How to Spot Trading Opportunities | Don Wilson, 1000x

moved back to Chicago in 94 and I said you know if this stuff if the CME hasn't completely transitioned to the screen by the year 2000 this place is going to be out of business and and I just couldn't have been more wrong um I I couldn't have been more wrong about the timing it took far longer than that um I think these transitions always do [Music] thank you thank you guys for joining in for another episode of the Thousand X podcast we welcome you back and this time we have a very special guest who has not done a lot of podcasting before and we are very lucky to have him on this time actually is the Hefe of Jonah my partner in crime on this podcast we have uh Don Wilson uh the founder of drw joining us and I'll let Jonah who knows him much better than I do courtesy of working together give the intro thanks Avi and and thanks Don for for joining us sure we've got a lot of really interesting interesting content to put out today Don uh graduated from the University of Chicago and went straight into trading uh you know right into the the pit in Chicago and in 1992 founded drw which is a global trading firm uh which which touches pretty much every every asset class uh both prop trading and and you know liquidity Provisions so pretty exciting company at the intersection of trading and technology so don thank you very much for joining us without further Ado can you tell us what it was that Drew you to trading straight out of college how you just knew that you wanted to uh to make that your career the foundational stuff yeah so so when I when I came to college I um had no idea what I wanted to do but I knew that I was good at math and I knew that I liked using math to solve problems and my initial inclination was you know maybe I'd do something in science and um as I kind of experienced college and the academic setting a little bit I was a little bit concerned about um about the very slow feedback loop that had happens in Academia and um I actually I I raced sailboats in high school and in college and um one of the guys that I raced with was working on his post doctorate in uh in physics he actually went on to to fly the space shuttle but at the time he um you know in addition to working on his postdoc he would he was fiddling around with uh FX modeling and I was like you know that's really cool like you get this immediate feedback loop and you don't have to like write a paper about it and present it and kind of not really know if you're right or wrong um you just figure something out and then go see if it works and and you find out right away uh that sounds like a lot of fun and so that's when I decided that I wanted to go into trading and obviously being in Chicago the trading pits were right there what what was it like uh when you first when you first stepped into the uh stepped into the pit I mean what what's actually the process that you went through of getting up to speed and and figuring out how to trade I mean I can imagine if you walk in there and it's hectic and it's crazy I mean how did you how'd you figure it all out what would you what did you start with yeah so so it was um so what I did was uh and you know I graduated early so I graduated when I was 20 um and and I was um an extreme introvert had a real hard time interacting with people and uh but I got a job with a small trading firm called letco and they said Okay um you're gonna we'll have you spend a couple weeks standing next to different traders that work for us and then after six months they said okay uh here's a hundred thousand dollars uh good luck and I uh became a member of the Chicago Mercantile Exchange at least a seat and decided to go in the euro dollar option pit which is uh three month Libor options and you know at that point you walk into the pit the pit opens at 7 20 in the morning it's open from 7 20 to 2 and um you you know find a spot to stand and uh um it's pretty intimidating because there's I mean it's super crowded a bunch of people pushing and shoving and yelling and screaming it looks like total chaos um but the reality of it is is it's just math um and so I'd stand in the pit during the day and then go home and uh write code build option pricing models right risk software um fiddle around with different volatility you know kind of trying to model volatility surfaces and um and then go back the next day and and see if any of it worked um and and after uh uh you know after a little while um I I started to figure some things out and um you know the the whole my whole uh mindset was how do I how do I Define the fair value of every single option on the you know across the whole surface and um and then how do I then use that framework to and the order flow coming into the pit to pick up small amounts of positive expected value um and uh yeah so that's that's how it all started so don what's an example of something that you went home and coded and brought back into the pit the next day that just kind of worked yeah so so you know there were a few um a few iterations that were helpful uh I mean first of all you know I had some stuff that was I think not all that Innovative but but you know I designed my own my own sheets with all my own option values on them I actually used an image writer too to print them so they took hours to print I lived in a studio apartment so I had to put like a pillow on top the printer when I went to bed um not sure all that stuff was that you know was that amazing but it was nice to just be able to configure everything have calls and put some different colors and and you know some kind of little incremental things and then you know the risk the risk views that I developed were were really pretty good um all the different scenarios and uh and those formats were certainly much better than the just kind of off the shelf uh vendor things that you could buy um the you know I think some of the places where I started to pick up valuation edges though were when I started to think about kind of how the Vault surface evolves in the fixed income space um there was um