and they'll say, I'm willing to lose nothing at this point. I want protection below 10% or 10%, 20%. That means that they're going to want to hedge it somehow. And then you look at relative value, right? Buying an outright index option for one month makes no sense because you're paying a lot of premium. But if you want to go

out and lock it in for six months or a year, you can do index options. Otherwise, you're going to these indirect hedges. And again, the common theme there is, yes, if you take basis risk, it's not as reliable as just buying a cheap pure S&P index option. But having some hedges on is better than not having any hedges on if you're at that point with your portfolio. And then talk through if you could, or down whatever, when we're down 20% for the highs

and I wanna put on another 20%, right? Like when does it become in your mind too far away, right? If we're down 60 percent, do I go down another 20 percent? Like I get, in theory, can always go another 20 percent, but it seems like there's a practical limit to like I should stop getting way out of the money. Yeah, so you know that's something that we usually, I mean I know my own kind of utility function, objective function, and so on, and I try to never get into that type of situation, obviously, but if you're already in that situation, you're down 50% and we know that market sell-off

of 80% has happened maybe once or twice, right? In the Great Depression, you really kind of have to think about it and say, do I really want to hedge down 20 at this point or not? But if an investor says to us, yes, I understand it, that's never happened before, but if it happens, the severity of that outcome will be so huge for me.

I'm out of business basically. I'm out of business or I've lost my life savings or whatever it is. Then that tells me is that some hedge is still required even though the premium will be egregious. And at that point, you just have to kind of give them the tradeoffs and say, here's the tradeoff of doing nothing versus the tradeoff of doing something at this price. But back to current where we're at now, right? We're down 20% and people are saying even now, like, well, it's too, I missed it, right?

I forgot to do, or I didn't do my tail edging, now it's too late. What would you say? Oh, I mean, seriously, after what happened yesterday, I mean, you got a reprieve. You got another chance. You got another chance. So like, I mean, I'm not just saying this

because this is the business I'm in, it's like, you got the VIX dropping from 50 to 30 overnight, and you got the stock market going up from, you know, a thousand points on the S&P and whatever it was, 2200 points in the NASDAQ. If you came in this morning and you were not hedged and you knew you had to, there's absolutely no excuse for you to not have done something. And that's kind of our mentality right now is that we've only receded back down about half of the sell-off of the last week, and you're still only down 10% at least in the S&P for the year. So it's mainly, I mean, you're sitting in

correction territory, not in bear market territory. And we were in bear market territory yesterday. Yeah, 15. That's how crazy it's been. Yesterday, bear market. Today, just correction. Over the long term, doing hedging at VIX 40, 50 doesn't make a lot of sense. Would you agree? Well, I'll say it all again. It comes back to the portfolio, right? So we ran an analysis, just a composite, and I can't give you obviously all the private details. But we just run a research thing of one type of portfolio. And we said, if over the last five years, and you can go back and look it up, if you had bought S&P 500 and if you had hedged continuously and spent premium through ups and downs, through the debacle of 2022 and all that,

where would you have ended up yesterday? And guess what? You ended up, obviously S&Ps higher, so you would have made money on the S&P. What was shocking to me was to find out that if you had done it pro-cyclically, if you had bought hedges when they were somewhat cheap and done less hedging when they were expensive,

but still hedge, you actually have made cumulative money even on the hedges in isolation, and all of that has come literally in one week. And so that's kind of par for the course in this space is that you spend, you spend, you spend, but when the house is burning down, your insurance pays off. So you got to live in the house, i.e. the S&P went up, and you got to pay for the insurance that paid off, and now you can build a brand new house. I mean, I can't do any better than that. So if the price of insurance in California, we know I'm a California resident here, it's crazy right now, right? Because of the fires and everything, and insurance companies are just jacking up the premiums. We have two choices, not buy insurance and not have home insurance or live in our house

and live in beautiful California and have home insurance. I think most people's choice will be, as long as he can afford it, live in California and buy the home insurance if he can afford it. I think that's basically what it is. So I don't try to time insurance, but I do try to plan it so that at the appropriate time you can re-negotiate. That's the beauty of index options and financial

market options markets. In a sense, when the price goes up of insurance, if you already have insurance, you can re-negotiate the price to a different insurance contract. You can strike it down or whatever you want to do. What sort of things would you want to see? My brain goes to some big private credit funds blowing up or private equity marking down 30% things like that. Either what would you see that start to say like, okay, this is picking up steam, this is probably an extended event versus what would you see on the other side of like, okay, we kind of have the all clear and I'm not as worried about things anymore.

