Vol Curves and Vanna Charm with Cem Karsan

[Music] thanks for listening to the derivative this podcast is provided for informational purposes only and should not be relied upon as legal business investment or tax advice all opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of rcm alternatives their affiliates or companies featured due to industry regulations participants on this podcast are instructed not to make specific trade recommendations nor reference past their potential profits and listeners are reminded that manage features commodity trading and other alternative investments are complex and carry a risk of substantial losses as such they are not suitable for all investors welcome to the derivative by rcm alternatives where we dive into what makes alternative investments go analyze the strategies of unique hedge fund managers and chat with interesting guests from across the investment world it is a second order derivative lana is the change in delta per change involved invert change in implied volatility yeah so as uh implied volatility decreases by i'm sorry let's say increases by one it's the amount of deltas that that change of your options position um another important one that kind of goes hand in hand with it which i talk a lot about is charm charm is a bit more commonly looked at and used but but still you know second order derivative um that is pert per change in time um so per amount of decay call it right how much your your delta changes as well [Music] all right hello everybody we're back talking french baked goods today because if you've been anywhere on baldwin or finn tweet as of late you've been hard-pressed not to see the wide-ranging and increasingly popular opinion of the vaguely mysterious handle at jam croissant and we've got the man behind the handle on today's pod jim carson see what he did there who's founder and senior managing partner at aegea capital management so we're excited to talk about some of our favorite uh twitter and non-twitter topics with gem including volatility retail call buying growth versus value just how complex trying to trade and uncertain election is and more so welcome jen thanks for having me thanks for thanks for being here so it looks like you're in the office yeah so uh about two months ago got back in the office uh the other tenant we share space with uh left so we have twice the space and perfect we're all spread out so twice the space half the price exactly the um and where are you you you just mentioned off on your river north to just north of the loop here in chicago yeah 401 west superior so right uh right in the heart of river north uh easy commute for me from uh bucktown so uh you know perfect so that's superior and what lasalle no disappearance cedric so just south as chicago here kind of bright and yeah they're right in the heart so cool um so uh first question i alluded to in the intro there your name is spelled c-e-m but it's pronounced more like uh with a j jim that's the handle so give us the background on the name and the pronunciation yeah it's turkish uh i was born in london lived in turkey as a as a child uh grew up speaking turkish english at the same time and then moved to texas and as you might imagine that's quite a uh quite a change um you know from istanbul to uh to to houston but uh some people had a hard people had a hard time with it uh so i get all kinds of uh jam jim jim bob joey jeff to respond to anything at this point so uh i figured the handle jam croissant might help clear that up uh that's kind of a joke that's come around my wife's last name is barry actually so we're kind of the jamberry croissants all right so her middle name's baron her last name's carson and you can well her last name is barry but she you know she hyphenated it uh she's barry croissant i love it uh so born in london or you said lived in london born in turkey or in london born in london i actually have three passports so british because i was born there turkish because my parents were turkish and uh lived there as a child and then i became an american citizen and naturalized what my parents did when i was i think six or seven so and then citizen of the world boston is in there as well in chicago yeah so my parents moved to norway when i was uh at the end of junior high um and uh my dad's there wasn't you know good american schools in norway um so uh my dad's company paid for me to go to prep school in the east coast very you know amazing experience changed my life i went to went to andover outside of boston so what i think we lost to them in la crosse down in florida they would come down to uh for their spring breaks and beat us we played football with sticks but uh they were playing a different game but and never might have been the one i picked up yeah and it was got a great lacrosse program i played there actually uh i started late compared to most of those kids but i actually made the varsity team by my senior year that's a lot of fun great support wait what was the dad's company that they paid for you to go to northeast prep school conoco phillips so my dad was a structural engineer pt designs offshore oil platform so uh hence all the move the connection between london turkey you know texas oklahoma and norway have you ever been on one of those platforms i have i have taken a helicopter out with my dad i mean these are six billion dollar you know plus uh projects that last take four or five years to build don't break even for 50 years right they have like a hundred year life um to them you know a thousand people uh on a floating uh city in the middle of uh kind of the north sea for example tethered to the bottom you know miles down to the ocean so pizza you know it's like going to space it's their crazy feats of engineering so and super technic right there they're like the jets keep them above center and all that stuff absolutely absolutely i mean each one's different they have all kinds of different kinds you know i'll leave my father to kind of give you the specifics but right but i grew up around that are pretty pretty cool and so what was your favorite accent at all those places it sounds like you haven't really adopted one do you flow in and out of them well my daughter and i speak with a british accent quite often just to play around but uh no but for the most part no i mean i i grew up speaking turkish in english actually there's another country in there i lived in south america in chile for uh a year in college uh that was supposed to be a one semester thing and i met a girl and kind of stayed a little longer but uh did live in south america so speak spanish as well um when's the book coming out this is all this is all good stuff for about yeah one of these days when i can find time i'm uh it's a lot a lot a lot lots right about so got it and so now in chicago office and you said live over in bucktown which is just a little west of the city so cool um yeah so give us a little background on work wise on what you were doing in all those places up until uh aegea yeah so uh believe it or not i've been here in chicago now 20 years or more 22 years um but never lived longer than four years anywhere before here so my whole career has been here in chicago uh came out out here from rice uh in houston uh was hired by a gentleman who uh had a trading operation uh out here who was a rice grad and uh there's actually a bunch of us uh kind of a whole lineage of guys that have started their own uh shops out here uh there's a big prop shop called belvedere trading here in chicago the head of that tom hutchinson is you know hired me in the business basically i worked under him uh early on um so we're still very close friends we knew each other at rice he played rugby i played lacrosse you know we were kind of uh friends so um but yeah it's there's a whole bunch of guys like i said uh in the business that have come up that way it was a bunch of old o'connor associates guys uh who uh who started a group for the royal bank of canada and uh so we kind of came from that lineage learned kind of the right way how to do things uh trial by fire it came in late 98 99 right before the bubble burst and uh really kind of learned sorry with jim kleinhops who had been o'connor somewhere where you're talking to o'connor and i'm like that would be a great book of just detailing the right it's kind of like the tiger cubs and just the amount of managers and pros that have come out of the o'connor tree is is huge i think it's even more important than the tiger you know for the derivative space uh i mean they pretty much wrote every single model that's out there right um every model is pretty much based on every prop shirt you know firm in chicago about every but i'd say you know 85 percent of them primarily use the same model that comes from you know uh you know at least the original route there definitely 85 of the ones who've survived correct correct correct yeah so no it's uh amazing story kind of yeah i agree it'd be amazing but somebody should write it all right we'll do that that'll be a separate pod and or book at some point down the uh down the line so i cut you off there so somewhere in there you were a market maker yeah so i came out here as a market maker um and uh trial life fire you know moved up the ranks quickly i mentioned tom hutchinson he and some other guys left to start belvedere i moved up very quickly to kind of fill the void i was right as uh you know 2000 came around and uh you know made a lot of money for the firm in our uh you know in our world it's a very black and white world you either make money and you're good at it or you're not and uh you know i happen to have uh the capacity to you know to excel at it and uh