you know a a couple you I don't know not long after I started they listed um serial options so uh short dated options on longer Futures and in this case you know it was like um you know uh July and August options on September Futures so you'd have July uh August September and in the fixed income space generally the front of the curve is less volatile than further out um you know at the time typically it was the first red future so the future that's just over a year out that was the most volatile lately of course it's been further out the curve um well certainly in the period of low rates it was much further out the curve and then more recently it's it's it's moved towards the front of the curve that peak of peak volatility that area of peak volatility evolves depending on the FED regime but but generally pretty almost always the front of the curve is less volatile because of course the FED controls the overnight rate and um and so that's relatively static unless the FED changes it and so there was this persistent volatility roll down um where you know the front month was less volatile than the second month was less volatile than the third month was less followed in the fourth month and so the so when they listed these serial options the July and August the natural assumption was well obviously you know if June volatility is is you know 20 and September volatility is 30 then obviously July and August have to be kind of in between um but that's completely wrong because of course July is alive when the September Futures are more volatile than that forward period after July expires and so um you know if you just think about the volatility forwards obviously uh July should trade at a much higher volatility than September and August should trade somewhere in between uh the July and September but certainly you know well above September as well and so so that was kind of a early realization that I had in in modeling the stuff and the market did not understand it that way at all um and that was definitely the kind of thing that gave me an edge because you know I had a very clear idea of what the fair value of these things were the market had a very different idea they're pretty low variance trades and uh um so you know I traded a lot of those types of things and your your trading style must have had to evolve uh you know over over time especially as we transitioned over from you know pit Trading uh to electronic trading and that transition was not managed well by a lot of people obviously you being a major exception to this you you manage that transition exceptionally well and I'm wondering what that was what that was like if there were any uh you know why why do you think you were able to make that transition effectively and you know today does coming from the pits give you edge you know you know one of the things about about the trading pits is um that you do have this uh you know it's ingrained in you that you need to be able to price anything at any time you know at a moment's notice and uh you know if you can do it in your head it's it's you have that much more of an edge and and I think that that practice is actually still useful to this day um you know when in March when silver Futures had uh you know September so for futures had 100 plus basis point range um just kind of thinking about the volatility surface and that in that environment and and having that kind of really intuitive grasp of what's going on um that I you know I I think that that gives you a a Perpetual advantage um But but so shortly after I started they launched Globex uh which was an electronic trading system and um you know I I had a pretty small operation at the time but I was like I definitely want to get a Globex machine I definitely want to have a guy making markets overnight um and because that's of course how this stuff should trade um and so I was you know I was excited about it when it first happened it was funny I still remember that the Globex was something that was this the software and Hardware was actually developed by Reuters and um and CME licensed it and they handed out t-shirts on the first day that Globex launched and and uh it said um CMA CME by day on the front had a big sun and on the back of the shirt it said glow backs by night with a moon I was like you know this is set just an awesome lie and uh obviously all designed to make the pit Traders feel comfortable that they weren't you know their jobs weren't at risk um and I thought it was pretty funny in 92 I moved to London and uh set up the the London operation and I stood in the Bunda option pit for the first year and then I was traded from upstairs for the second year but but that was right when urac's fought really hard to get the Boon Futures to transition from life to your ex and uh you know we had a team trading the ARB between your ex and and life we had our own broker in the pet in the Futures pit and you know sometimes our broker would like go out for lunch and and have a pint and then come back and like be a little bit off and I'm like you know this pit stuff is just ridiculous I mean the sooner this stuff transitions to a computer the better um and so then I moved back to Chicago in 94 and I said you know if this stuff if the CME hasn't completely transitioned to the screen by the year 2000 this place is going to be out of business and and I just couldn't have been more wrong um I I couldn't have been more wrong about the timing it took far longer than that um I think these transitions always do but but suffice it to say I was always a uh you know a big believer that of course this stuff could be handled more efficiently electronically um I I but I was definitely dead wrong about the timing it's interesting you bring that up I mean that probably meant you had more Edge for longer given that it the transition took a bit longer than you might have expected so definitely a boon in the beginning of drw but I guess a follow-up question to something you said you said you have to be ready to price anything at any time there's a price for anything you know classic pit Trader