Yeah, I think we communicated this in some other forum here, but my metric was it's a CDS spread, CDX spread, which is the high investment grade index. If the spread moved above 75 or so, I mean, initially my number was 65, but now I've moved up to 75. If it moves above 75 and stays above 75, then it tells me that the credit markets are coming under stress. And we all know or have read that the way the transmission mechanism works is that when the credit markets come under stress, corporates cannot borrow easily. They start shutting down factories, laying off people. So a crisis turns into a bigger problem, a recession and so on. And credit spreads went up to about 85 yesterday,

then they retraced to about 68 on the massive rally and they're back to 75. So we're right on that boundary. So if I don't see them grinding back down again, then I start getting worried that this thing is morphing into something else. But if they nicely grind down and things settle down, I would say it's time to maybe try to dip your toes in and try to buy risk assets.

And what's the 75? What's that represent? Oh, sorry. I should have maybe said that. So that's basically the spread that you would get on this investment grade credit index over the treasury market, basically. So the CDX is an index, a synthetic index of 125 names. And effectively, if you buy an insurance policy on that basket of corporate credit, investment grade credit, you would today pay approximately 75 basis points of insurance premium against defaults, you know, with some other contractual details. And in practice, because it's an index, it's hard for that to move substantially, right?

How many? 100? What did you say? 125 names, yeah. 125 names. So even in 08, how many names actually went bankrupt, probably? Very few, but exactly to that point in 2008, very few investment names went bankrupt, but this spread blew out very, very substantially, right, into the five or six hundred, if I remember correctly. And that basically puts a complete kibosh on credit because if you are paying, the short-term treasuries are four and a half, 10-year notes at 425-ish, you add a 500 basis point spread on top of it.

An investment grade corporate has to pay 10 percent interest to operate. That is a big, big negative drag on their balance sheet. See, they can't do that. So that's my metric actually, as we talked right now, it's 74 bid at 75. So it's right on that cusp. And we better see it come in if we want things to settle down. If it doesn't, then I think this can continue. And I guess these feed into each other, right? My brain's like, well, if there's demand destruction

because I can't ship my goods to wherever and I have to shut down factories and lay off people anyway. But that'll be reflected in the CDF. Right, it will be absolutely. It will get reflected immediately. It's not a credit issue. It's driven by the fundamental issue. That's right.

And people will start pricing in stress and less coverage in the future. And then each individual name that's inside the index, its spread will start widening out, not in the same proportion obviously, but and then the weighted average will start going up because people will just say, hey, I need more protection against lending money, basically, which is what this is to a corporate. Yeah. So, because other metrics people watch also, the yield curve steepening trade, that's a huge, huge signal.

You know, the curve has steepened massively, 50 basis points this year. And that basically tells you is, again, I think of that as a straddle on the macro economy. Either inflation picks up long end, you'll sell off or rise, or we end up into a deflation, depression, recession, whatever it is, and short end, yields collapse because the Fed cuts rates. A curve steepener is what the market is looking at an indicator also. If the Fed cutting rates, what does that really do if it's in this tariff situation? I don't think it does very much at all. You're right. I think maybe it even raises the long rates more, but I think it's a signal

to the market that we have a backstop and the Fed, as we all know, has something else they can do, which is QE. So they can come back and they can just say, corporate bonds, we're just going to start buying them to keep the spreads tied. Treasuries, you're worried about? We're going to buy all the treasuries. So. And what my worry is we start last Trump term and we did the tariffs and then paid 35 billion or whatever to bail out the farmers. Yeah. Because China wasn't billing like maybe they'll do 500 billion across all these different industries and companies that everyone comes looking for a handout.