you know my background was a math econ um and so it was well suited for the business and you were making a market for the prop firm like for their own money not for a bank desk correct yeah correct i mean it was it was a division of the royal bank of canada so it was backed by the royal bank canada but it was a separate kind of uh you know deal basically that you know the economics were were uh like 80 20 to yeah they basically bought it in order to get the profit stream right correct correct so um anyway so learn there moved up quickly uh as one is prone to do as they gain confidence and you know start seeing how much money they're making for who they work for they start saying hey maybe i can do this you know for myself uh and get my own economics and that's essentially what i did i went and started a group for a bear wagner specialist a specialist firm that was you know in new york in decline as all specialist firms were in 2003 2004 uh and uh they were looking diversify into the market making business they were talking to ctc over a couple other big firms here in chicago to potentially acquire them a gentleman and i uh you know approached them to create the you know firm from scratch for them and and we did that we built that out to uh you know significant number of traders on and off the trading floor um and uh what was the decline in this place from more trading going to the screen yeah exactly the specialist business was basically you know stock specialists at the time were you know up until that point where it was a very lucrative bid-ask spread business and everything just went uh electronic and you know the writing was on the wall like a total collector business right like i'm here if you want access to the stock pay the toll right and if you think about it market making you know on the option side is same idea but much more quantitative and much harder to kind of uh completely automate um so just because the number of strikes and the complexity um and so it was a natural you know he john mulhern is actually quite famous he's the last poker the gentleman who hired me to um to start the group for them um you know he had been a options trader early on in the 80s um so he had a good understanding of the space and knew he wanted to get you know diversified it was the right idea it was just a little too late because by the time you know we were two three years in and building the business uh you know i think their market cap had dropped from over a billion to like 500 million dollars and but you were tasked with building a option market maker unit correct correct and and we did so successfully um the problem was the you know the economics were supposed to scale it to you know 100 million dollars in equity um and leverage that and uh you know they had capital constraints on their hand and then john mulhern passed away um and and so it just didn't end up being quite uh you know as as big as we hoped it was a great operation we learned a lot built a great business but uh you know i am completely split took five of the gentleman with me in 2006. and started my own group back to myself with one outside investor and uh you know that's really when i kind of made my name in the business we grew that's one of the biggest market making groups you know in the indexes we were 13 of spx volume at our peak during the financial crisis uh 2007 2008 we were one of the biggest market making groups on the floor and off the floor and uh you know left that uh in 2010 after a crazy one we took you know several million dollars and turned it into you know 25 times that basically um over the course of three years and uh you had 95 of my net worth in the business and was just ready to kind of take a break after a crazy run so so and we can get into this little later but just talk through real quick the because it's so prevalent in the headlines in the news that market makers are doing this market and i don't think most people really understand what the business model is there so talk through just quickly what what that what the economics look like what they're actually trying to do um yeah absolutely so um you know it market makers as most people know are kind of the the uh the gel that keeps the market together right without uh without a bid ask spread there's nobody to sell 90 of the time there's nobody to buy because you're not going to match exact orders all the time so somebody's got to provide that infrastructure and they're the infrastructure markets um at its base it's there's nothing nefarious about it it's very um it's a very useful and an important part of the business yeah i feel like most retail traders especially believe there's another retail trader on the other side of their trade yeah i mean in equities a lot of times that's the case right there's you're talking about one equity buy and sell order is kind of hitting but um you know options you have tens of thousands of strikes for every you know uh for every series and you know you have uh a million different uh stocks and products so it's a you know it's an important thing to have a good market maker on the other side to provide liquidity especially during times of of stress um and you know when volatility markets are probably at their most important um you know that haven't been said sorry go ahead i was saying so at the base level is hey i want to buy this option on krispy kreme donuts three years out there's no one else on the other side of that trade i'm the only one in the world who has this view the market maker steps is like cool i'll sell that to you but i'm gonna analyze the risk and add some add some uh spread in there basically to cover my what i believe is the risk and the successful market maker correctly analyzes that risk and prices it correct actually yeah correct and in order to be a market maker you actually commit to the exchange that you remember at to to provide a certain width market at a certain time and uh and that they can widen that out or tighten it um but for the most part uh you know that's your commitment to the business now you know how much you trade there and how liquid it is will depend on the risk that the market will bear and and risk is broadly not measured in kind of just general waving of hands i mean the whole the market makers you know market makers see the world in a in a you know multi-dimensional matrix matrix and every risk is related to everything and you you model um you know every risk as it relates to wherever other things are trading in the market so you're able to perfect market maker world you've hedged it all out and you're just making a market with no risk correct yeah i mean a great example is you know when you trade an option particular role you have interest rate risk right um you know or something that's in the money and and you know the first thing you do is you go fire out your your euro dollar you know bootleg strip uh to hedge out that risk right and your pricing model is based on where that's trading at any given time uh obviously your underlying as well is you know another component and you know all these things are you know are now automated automatically hedged into a central book for most market makers uh and you know the real trade is as being um you know the edge is being generated off of the implied volatilities uh and directional components if uh if you have some directional edge um based on the flow that you see and it seems like a winner take all market for a market maker that's like why citadel's gotten so big and things like that right the more capital you have the more strikes you can cover increasingly yeah yeah absolutely i mean look it's uh there's a lot of data involved there's a lot of execution involved uh it's a lot of volume involved and at the end of the day if you can get economies of scale and lower your trading costs and increase your informational flows by getting more flow right and and improve your technology and execution uh which itself is an arms race you know you're gonna come out ahead and uh it's a very profitable business uh the information especially in this day and age the information that you gain is probably the most valuable thing of all uh that wasn't always the case but now you know just by seeing flows you have uh an incredible edge to kind of get ahead of where things are going and and uh make money on on that side of the trade uh that's it and that's the point uh directional for ball directional for for the underlying stock just directional for the implied volatility right there's a lot of components so it's multiple is that flow allowing them to hedge it better or is it allowing them to trade basically opposite it or with it in order to make a profit yeah so if you imagine the system yeah both imagine uh imagine a system where you have in real time uh the quickest systems and you're able to make a market um to knowing that you're that somebody's coming in to buy something they're showing your hand that they're a buyer right uh what are you going to do instantaneously you're going to go sweep any implied volatility you can't elsewhere right not necessarily in that that but uh elsewhere to uh you know if it has interest rate exposure had your interest rate risk or whatever right um it has directional underlying risk to kind of go take that um and your offer that you give them to begin with is firm and it's instantaneous and they they may come and buy it but if they decide to kind of walk it up and kind of slowly keep upping their bid right uh then the market's gonna move against them and that's true for the stock market you know it's it's true for it's true for all products but it's um particularly because the uh options and volatility