mentality um what was it like when a whole block of this new thing called Bitcoin came up for auction sometime in 2013 or 14 and you had to Think Through pricing it and maybe starting starting a company around that how did that work yeah yeah so so you know we had a number of people at Dow who were interested in Bitcoin and and I started thinking about it and you know kind of read the paper and and um I I was super intrigued by it I mean this idea that you could transfer value in a trustless manner uh was very appealing to me I mean the lack of intermediaries um uh it can be you know can dramatically reduce friction of course I had a very dim view of intermediaries because over time I became the largest Trader in the euro dollar option pit and um there were often these trades that would come through the pit and you know we would take down a huge chunk of it and then 10 minutes later the block trade would go up from the board it's like oh so some big Bank just ripped off their customer and then came and back to back the the the trade into the pit like that's not even trading that's just ridiculous and um and these you know intermediaries are not providing a ton of value in the in the system I'm saying this in the nicest possible way at the time I wasn't saying it in such nice such a nice way um and uh and so this idea of you know of a financial system that reduced the intermediaries in the in the system was just kind of naturally a very appealing thing to me um and so uh you know so so we had all these debates about you know wall is this important uh what is it that's important about it is it you know is it Bitcoin or is it blockchain I mean all that stuff that people eventually started having debates about we were having debates about in 2013 and so we decided that we would do two things we well a few things we you know we started Cumberland um to provide liquidity in in Bitcoin uh we started a company called digital asset Holdings which is based in New York that was more focused on the blockchain applications and um and then we decided to buy some Bitcoin and so yes you know then uh you know the the government auctions came up and of course a lot of those were uh Silk Road coins that had been uh seized and and you know at the time there was this misperception the misperception was you know any criminal is going to use this stuff to to do bad things and of course I I mean Bitcoin is I guess the advantage for criminals is that they can you know uh they don't have to you know go out and pick up a sack of uh of 100 bills or something but but the the really bad things criminals is that every single transaction is memorialized forever and um so that just doesn't seem like a good uh a good you know uh characteristic to have if you're gonna try to do something illegal of course Silk Road you know found out the hard way that that was uh in fact a really dumb thing to do but that's actually the reason that we named Cumberland Cumberland because we figured well at the time everybody believes that this is only going to be a place for criminals so at least let's distance the brand a little bit from uh from The Core Company um yeah and so then uh you know the auction started happening and and and to us it was just a matter of of kind of pricing you know understanding the liquidity in the market and pricing the auctions accordingly when you first spun out Cumberland I actually have a question where did where did the name come from Cumberland so uh so one of my longtime Partners at drw um Jeff love off is is uh you know former a lawyer in his former life and and so he often was involved often naming new companies and Jeff is a big Grateful Dead fan and uh there's a you know a mining song about the uh you know about the Cumberland Blues um and uh you know given the the you know the mining Link in cryptocurrencies uh he decided to call it Cumberland so it's a it's a good good story there it's uh and and I get I get why in the beginning you wanted to you you wanted you wanted to separate it out I mean but when you were first like spinning it out when you were first thinking about what it what it could be what were you envisioning Cumberland doing or providing in the space was it was it always going to be somebody that provided provided liquidity were you thinking of it more as a risk-taking venture you know what was the what you know what was the thought process behind starting yeah so so the idea was just hey there you know we we uh at Dow we know how to trade we know how to take risks we know how to provide liquidity to the market and so let's do the same thing in uh in Bitcoin and that was the that was the Genesis of course with with Cumberland um you know there was it was much more kind of a counterparty facing situation um but also you know trading on uh you know providing liquidity in other venues so I guess just a follow-up question on that um you've obviously been through multiple crypto Cycles now um and more broadly you've been through cycles of Market maturation you know you were talking about the eurax Globex things going to the screen is there a is there a recipe for cycle survival that you adhere to because you've managed to do to do this through so many different uh Peaks and troughs of you know Euphoria induced despair not just in crypto but in in lots of different markets what how do you how do you think about navigating these things you know there are two different cycles that you're talking about when it's kind of a market structure cycle and the other is uh you know a hype cycle I guess um bubbles uh so so you know the way that I think about it is I just you know think about risk management first and foremost um uh I think about um you know yeah I mean I mean it really all comes down to to basic risk management by the way I I will say I think that I think that Bitcoin and cryptocurrencies in general but especially Bitcoin is really one of the hardest instruments to uh to trade um I you know and and the only thing that is clear is that when there's um I think of it as a negatively convex instrument in that when