And then what that's back to, maybe inflationary or maybe, I don't know. Yeah, one of my old partners from Pincor Road, a piece many years ago, he called it, I still remember it, he called it no exit. And basically like what you just highlighted is that, is this problem ever gonna go away? Or is it gonna keep recurring

because we've used the tool once, we'll use it again in a bigger size. And his point was, once you've done it, you have no end, it's gonna keep coming back. And his point was once you've done it, you have no end. It's going to keep coming back because if these tools are out there, they will be used at a higher and higher size. Yeah. Yeah.

And the COVID lesson was, hey, if we ever want to really juice this economy, just give every person in the country $2,000. That'll get things rolling. Lastly, I said lastly already, but one more. Trend following getting smashed in the face. Anyone who wants to throw in the towel on trend following, give them some, hey, we've been here before, this is how it works. Don't panic. Absolutely. I completely agree. Trend following has a long history, 400 years, of working. 400 years of working. 400 years.

Yeah, people have actually very painstakingly collected a lot of data, including rice farmers, I think, I don't know, China or India or something like that. And certainly 100, 150 years that some very well-recognized people have done research on. But yeah, every 10 years or so, there's three to four years for trend following that are dismal because there's overcrowding and people are running large position. They get stopped out like maybe we're getting seen right now. And then got three years of kind of flattish returns and then three years of amazing returns. So we are in that cycle and my views are exactly the same as yours is if things continue to move in one direction, trend following will take the hand off from

explicit hedging and will start working really well. This is not the time to throw in the towel. This is the time to actually add, in my view, to trend following. And for you as a systematic quant, are these periods completely frustrating? Like, do you want to pull your hair out? Or did you, it looks like you already pulled your hair out. Sorry. But do you want to pull your hair out or did you it looks like you already pulled your hair out sorry but you want to pull more of it out right of like what we're just moving 10% on a on a tweet what is happening I

can't model that or do you just say that's why we have this longer term right you've created the your own sandbox to play in in case this kind of stuff happens yeah you know like my firm's model or the thing that we remind ourselves is you know is like my firm's model or the thing that we remind ourselves is, you know, is basically expect unexpected for resilient portfolio, right? So every single day when I come in, I mean, yes, I'm a quant, but I come the grain of salt that I use in my model. It's like a, you know, like a big sand pile.

It's like, you just have to make sure that you leave a lot of room for error and the kind of things that happened yesterday, which didn't really bother me at all because I am completely expecting those kinds of things. You were at the doctor, you weren't even watching. Yep, no, and you know, so it doesn't bother me. I think it's gonna keep happening. I think you just have to go in knowing this will happen. And your primary tool for modeling

is not going to be quantitative models. Your primary tool will be literally market feedback mechanisms and response functions and other players and so on. But that's not part of modeling. That's all part of investing in my view. So, yeah. Where, where do you put yesterday on the, your Mount Rushmore of craziest market days, does it even make it, or was there crazier stuff in your career?

I think I've seen worse during COVID, maybe three or four days, definitely during GFC. The day the Lehman failure, I think some of the younger team members on our team who have not seen, you know, a day like this before were asking me what was it like Lehman failure, LTCM failure. Again, you know, all the hair over the past 30 years. I've seen events where I can believe that this is happening and now I just come in and I just go, yeah, another day in the financial markets. Yeah. So, yeah, so anyways, yeah. Fortunately, yeah, if you can not get hurt in days like yesterday, you're doing pretty

good. So yeah. All right, Vinir, thanks for copping on. We'll hang in there. Keep fighting the fight. We'll talk to you soon. Great. Thank you. Take care. Appreciate it. Thank you. be in the episode description of this channel. Follow us on Twitter at rcmults and visit our website to read our blog or subscribe to our newsletter at rcmults.com.

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