world is is so complex and has so many factors it's um there are a lot more opportunities to take advantage of it and would you so the broad brush is painted a lot of that stuff's nefarious and kind of a bad actor what would you say to that i don't think that's true at all i mean the reality is it's uh the most sophisticated players out there are going to win and that's true pretty much in every business and the most sophisticated players here um have seen more information they have economy scale they have better technology they're faster they're smarter they got better models and uh and they they benefit from it um i don't think you know nothing here is uh illegal or you know i think the term front running gets you know gets thrown out there a lot i don't i don't see it as you know front running it's it's essentially making a market um saying i will buy here and i will sell here based on the risk in the market right somebody's got to provide that service um and you know it as they make that market and they and the trade comes in they hedge it out and if they have the opportunity to when they see a big trade is coming to take advantage of the informational flows they have they do and that's probably true for any individual out there see they see information you know correlation information basis risk other things right they're going to act on it on a more macro scale um and so i don't think it's any different it's just on a micro level got it and it in theory there can be no but there isn't necessarily a loser on the other side right like some retail guy could buy this option the market maker makes a market hedges it off front runs it for lack of a better word they make money the stock goes up the option buyer makes money and everybody's happy oh correct and that to be clear this is not a riskless trade i mean they've gotten you know they've gotten very good at uh you know garnering the information and using uh you know the edge that they have to to help ensure that they're the casino and make money over the long run but they lose money on trades all the time uh and and the bigger the trades probably the more they lose right they get because they have to uh if there's a block order coming in and they get run over right they have to take the first second third fifth tenth level right um and you know clearly they're trying to you know they're getting out of a lot of it along the way um and and in the long run they'll make money on it and they'll move the curves aggressively to make sure that they have enough edge to to do well but you know this kind of leads us into what's been happening kind of on the the retail call buying side right right i was going to save that for later but sure let's let's hit that now because right is that as big of an issue as is being made out in the press the robin hooders are buying all these call options and the dealers which is the same as market makers right it's kind of used uh in the same vein the dealers or market makers are covering their gamma exposure by buying more stock which drives it higher which leads to more call buying yeah yeah so yeah i think so first i want to clarify when we say dealers everybody you know that's a broad term yes market makers are a subset of that but market makers are also laying off their risk to other places that house this risk right and a dealer is essentially somebody who is um housing you know the risk and a lot of times that's banks right um you know it's also prop firms um you know buy side firms that that that will take uh on these positions but um you know the important idea here with options is broadly you know these people are hedging the uh the trade so when they when they warehouse this risk for edge they're doing it um you know hedged and trying not to take the full exposure right they're trying to take the the edge out of it so um dealers are yeah dealers are are taking uh the the trades they're getting short calls uh and there's a lot of robin hood is just one of to be clear many platforms retail options trading has uh doubled uh in terms of as a percent share of volume in the last seven years we're not talking decades we're talking uh you know doubling very quickly and i think i saw one of your tweets it's up to 38 our single name options now what was that 30 38 of of total uh of total option volume currently yes but in the last year it's been right around 20 25 so it's it's um you know it's not that's that's a bit that's a bit over over exaggerated there but but the reality is it's a you know we're talking about something that used to be five to ten percent um and uh you know it was always the kind of the dumb money that would get faded right yeah and get uh over you know overtaken by the more intelligent sophisticated players out there i guess i shouldn't say intelligent more sophisticated players out there um what's happened is now it's kind of the tail wagging the dog it's such a big set of volume and it's also you know very importantly single directional right the all of these retail trades tend to be call buying it's what's kind of more easily understood um it's also kind of betting on these growth names and the convexity to the upside and kind of buying lottery tickets right it's the same idea so it's important that it's not just a large amount of the volume it's it's all concentrated in a very specific group so i'm having significant effects in that in that group um you know the the obvious effects are as we saw in late august throughout august honestly was was because of the short uh you know dated call buying uh you know they had the ability to kind of push the market you know it was already kind of moving momentum wise uh up but they have the ability to kind of push those names specifically because of the pure scale and size higher because of the gamma involved on all these options and there's so much notional leverage and options right i mean you buy a 10 delta call and then it becomes 100 delta all of a sudden you know you have 10x the leverage uh on the market than you than you originally did and so it's a big very concentrated buyer with lots of leverage and uh it has major effects so the gamma pushed the market up now importantly dealers are taking this other side of this uh the implied volatility is being forced higher because market makers and dealers are moving they're losing money on this trade so they're moving the right they're making their spread that we talked about earlier like this is getting more risky for me i got to make the spread higher i'm going to charge you more for that option absolutely not just the spread wire but they're moving up the level implied volatility aggressively because they know these guys are buyers right so so um you know i mentioned supply demand they're buyers i'm the seller i'm going to try and sell it higher yeah correct especially there's embedded lots of buyers right you're going to use when they're pricing sellers go to infinity yeah um and and you know the the the more buying there is it doesn't go really linearly it kind of increases exponentially right because at some point uh you know you just there's not enough liquidity or capacity to absorb it and the only way you're gonna sell it is if it's uh you know significantly higher or the the risk return is is worth your time so anyway this is what happened and uh you know ultimately that street got really really short uh implied volatility to the upside and growth names very specifically it was widespread and the only way to hedge that uh is to buy implied volatility elsewhere and to try and spread it off um so there was a uh you know the natural place of supplies in the s p 500 and in value right where there's always uh call writing you know buy rights are a very common thing and they come around very regularly um there's natural call you know supply in these names so you know ultimately the the street ended up taking very very cheap calls uh in in the s p and and the ball complex you know index well complex in general versus these single name um uh calls and and how did that end up right eventually all of the deltas that uh locals or or you know dealers were long um and underlying they had to sell out um as the market declined right so they're short gamma they're short these calls and and the growth names are long the stock and they've gone from a 10 delta to 100 delta they have all of this long delta and as it declines uh the gamma goes the other way and they have to sell it out and that also importantly didn't just help exacerbate the decline in the market but it did two other things and i kind of put this out there before it happened you know you could see this in action about to happen but because the way you hedge all of this wall is by buying extra vault to help protect yourself against because you'll make a lot of money at that ball declines but you won't in theory lose too much if you have enough ball on the other side what this ultimately did is there was an oversupply of implied volatility once you moved away from the calls and the growth names there was all this ball in the s p complex other places on that decline ball implied volatility got crushed and it also led to a rotation so you had all the selling a stock in the growth sector right and all these names that where the the calls were bought on the decline whereas that pressure didn't really exist uh in a major way in in the broad index and the index was more broadly pinned because of low implied volatility so you really got an interesting dynamic there where you got to kind of you know we called it in real time you know look this market's going to decline you're going to get ball compression and there's a good chance you're going to