there's a lot of hype then that increases adoption and um and that increases the probability that Bitcoin becomes viewed by a majority of the world population as a superior version of a store of value um and uh on the other hand when the price of Bitcoin declines then people become less interested and the perceived probability that Bitcoin becomes a golden replacement declines and so both of these things are kind of like so when the price is going up you know uh you can build a model that would argue that the fair value is higher than it is now and the boy and conversely when the price is going down and and so it you know I think that it's actually a unique um in financial instruments that have that characteristic that's really interesting I mean I guess in Commodities you kind of have the opposite when when the price goes up too much people just demand less and then the price mean reverts that's sort of my background but I guess just a follow-up question so a negatively convex asset as you described it like Bitcoin that you know creates self-fulfilling rallies and and sell-offs what about that makes it harder to trade wouldn't you be able to just Implement a momentum strategy that that follows the the trend uh of which there would theoretically be large ones and you know yeah I mean I mean maybe it's a momentum strategy but but it has big props and valleys along the way and and so you know it's very easy to you know if you don't have conviction to to get washed out you know if your strategy is kind of a levered long and oh if it starts to go down I'm gonna get out um it's probably a money losing proposition are there any other markets that you've seen that trade similarly to this or what is it or another way of saying is what is the most similar Market you've seen if any to crypto I I think it's really it's a very different Market I guess that the closest thing you know I I mean I mean you see some similar price patterns in um in emerging Technologies um and you know this kind of you know like the internet bubble and and um that kind of thing but but I would argue that those things are fundamentally different because still you're talking about the valuation of a company and um you ultimately have to make certain assumptions about the earnings of that company and market share and total addressable Market um and in Bitcoin it's you know it's not an earnings question it's just a question of is this a superior store of value to gold and uh and that's really all a question of how many how what percentage of the world population feels that way yeah and it's and it's and it's very it does it does also seem to be that the answer to that question is is almost a little bit path dependent it's like the more you know the more the more people that adopted in a in a short in a shorter period of time leads to crazier momentum and crazier outperformance um so you know it's like it's it's a pretty it's you know from from mine definitely a very very interesting interesting asset to trade and one one thing one thing that you said one thing that you said in there is uh emerging emerging Tech sometimes acts uh like like crypto and we've been hit with this recent wave of uh of AI applications and llms and and they've at least even in the short term over the last six seven months since Chachi Beauty really went viral there's been so much discussion about how it might impact our jobs as as peop as people that deal with the financial markets and and you know a lot more than just that and you as somebody that has navigated a lot of change when it comes to technology and how it impacts financial markets how do you see this recent development and are you are you keeping are you keeping your eyes on it yeah so right now I'm in Woodside California I'm 10 minutes from Stanford um uh uh I've you know met with a bunch of uh AI people over the last few days um and I've been coming here regularly and doing that um so yeah I I think that it's uh it it is a consequential technology um you know the The Innovation that's taking place in uh you know even specifically in llms is is really very interesting um and so I think it will have all sorts I think we'll have I think it will impact pretty much everything um aside from you know somebody that's living off the grid in a cabin in the woods so is this kind of a um is this kind of one of those moments in let's say Financial history where an enterprising young person can go back to their studio apartment and use some new technology to print out some sheets and then come back to the pit the next day and and and when is is the llm sort of the modern equivalent of that uh in that it will give the first group of traders who figure it out an edge and if so how do you think so yeah so so it's entirely possible um uh but it's unclear I I I'm convinced that llms are going to be uh really useful for thinking about some aspects of markets and risk taking um but it's it's pretty unclear um exactly what those are and and uh how much human intervention you need in that process so it's all it's all you know it's a matter of I think it's like will be discovered very shortly and then the technology will conduct continue to evolve and so the answer to those questions will almost certainly change it's it's kind of interesting to think about like hey are we at this deep blue moment where technology is about to beat human Traders at you know at their game or are we more at the kind of CME going to screen moment where it just uh should have happened years ago and it still hasn't um well now it has but maybe in 2000. so I guess are you or is it it has AI thus far changed the way that you run your life or your business or your approach to markets or are you just still in kind of uh information absorption mode yeah right now I'm in information absorption mode I wouldn't say that I've changed anything meaningful other than spending time on it please let me know when you do you know I think one of the uh one of the one of the great quotes that you had I was I was reading reading some of uh some of the articles that you had been mentioned