get a rotation as well and sure enough they all happen and it's to a sizable extent which is basically we're seeing mark it down vol down and then some scenarios mark it up ball up and so we're saying this was some of the mechanics going on behind the scenes so we got way off script there but it was good but uh but i want to do two things one week we'll get back to aegea but one can you just run through quickly because we've already thrown some of these terms out there let's just do a little rapid fire definitions of some of these uh option terms if you don't mind so we'll start with the uh simple ones can go super short on these delta yeah delta is the uh change in price of options relative to the underlying market and when you say yeah a 10 delta would be 0.1 delta so per one point move in the underlying that would be a ten cent move in the option in the option price cool vega vega is the dollar change in options relative to a one percent move in the implied volatility so if implied volatility goes up by one percent for an option and there's a thousand dollars of vega the option goes up in value by a thousand dollars theta theta is the decay so the amount of money that comes out of the option value per day of time it's they really wanted to make it complex but we're going to give each greek a different denominator and different unit right right right like summer percent some are dollars summer time um all right somewhat more involved you throw this out on your uh twitter a lot the fixed strike balls yeah so a fixed strike hall a lot of people ask me about this and it's it's a much more it sounds much more complicated than it is but the reality is when you look at the applied volatility or of uh of an at the money option in the underlying options for let's say the spx there is an underlying skew so if we move down one percent in the market you're going to actually naturally slide you know the the implied volatility of that option that is one percent out of the money is higher than it is here so that straddle is naturally going to increase um as you slide down that doesn't mean that implied volatility has increased if you see the vix go up on a down move in the market that does not mean implied volatility has actually increased most people don't understand that people say oh the vix is going up the vix naturally goes higher when the market goes down based on the skew in the underlying s p 500 or these products put my pencil up there right you're just going to but tie that back to fixed strength so fix so what's important to look at what market makers do and most sophisticated players do is they look at fixed rifle that gives you a real color of how volatility is performing relative to the underlying volatility assumptions that the world is pricing on so if the market moves down one percent and we just and that that one percent down ball was a 50 ball the question is not whether it's where are we relative to that 50 ball that we've moved to not the fact that we were at a 45 volt to begin with right um so when you look at fixed strike balls you're looking at the strike by that strike that you're moving to how much has that volatility changed and that's why i'm always talking in fixed rate well that is actually the correct way to objectively look at what's happening in the implied volatility i'm a sailor so it's kind of like true wind versus apparent wind exactly it's all relative to the embedded assumptions of the market exactly uh skew which we mentioned already a little bit but yeah skew sku uh is essentially the skewness of distribution the downside in equity products is always uh more highly skewed uh that means there's a higher implied volatility to the downside that we just talked about even in august okay in august um i mean there's relatives steepness of skew and it changes all the time um you know that was definitely on the lower end of sku but equity indexes always i mean always i mean we've never seen um i guess there are i say always not for single idiosyncratic you know stock necessarily but for indices always um uh why why is that two reasons first reason market the market historically moves much quicker to the downside than it does to the upside so uh there isn't actually a real reason that there should be skew in the market on a realized basis realized ball is higher than the downside right i've heard the player take the elevator yeah exactly elevator down stairs up that's exactly right but we're saying the sku's just saying hey 10 away uh put is more expensive than ten percent out of the money call correct correct it's uh yeah the same moneyness or you can look at it in terms of probabilistically delta sticky um people looking in different ways uh that relationship is always going to be a higher implied volatility per amount of moneyness or probability to the downside versus the upside the second reason which i want to get to is not is a supply and demand issue and i think that's the more important issue the world is long the market it's long assets it's long you know if you live you have a job you're long right like that's just how it works i caught the financial uh industrial complex like the military industrial complex right everyone's geared towards making you as long as possible 100 and and you know that's where the money is made in the long run right the assets create a yield um for the most part so these are insurance products at the end of the day and so if you want insurance you don't want generally insurance for the upside in the market you want insurance for to protect your long position so people buy puts and they sell calls they write calls against their long positions and they buy insurance protection for downside complexity um this supply and demand uh has always been there and it always will be and it creates a overvaluation right relative to outcomes of downside relative to upside um but uh so that increases the skill um and particularly during times when the market's uh you know up on a big run and people are making lots of money skew tends to be even more exaggerated yeah actually an interesting point and the s p 500 you know we we tend to have the highest view in the world um there are lots of other products where the sku is not as steep as here but this is where broadly the world comes to hedge um and that's an important point right even if i'm along any country pick a country if i'm going to put some hedging program into place i'm probably using some smp if not all s p correct and that's because you know rule of law this is a safe place to buy insurance the world's liquid you probably don't want to have puts in venezuela right like if the uh you know that's for one two it's very liquid like you said and they're dealers and you're able to get some significant size of these things done and get in and out of them um there's several other reasons but you know i think those are the main ones uh all right now some next level stuff vanna yeah so this is one that is not well known and well used i want to be clear everybody's always asking me on twitter like where can i read more about this is this you know how the effects of this uh you know there are very few number of people who use even in the market making space that use vada regularly it is a second order derivative um lana is the change in delta per change in law invert change in implied volatility yeah so as uh implied volatility decreases by i'm sorry let's say increases by one it's it's the amount of deltas that that change of your options position um another important one that kind of goes hand in hand with it which i talk a lot about um is charm charm is a bit more commonly looked at and used but but still you know second order derivative um that is pert per change in time um so per amount of decay call it right how much your um your delta changes as well both of these are you'll notice are are are delta focused um derivatives right right which ties back to the market maker's desire to be delta hedge neutral right correct so the reason i use them so much i look at them so much is these really embody a lot of the delta effects of the underlying assets and the the broad world looks primarily at the underlying assets and uh most of the world is not very familiar with how these derivatives can have a substantial effect especially now that they're you know the leverage in these products has increased so much over the last 20 years and so understanding these these delta-based uh kind of derivatives of the underlying uh you know options is is very important to understanding those flaws now what who came up with charm where they lost the greek alphabet there what that's a great question i'm actually not not sure like that doesn't i think that might be it's still a greek uh i don't know maybe i didn't troop that that's the wrong guy i don't really know we'll look that up separately i'll have to get back to you yeah and then i was actually clerk in the bond staring at the bond options at the board of trade and right that was they all had their sheets right and the bond market's moving and they're looking down at their sheets i don't think they had vana charm listed but they had the calculations of if it moves two points up i got a hedge with this many futures and they arbit into me in the future spin so that's the whole concept of delta hedging of based on these statistics based on these greeks i know exactly how many futures i need to buy or sell to maintain a zero directional risk and i'm just then betting on picket volatility or time decay or whatever um right yeah and i think i think yeah going back to my market making days like we didn't have vana or charm on our sheets we didn't even really look at it uh very closely right we we did look at charm in a sense that we'd move our market our our model forward a day or in time and we'd have a sense of okay i'm gonna have a bunch of stock to buy back tomorrow or something right yeah but it wasn't uh it definitely wasn't as discreet and and uh definitely not looked at as you know as meticulously as i look at it now um uh again delta gamma those things were were you know every second every minute kind of looking at this and understanding the the risks associated with that but uh yeah vana and charm have been a much bigger part of what i look at um and i think are increasingly important to understand and volga last one yeah so so volga is is change it's like the gamma of all so per per change in uh and vega it's it's how per change involve how much vega you add or subtract so how much ball in an increasing volume yeah correct so it's essentially the gamma of vega uh it's kind of like gamma is to delta volga is to vega and people people look at volga a lot more actually on the market making side uh you know then they do some of these other effects i tend to look at it less because it doesn't have as much of an effect on underlying assets as much as it has an effect on the underlying volatility of the product because for a market that's what could take them out in a body bag right if that just explodes their focus is their focus tends to be on managing implied volatility and the risks associated with implied volatility uh they try and tend to be marked more market neutral um again every shop is different um whereas my my focus and a lot of people's focus is understanding how does this move the underlying product [Music] so with that background it seems that and you just mentioned looking at um vanna and charm it seems you like to play the players more than the the game is that fair to say and you can get a little i think there's a song right there there is i'm not going to go down we go there but yeah don't do it don't don't hate the player hit the game yeah donate but uh but you're kind of looking at how the ball service reacts to um all these different players and what they're showing in the market with these different readings and then kind of the feedback loop that that generates so yeah so what i discovered in the last yeah what i've discovered really in the last five to ten years is um there's a ton of sophisticated players and some of the most sophisticated players out there looking at what's high what's low trying to put on relative value positions and implied volatility on a dispersion basis on an underlying basis within each product on a correlation basis you know that that is so picked over right and the reality is what ends up happening is the edge in those types of positions are are very transient they don't they don't really kind of stick at the end of the day uh the way you end up capturing those that edge that's there is essentially getting out ahead of how the underlying movements are going to affect the balls and skews themselves right based on that position as well as the underlying uh movement of the moving of the underlying asset as well um and i'll give you a good example again that may be a little bit confusing but um imagine and this is kind of a common uh this is a kind of a common one is you know at monthly x or quarterly expirations um vol and skew tend to be elevated relative to the week or two weeks following it why is that because supply and demand those are the most traded assets there's a lot of structured product tied to these monthly and quarterly contracts um it's you know if that's where all the volume is and that's where the buyers are you're going to get a lot of buyers of puts uh you know in those those products sellers have calls and you're going to get higher skew and broadly higher implied volatility so if this is a regular occurrence you know you think well i'll just go sell those monthly and quarterly and i'll go buy the puts or ball behind it right great spread yeah that is a good spread but not surprisingly it doesn't tend to realize into you know any meaningful profits why because the whole street has that position on yeah right if the whole street has that position on it's a valuable good relative value trade but what ends up happening is it has effects on how the market moves both in terms of the underlying and volatility and skew as the market moves so given that same position let's imagine a downside put spread the market goes down you're you uh right going into expiration let's say a week before that let's talk about now what happened on monday the october uh you're short you're along the october uh 30th puts behind it market goes down into your shorts and they're high um what happens to the october 30th the october 30th sku and vol gets compressed and vega broadly gets compressed because you own really cheap skew and really cheap vega because of this relationship that exists yeah so the reality is you can't just put that spread on say i'm going to make money because everybody has it on so the second that the october declines the october 30th is going to decline and skew's going to have to decline and implied volatility behind it's going to have to decline right and so understanding that that's those are the effects that are internal to skew and ball and the effects of these positions will have on on on uh on the skin ball but also what you'll realize is as that october decays away and you're just left with the october 30th which was really cheap you have to there's charm and there's um and there's mana to these products so the october is disappearing that was your long delta versus your short delta behind it um what happens as that disappears you have to be you can be buying the underlying right or selling some other boss somewhere in the puts in the put wing that's an increasing gray and increasing rate exactly yeah and so what does that do that affects you know as the days pass and as the implied volatility drops into these down moves it forces buying forces buying of that underlying asset and it supports the market and these flows are big these are big i mean the world has a skewed trade on everybody buys put sales calls dealers are short long quality indexes and it's a very profitable trade because you're selling a high ball you're buying a lower ball and you're short stock and there's some short convexity to it there's some risk to it right but on in total this is a a carry trade that's very profitable but every day that goes by right you have to go buy that delta back that's charm and as that volatility gets volatility gets compressed you have to also buy that delta back and so during periods of the calendar it's very important it happens every month every quarter to accept there's open interest that's sizeable uh and that there's more you know you've moved into uh you know more you know long ball uh or short sorry short put in the front long ball in the back it's even more um it's even greater so um by using this framework and understanding the positioning that's actually out there you can really get ahead of what's about to happen you can see the supply and demand flows coming now but is that the only is that the only factor out there is that driving everything like no and i think you know i think some people interpret like that's all i look at and that's the only absolutely not but if you if you're looking at a world that doesn't include that information you are flying blind such an important factor you're lost and people don't understand why these things are happening and you know people's eyes are coming out of their head when they see kind of the predictive power of these things it's incredibly important um you know these flows are increasingly um you know driving markets and these and these windows and these important periods where vona has increased right towards expiration cycles so understanding this is very important to uh to getting out ahead of the delta and the uh let me ask so that was that was present in february of this year right so it's like there's a feedback loop feedback loop until there's not right yeah so that's exactly right from everything you just said to when there's a crash yeah that's a great question so there's basically two counteracting factors right there's there's gamma right and then there's vana and charm i kind of put fond and charm together they're two kind of sides of the same quantum as a function of time that's a question of of all but you know if i'm short out of the money put and i'm long and out of the money call right and i go to strike or towards strike and time passes and that put expires right i have a lot of deltas to buy back right yeah but if you go through it and the speed of the the move is big enough right right then you don't have stock then you then you've actually that's gamma right then you've accelerated that's that's convex right you can really lose a lot of money on that and that effect itself is very important as well i mean so you can't just look at bond and charts hey i'm going to go buy stock and that's why people don't just go go preemptively just go buy a bunch of stock going into periods like that's why they do it all over time time passes they'll buy stock end of the day every day buy stock morning decay comes in buy stock that's why it comes at the beginning of the day and the end of the day right people are moving their curves resetting their curves saying okay i've dealt with them and and there are people out there with algos front running these as well so it kind of comes in a little earlier but the reality is it's you know there's embedded risk because you know that speed all of a sudden you buy back all the stock