in before do it do it doing the podcast and I found I found a really funny quote that I liked uh which is that when the lme had their nickel incident you called it one of the most in-depth moves I've ever seen an exchange make and I thought that was uniquely funny for somebody that spent so much time in crypto you know because uh We've obviously had our our fair share of uh dealing uh dealing with venues um and you know one one question I had is you you've seen the crypto Market evolve in terms of liquidity uh over time and and I'm curious how how you've sort of how you viewed the last you know I guess eight years nine years since you've been in crypto and how it's how it's evolved and where you think it's going to go in the next five years yeah um here you know obviously there's a lot less um at least from outside the crypto Community there's a lot less excitement about it than there was you know maybe pre FTX blowing up um but I still think that there's uh really important innovation that's taking place in the space um you know I think that the ability to move um to move value instantaneously and uh um you know and and if you want trustlessly is a really important innovation I think that um applying leveraging that technology for traditional financial markets is one of the most uh exciting and impactful ways that um that this technology is going to be used and so I'm super excited to to see that unfold which it well do you think on in in the terms of in terms of uh the way that we interact with the with the markets so right now obviously in the traditional world use there's a separation between where liquidity lives where you custody that asset uh you know who who could who can who can provide Leverage is the exchange that provides leverages of the Brokers that provide right there's a primes that provide leverage do you think that system is where crypto will eventually go to like do you think that's the end point of financial markets or do you think that crypto is going to show us a different a different way that financial markets could operate I'm curious your take on on that yeah so so it's I think it's um let's see so so first of all you know in the centralized crypto exchange space you know these exchanges decide that they should do everything you know they should be the fcm they should be the DCM the dco um and then in addition to that they should provide leverage um and and of course you know as Ike was watching this unfed I said you know this is inherently less stable um one of the nice things about traditional financial markets is that by breaking up these different uh you know these different responsibilities you get more transparency and you get more safety and resilience now obviously when you switch over to the D5 World it it does enable you to open up those different responsibilities to different Market participants in an even more granular way then you can do in traditional finance and it also opens up the ability to provide short-term loans to do um you know to move money instantaneously it's it's one of the things that you know the lme decided to um to not ask for margin because it was going to blow up um some of the large nickel producers and then of course they decided to cancel all the trades one day because is you know they were worried that a bunch of mem you know clearing members and customers would default and so that's one way of running things um the other way of running things is to say hey we're going to move value in real time when there's a margin deficit you know you top it up right now and of course you have the ability to do that because you can move money on chain and my belief is that that actually leads us to a more transparent more safe more resilient uh Market Financial market and and that is the promise of of a lot of this technology that will in fact enable that to happen so what types of time frames if you had to make a sort of a prediction would you say we're looking at when it comes to um the blockchainification of certain assets perhaps nickel things that right now aren't necessarily associated with crypto yeah so so I'm perpetually wrong in estimates like that so I always think they're going to happen sooner than they will so whatever I say just take the over um uh so that's one thing the other thing is of course there's some assets that are um that are physical assets and you know like nickel so you know yeah you can put nickel on a blockchain But ultimately the nickel has to sit somewhere and if you know somebody steals the nickel then you know you have a blockchain that represents nickel and the nickel's not there and that's a problem right so so that kind of stuff is something that still has this uh intimate link to the physical world that is super critical now there are other instruments that are already virtual instruments like you know equities and and treasuries and you know people don't usually walk around with their chair certificates and and I think that those uh assets probably lend themselves more to um to digitization to blockchainization um and so so I think that that stuff is going to happen I mean you know like right now we're experimenting with intraday repo um using blockchain technology so that's on top of uh Canton which is the digital asset Holdings uh blockchain and um uh you know so and that's kind of powered by by broadridge so that's an example of um of experimenting with you know the kind of the early days of using this technology to do that and ultimately of course what that does is it enables uh value to be moved in real time and even 24 7. um that's the kind of thing that does will make Clearing Houses more resilient if they want to Avail themselves of that of that uh technology interesting so I guess just a quick follow-up question if you could tell the listeners a bit more about digital asset Holdings the Canton blockchain and what sort of problems it solves that perhaps ethereum doesn't I think it'd be really useful for everyone to learn about yeah so so uh you know ethereum is obviously a very powerful Network um you know tons of of