and let's say the last day or two days before expiration work all of a sudden you bought back all the stock and then it declines dramatically through your shirt right you lose your shirt and so what happened so what happened and then they're puking out yeah exactly and so what happened in march is not a coincidence i think that not enough ink has been spilled on this but i think the you know in march when we declined the bottom in the market happened right at march expiration really the bottom the peking ball the bottom of the market happened the day of march expiration march 23rd or something yeah yeah not a coincidence why did that happen because everybody was short gamma they were getting margin calls everybody's short march they were along behind it right because march is where all the demand is and people were short and the second march rolled off and expired everybody was left long ball long protection no longer had margin calls market stabilized took off um and so yeah these factors are and again then they could go back to just their normal buying buying pattern yeah not just buying pattern like then you're less this ball at a really high ball everybody is all of a sudden went from i gotta buy this back to oh my god i better get rid of this and sell this otherwise right this is not an 80 volt right like um but it's still elevated for quite a bit but yeah i mean 80 down to 30 yeah yeah yeah no 100 but there's but that's also we can get it go down a rabbit hole here but that's also why after big events tornado comes through town insurance is always the best sale at that moment right you're less likely and it's actually there's a reflexivity to it i mean you're less likely to get these declines in the market when everybody's prepared for them implied volatility is higher right now you know people are less willing to sell things because they're they've been the sellers have been pushed out of the market a people have a recent memory of uh but isn't the risk involved that seems like it's true only until it isn't true right so you can be like oh we just went down 30 now is the time to sell ball until the day when we go down 60 percent then you're right oh i'm not talking absolute terms these are probabilities right yeah yeah you have you have uh i mean i think a great example of that is 2017 the amount of risk at those low implied volatilities right in 2017. well no i i beg to differ and that's the thing nobody nobody would uh want to sell because the risk on their sheets looks awful it was actually the most profitable year in history to sell implied volatility um it was the lowest realized volatility and risk adjusted as well i say risk of justice relative to the amount of money that was lost at any point right yeah yeah yeah yeah it was but that's hindsight in the moment it was scary trade though right because you're so low well for some but the reality the reality is there's a reflexivity and i think that's important that a lot of people miss here and we're kind of going off track but when implied volatility is compressed the market everybody is long it again supply and demand if the world is stuck long wall market's not going anywhere yeah it can it actually like it's not just because oh people are long ball and they'll make a lot of money they're structural like people have to we'll hedge that profit as the market moves the market moves half a percent and you're long very cheap you're gonna you're gonna buy some stock and mark goes up half a percent you're gonna sell some stock and that's that's the power of gamma and bond everybody was long ball in 2017 and it reflexively pinned the mark and created you know the lowest implied ball in history by thirty percent yeah greater than a three percent more than a three percent yeah right i can't remember what a 61 days or something without a one percent move yeah it was uh the biggest move was less than three percent yeah and you know from peak to trouble [Music] so i want to talk for a second about so you're using also some of this flow information and vana and trump to inform trend following right correct so we should take a a stop and go into what aegea does so we can come back to that yeah so g has been around uh since uh late 2011 uh our primary focus was originally and still you know a big part of it is is relative value long vol our flagship products uh are still long ball uh products um we uh obviously started that in 2011 and riding it through uh 2017 was uh you know we created a ton of create a ton of that alpha uh but the market went straight up and uh you know i think our average alpha for including uh these recent years is just over eleven percent uh just basing on underlying right i know that's not a perfect metric but uh you know i'd actually say we have a lot more alpha than that because we're a long ball and long vowel itself intrinsically has negative alpha so we've kicked off a negative a positive sorry 11 um to the market um with a negative one beta you know this is a product that you know has has been has had a lot of edge in it we've done a lot of great things with but the tough the tough business side of being a long vol product uh is the markets tend to go up uh and implied volatility tends to be uh overvalued you know relative to realized and so uh you know it's not a very profitable business in the long run unless unless you're just collecting a man a really chunky management fee um so we have a decent chunk of assets you know we've been doing it for a while we have a couple of institutional clients but um you know we decided as a business to really uh shift towards where we think there's more edge a much more scalable product uh you know understanding we have this deep expertise and and understanding how the markets move uh and uh how these uh these products affect those moves and uh you know part of me going out on twitter you know yes i like to to educate and to do other stuff but it's really to get the word out about how this is an important product and how you know people should be uh understanding uh how this can add value to uh their investments like sometimes you're like this i'm getting out of my lungs here at 35 like it seems like you've given away a lot of info there yeah i know uh 100 sometimes i you know wonder how much this i should be you know communicating right uh but but yeah no this is very inside baseball stuff this is you know forged by fire nobody taught me this that i thought you know this has been complete self-education on how markets move you do this for 22 years and i think these markets you learn a lot so i think this is a valuable important stuff to people um but i also think without being on the inside and really understanding these flows and having the the approach and expertise that we have i think it's very hard to replicate so um i think it used to be easier seems so hard now right like you got to know all this stuff it used to be like okay i got to have a view on where the market's going and i'm going to trade that making money on the implied volatility relative value stuff used to be easier uh and that's part of why i think we're moving away from that as well i think there's just much more edge you know i think the edge from these relative value trades in the ball market really get like i said stripped out by the actual underlying movement if you can get out in front of the underlying move in a you know in a very kind of risk-adjusted and positive way you can make a lot more money with a much more simplified position and do it in a much more scalable way these small trades are not that scalable um and they're also not as liquid and so just i think it's it's a it's a great business model i'm excited uh that we you know we've started kind of uh running this on the prop side and we're going to have you know we have an amazing track record going on it already and then they're excited to launch that probably in the next six months wait so dive more into that i lost myself there for a second so because i asked about trend phone but we didn't talk about trend phone yeah yeah so let me go let me go into the underlying so obviously there's a lot of trend following means a lot to a lot of different people and you know again i'm i don't come from the trend following you know uh world so some people might have to kind of some people might uh you know beat me up for for the the terms the semantics i use but but uh yeah i mean i i consider it trend falling in the sense that we are you know we're using big data sets uh and looking at technical indicators as well as um you know volume and flow indicators um in the broad market and pairing that with the flow and uh you know uh indicators that we have on the ball side to to to come up with uh you know predictive analytics to help us you know get an edge and i think everybody's kind of seen how how good some of these things are but i mean to be clear i'm not just looking at these uh divana and charm flows on their own you know looking at it uh you know looking at basic mean reversion looking at momentum looking at uh you know sentiment and uh you know put call ratios uh you know i could go on and on but they're you know we have a 24 factor model and and we're really kind of uh first starting with qualitative measures of understanding uh our framework and how we believe this world works and who the different participants are not just in the ball space but you know risk parity um you know uh ball ball control all kinds of other products that are out there the trend following space and trying to get out in front of when those flows kind of tend to tend to come into the market at which spots and and get ahead of them and but it's all still reflected in options so it's all option training or you'll videos you do outright over something no no the ctml is very much trend following underlying um we are looking at where the underlying and the s p and the nasdaq as well as we're primarily focusing on equities now that's just where our expertise is but really trying to understand um you know get out in front of how these things are going to move relative to one another and and independently on their own and then taking delta directions uh as well as uh implied volatility directions um based on that so it would be all right short ball at times yeah great absolutely a great example i did that the other i think last week uh i was like look implied volatility is over supplied we're up against uh we're very overextended we're like the two standard deviation up right there's underlying vana flows that are supporting this market right you have all these different flows and factors so this market's going to be pinned for a week go solve all don't don't try and take a direction one way or the other there's not much to do there but you shouldn't do this and so that's what we did hybrid between this is the model and the factors and discretionary the discretionary is more um is more leverage based so we will leverage on leverage off risk on risk off uh even that is is fairly quantitative but you know we do have the discretion there the model itself is very kind of uh algorithmic quantitative uh it's not auto execute you know we are we are deciding exact moments and uh you know or trying to you know when you have a lot of experience you want to use as much of that as possible without without uh you know being you know messing with your kind of system too much right and without spending 12 million dollars to code your brain right of like correct correct and there's just some things that you know almost impossible to code [Music] so next we got some twitter people wanted some more color on this of you and uh mike green on twitter got into a little friendly debate i wouldn't call it a debate but a friendly pairing of info on episode momentum verse value so give me your side of the equation yeah i want to like be clear about this before i get started i don't want to speak for for mike uh he's not here to defend himself not that he needs to i have the utmost respect for him he's been on the right side of most trades for many decades so i'm not you know i tread very lightly when i'm debating with that man um yeah to be clear though you know my expertise is i'm a practitioner in the ball space i have a very kind of unique perspective on on how these things work this this debate is not uh central to my my background in the ball space it's really uh you know i'm also the kind of sort of at the front of this uh you know i studied uh public policy in college as well as math econ so i have this great interest in uh you know economics policy and you know it's something that i do on the back end that informs some of my kind of broader kind of trend ideas um but um but for the most part i just want to say like you know this is really kind of healthy debate on something that i'm interested in and not really which is what i'm interested in too so yeah so um but but mike's you know obviously as everybody knows or most people know he is he is uh the last you know decade been right on about the move from active to passive and the effects that that has on on the momentum um factor and particularly growth large cap growth which is tied to that momentum factor and has been in recent history he's been spot on and he continues to pound the table on this is just the beginning and that this will continue for um you know for an extended period of time and my again it hasn't even been pushed back but my you know the reason we kind of got connected is you know i was really arguing at the top there in august that we're going to start to get a value to growth rotation and my argument was originally based on the ball arguments i made earlier but i also said i think this can continue for you know an extended period of time meaning uh this is a a beginning of you know and fits in spurts a decade-long um you know this trend could really be a broader trend and my point uh to that was i you know with the upcoming election um you know i had this mental model that that monetary policy has been a major um you know the influence and in terms of creating uh this growth momentum factor i think it's as important um as probably more important than um than just the active to passive move i think they're active to pass the move is important it's critical um it is a driving force but i do not think it's the force i don't think it's the only force and i think you know essentially we're giving and we're basically talking about fang outperforming everything else and apple being the size of the whole russell 2000 and all those correct stats of why is that happening besides those being great companies is there some thing and mike would say well part of it is because everyone's swimming to passive you're saying well part of it says there's huge fiscal policy stimulus i'm saying actually that up until now there's been a huge monetary policy yes a monetary policy at its core is lowering interest rates and providing money to companies if if you're a company like amazon or like amazon was not now but amazon wasn't when they were i think it stuck up for you on twitter there and through that uh amazon i appreciate it yeah that's right uh i need all the help i can get against them so keep it coming uber is another great example um you know these are companies that would not have survived in any other market time there are companies that have survived because they've been given uh basically limited uh liquidity um an ability to invest to be and drive lost leaders right for for decades plus and to to focus on a 20-year goal uh without profits and if you do that if you create a a a structure that allows companies to dream up uh mining meteors on asteroids or creating you know you know spaceships and going to mars um without a profit um eventually these things will win it may be 40 years but they will win if you allow them to do it without a profit you provide them unlimited liquidity right especially if they're the first mover in that space but yeah and allowing them to do it without a profit the monetary the federal reserve so the federal reserve is created directly but you're saying because investors can access that cheap federal reserve money for basically nothing or at the banks and the banks can in turn give it to investors for cheap that it's flowing down into the system and creating this there's no real risk if you can get 30-year money at three four percent right there there's no there's no real risk to a liquidity event for these names right tesla could have easily gone out of business right yeah uh four three four years ago or two years ago right they they don't have cash flows the argument was solid that you know they don't have the lifeline if there's a liquidity event during that time they'd be out of business but the market and broadly uh you know the federal reserve has allowed um you know infinite liquidity and protected the downside and this is communicated through two main factors you have scarcity or the tina effect right people have to put their money somewhere because there's no other place to put their money there is no alternative there is no alternative exactly and and secondarily because uh you have a a moral hazard for lack of a better term where the federal reserve will come in and support markets and provide even increasing liquidity at any with any risk of a liquidity crisis so if you have this situation you uh you're naturally favoring these names and eventually they're going to win you know a amazon is going to beat a walmart because walmart unless walmart is willing to do the same thing and compete on the same terms and and so growth names or you know that are willing to not spend attention to cash flows and pay attention to future growth will ultimately uh see the benefits in the market so that's a broad and that's a broad concept and the passive active is a critical part of the communication mechanism of how that works but my point to him was because this is the case as we move away from monetary to fiscal we haven't done that for 40 years and define that real quick monetary fed policy fiscal is sending people checks correct it's sending essentially lending money to companies and uh you know when you lend money individuals for the most part don't borrow money wealthy individuals and companies borrow money for the most part and uh so so monetary policies lending money fiscal policy is actually getting dollars into people's hands whether it's by uh you know healthcare like uh you know whether it's for infrastructure spending uh or just dropping money out of a helicopter i mean that's like kind of bernanke example right we're basically saying we've we've exhausted the monetary side yeah i mean we're at zero interest rates um you know yeah yeah you can go negative yeah you can do more qe but there the you're you know everybody's heard the term pushing on a string like the feds the more the you know they're at the lower bound the more they do they get very little effect at this point and they've been very vocal how about how they want fiscal policy to take the handoff they want physical policies and morata arrows over here can you guys correct and and because of the political environment here uh we haven't been able to for many many years we haven't had to until really about four to eight years ago it's been you know more pressing but we're at a point now where it's necessary the fed is very