energy and participation one of the drawbacks of ethereum is that every single transaction is is public and of course you know for most people if they buy or sell a security they don't want the whole world to know that they bought or sold that security um you know probably fine depending on the market structure for their counterparty to know maybe for a regulator to know maybe for a Clearinghouse to know maybe for a prime broker to know but um you know for for any any given instrument in any given transaction the um you want to be able to really control who could who can see that um and so the advantage of Canton and then the smart contract language on top of it which is called damil um is that it has a configurable privacy which was built you know at the core of this uh of this chain and this is something that that the team's been working on since 2014 so this is a very long very long uh process to um you know to build a blockchain that works with those characteristics I think it would be helpful to expand on what what is the current what is the issue with the current stack that doesn't allow this to happen right with the current with the current architecture why why can't we why can't we achieve this uh so in in currently in traditional financial markets yeah yeah it's you know it's uh you know why why is that why is what Canton you know enables not not necessarily possible I mean I think you know for for us here we're participants in the in the financial markets we understand the value that blockchain can break can bring to the table uh but I think it'd be useful for you know people that are less familiar to sort of understand you know what what the current what you know a lot of the current issues yeah so right now if you want to um wire money um you know that can take it can take hours and of course you can only do it when the wire windows open um and so you know let's say that you have on a um you know a spread between a Futures Contract that's in London and a Futures Contract that's in the United States and then after London hours there's a big you know a big rally um and you're you know long the long the Futures in London and you're short in the Futures and us um you know the idea that you could pull variation margin out of the London market and move whatever to satisfy the negative variation that you're experiencing in the US I I mean like you're not even close um uh you know actually what will happen is the next day that Futures Contract will rally you know assuming then the next day we open up and the Market's unchanged you know then the London Futures Contract will rally the variation margin will show up in your account at that point you know you can wire it out maybe that day maybe the next day um you know maybe now you're running into the weekend and so uh the whole system is just very um clunky it's it's a lot of it is batch um so you you know you have these uh cycles that kind of process like once a day or twice a day um and um and and so it just makes everything very slow to move around it means that you need to have a lot of extra capital in the system in order to deal with um that lack of um you know with all those delays that take place yeah I think I think that's that that's very helpful helpful framing for people you know it's it's just it's something that we're we're honestly blessed with as people that are in that are in crypto uh you know we we use a system that is accessible 24 7 and uh you know every time I go back to the uh you know quote-unquote traditional markets I'm always I feel I always leave feeling a little bit disappointed with what with what I can do uh you know what is what is possible and and what isn't and then I I flee back into my metamask and uh and then and end up much happier um so you know it's uh it's it's good it's good to hear these these these problems these problems are being tackled and you know it's something that uh we we look out as well um you know we I had one last one last question for you Don you know I think when when people think of uh you know when people think of the Chicago Chicago trading firms a lot of people think of you know high frequency taking taking bips uh here here and there a lot of it's a lot of it's Arbitrage and I think a lot of your career has been has been characterized by finding these types of Arbitrage opportunities but you also you've you've also you also take take risk you know uh and and some love to hear about your process as uh I think our listeners would love to hear too about you your process for decision making uh when it comes when it when it comes to risk taking and you know what what you think has helped you the most in your in in your career when it comes to be being right yeah so so you know obviously the little arbitrages are great um uh because you can generate these very high sharp High return trades but the reality is they don't persist uh markets constantly become more efficient and and those things quickly get armed out and so building a business that just relies on capturing those little arbitrages is you know it's not sustainable um and so uh you know being comfortable moving out the risk curve is is super important now obviously if you can move out the risk curve and you have access to super low latency uh tools and connectivity then you're in a really strong spot and that's where we try to be um but when I think about risk so when when I think about markets or really most things in the world um I I see a series of probability distributions um and um and and so it's it's when if you look at the world as a series of probability distributions then you're kind of well set up to think about about risk and um and so any time that there's some kind of a perceived dislocation in the market um because when there's a dislocation in the market when there's a violent move you know that there's a high probability that it's mispriced either it was mispriced before or it's mispriced now um or I mean okay probably there's some fundamental thing that changed but high probability that it's still mispriced because um you know new information has come out and there's been a dramatic move and um so so the way I think about it is is I I think about what are the drivers of this price action what are the drivers of supply and demand if it's a commodity or what are the drivers of the fed's reaction function and then on top of that the supply and demand for for kind of the hedging need of this part of the interest rate curve and um and then I try to think about you know what are the things that could change going forward that will shift the fed's reaction Function One Way or Another you know what is [Music] um what will cause the FED to ease right after Silicon Valley Bank uh the interest rate Market priced in a kind of an expectation that the Fed was going to ease by 100 basis points by the end of the year um and of course you know that's not what happened I mean so far the FED has hiked 50 basis points since then and I expect the Fed you know May well hike again before the end of the year I expect the FED won't ease by the end of the year but and of course you know those outcomes were all within the probability distribution but my view at the time was that that uh the probability of the FED easing by the end of the year was massively over overpriced that part of the distribution and the part about you know the part of the distribution of the FED continues to hike was significantly underpriced and and um so you know I start with that and then think about okay what's the best way of expressing that risk that that makes that makes a a ton of sense I always I I try I I always try to think similarly I think one of the hardest parts is constructing that probability distribution is thinking about okay well what what are the criteria that actually go into building this out it's like okay I think this is a 60 chance of you know you know this and then 30 and then but then uh turns out that you were just completely wrong no I mean I mean coming up with your own subjective measures of the probability distribution is super hard um and and especially when the Market's saying something very different yep as a closing closing question here are there any uh trades that you you know you really really loved that you can talk about here maybe maybe your favorite trade ever if you're if you're willing if you're willing to disclose it that you can think back on and say hey I I really really loved putting this one on and you know I don't know if it made you the most money or was the most interesting yeah I mean I mean here I you know I I've done lots of lots of Trades that I really loved um uh I I mean this year I I will say that the dislocation what I perceived as a complete dislocation in the interest rate market after Silicon Valley Bank was was one of my favorite trades um uh I thought that that that that was such there was such a gap between my perception of the uh you know what the probability distribution should be and the markets implied probability distribution um I thought that was just phenomenal um but you know going back in time um one of the trades that and this is a different type of trade but but um you know in 2008 when Lehman went bankrupt we were one of a handful of firms that the CME called to ask to price the their portfolio and um uh you know we were well prepared for it you know got the whole portfolio from the from the CME broke it down into different chunks of risk had different teams price the risk you know added it up and then submitted the aggregate bid it was actually by product but but uh you know we ended up being the best bid in something like three of the five uh buckets of uh in the auction and um and there's something you know and then when we did win those buckets we were super efficient about you know hedging off that risk um in you know in kind of the the optimal way and you know all of that that entire process obviously took um a lot of confidence in um in how we were thinking about the risk and and how we were modeling the risk and that ability to then aggregate it up and and in a very volatile environment say and you know here's our number that's an awesome story part of History right there it's pretty cool yeah I was I was part of the Lehman portfolio but I didn't get acquired what happened there I had to go find a find a different job after that I I had a follow-up question for you Don um does your you know another option does your Bitcoin trade factor into maybe the top five trades or did that feel like a uh more of a venture thing than a trade uh I I'm sorry which one the the Bitcoin trade the Silk Road you know I mean so that was a series of auctions and and they were really in relatively small uh in in terms of risk um I mean they were interesting right right you know the first one we'd never kind of interacted with the United States Marshals um and um but but yeah I mean I thought it was a fairly vanilla process I thought they did a good job thinking about how to you know how to uh maximize the value and and we were very comfortable trading the asset class so it it was great well Don thank you so much don't want to take up too much more of your time have to get back to uh oh oh I guess we lost ones you say we don't want to take up too much more time it's not just very valuable Jonah so I really enjoyed this conversation uh I I really you know I think I think I think I learned a lot I came away thinking about it if I although if I had to say one thing that I I'd really like to dive into you more is I need to figure out how he constructs those probability distributions me too I was like what what goes into that but you know I've tried a few times uh he he's the master at it we're more just trying to learn match that up well thank you all for joining us uh it was a wonderful conversation really looking forward to you know the next episode Avi as always absolute pleasure to co-host this with you and um again none of this is financial advice [Music] thank you

Channel: 1000x Podcast

Views: 17,543

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Id: V762GDXDdmw

Length: 52min 45sec (3165 seconds)

Published: Thu May 25 2023