uh aware of it and importantly i think this is the part that people are missing the zeitgeist has changed the way people realize the inequality that has been driven by monetary policy is unsustainable as well and the masses for once are actually broadly clamoring for more fiscal policy more infrastructure spending more direct spending and money to people as opposed to corporations and i think that has become politically untenable you know for for people who are not arguing for that so i think that political push it's in my opinion it's essentially an inevitability obviously you'll have corporations and lobbying that will will try and fight some of these trends but i think the political movement is such uh in such a place where regardless of what party you're in you're going to get some amount of increased fiscal spending you think we'll i think eventually you will yes i don't think that's going to happen right away that's going to be a stair step uh but i think that's the natural kind of ending place where we're going right now like hey the country can't keep going unless you pay these people another check give them another correct i i think the first you know like we'll see who gets elected right the election i mean this is why this has also come up i think i come up the election here is is not just important you know for other reasons but i think the most important structural reason for i think for markets is under a democratic or bind administration i think you'll get a very very quick move to aggressive fiscal policy and i think their first they've been very vocal their first move is massive infrastructure spending though um i think infrastructure spending has a has a massive multiplier on it you're not when i say that you know per dollar you put in you get three dollars out why because you create a job and you pay those people money but then you create something that then also generates more profits for companies for individuals construction here in chicago for example it depends what kind of infrastructure you're talking about right but yes absolutely but you know infrastructure is 5g networks it's uh you know you know electric electric gas stations whatever you know you can do a million things to help you know a green new deal right whatever you want to call it um all of these things are infrastructure spending and uh you know that money flows directly to individuals and that creates price inflation that when people have money for the most part lower middle class people spend money they don't go buy investments they don't do to some extent but lower to middle class don't have enough money to save they're they're trying to get by they're trying to pay their rents it doesn't amazon wins either way right yeah sure but you have to realize it's all relative to valuation right yeah so so yes uh this should be brought this is what the economy needs the fed says it as well this is not my opinion this is you know textbook like this is what the economy needs the economy will do better under this environment especially because with a reserve currency and we can afford to do this without a major you know problem on that on the right borrow it 0.1 for 100 years right the problem the problem with this for the markets is the economy could do very well and ironically that's not good for the market yeah that's not good for the market because if interest rates go higher if inflation goes higher which is a natural result of fiscal policy long-term rates this whole mechanism we've been talking about how the growth multiple game right you know the price you buy these things that almost doesn't matter right but if interest rates go higher there's an alternative there there's no longer latino effect disappears right you have higher you have three four five percent bonds you haven't i've always i've always contended like there's no way interest rates can ever go higher like everything is based so on lower that's depth if you give the people money directly that's because we haven't done physical policy we've done supply side it's not just monetary policy we've been doing supply-side economics since reagan we've been giving companies money and expecting it to trickle down and guess what it hasn't trickled down yeah right but money is good even the mom and pops like need cheap mortgages and like card loans like everything's based on low credit right on low rates correct so at the end of the day look the the my theory here is like it's not going to happen overnight i'm not calling for you know you know fiscal policy will take a while to work through the system initially it'll be very positive for the economy and the market will probably see that as a a broad positive right value so but this is bad for multiples yeah higher interest rates is bad for multiples eventually and and and things that are trading on ridiculous multiples will will be affected so this is like no no argument around right now i mean look when things get too extreme people are always like but what is the mechanism which is making which is going to make this come back and alive i'm trying to give you a broad framework that will will create this at some point this is how it will play out mike green's argument is you still have a secular active to passive trade and that's not going away and my argument is i don't feel that makes the system more fragile and it would be more apt to break with a little trigger so you could both true and that's right and that's exactly right we're talking about orthogonal kind of arguments they're not contrary uh and i agree with his argument um my point is i think this move from monetary to fiscal is how money flows through the entire system and is much bigger than the active to passive flow and ultimately if you get a revaluation of multiples and growth relative to value i think this cycle could eventually untether uh growth right from momentum value could become the new momentum name yeah and you could eventually get an active to pass a move that is a tailwind to value not growth right you can get a passive move in value yes and that's but again that would take a big kind of massive multi-year move right you'd have to have massive momentum move and you know there's a lot of mechanics where he still is kind of uh you know he basically doesn't agree with certain other the mechanisms that i talk about but that's the broad argument we could go deeper but you know and i love it i think i think he agreed on on some major parts of what i'm saying and i think you know i definitely agree with with his theories i think we we've agreed that the only way this is really going to happen is a broad view revaluation in the market where growth massively underperforms value on the downside and then uh and he said basically how how are you gonna get people buying value to begin with before how's it gonna create that momentum on a flow level and my argument is it'll come from corporations you know uh whether they increase dividends or whether by if you can no longer borrow money you're dependent on your own cash flows and if your cash flows are increasing and you're getting more earnings you're going to increase your dividends you're going to increase your buybacks and that will ultimately provide uh support for these names and create you know relative momentum relative to to growth and underpin those names and that's kind of where i think the ultimate you know whether it's through uh you know m a dividends buybacks lbos you'll have uh you'll have the ability to kind of support names with real earnings and cash flows we'll go back to a dcf kind of model i know it's like dust off those old attacks thinkable right right but yeah it hasn't happened in 40 years so that's the thing whenever you're arguing for something that has been in 40 years you automatically get people looking at you like you're crazy right but cycles happen and uh you know they happen fairly reliably on a larger scale and sometimes it's it's easy to confuse macro cyclical for secular and i think this is we're getting to the end of a macro major macro cycle of capital versus labor and people are lost thinking that there's a secular you know 200 year uh you know here so there you go [Music] last bit you mentioned the election and you've been uh talking a lot about the different right at first it was just like oh octo october vix futures are high because of the election and they look 30 days out and then it was like oh well november futures are now high and now december is elevated so go through a little bit of those it's fascinating right if i think we're kind of like how vaul works it looks out through these and we've also introduced this new thing of like how the election actually works right that there's a vote but then they get tallied and then there's the electoral college vote so it's like vol surface on top of how our elections work which is absolutely fascinating so until i'll be candid like until eight to ten years ago you know when i first started the business event ball wasn't even a thing there wasn't even like a discreet event ball people didn't even look at this they should have right and obviously they did it that's you know they did it in i want to be clear in the indexes on a macro level this was done for earnings right this was done for for arbitrage or something yeah correct but um you know people broadly kind of faded these events and you know a lot of sophisticated you know just like any other thing people started pricing in discrete event balls and and and doing it you know successfully for a profit and uh you know then you started seeing a real move in the surface of equity indexes and other products based on these events um and you know if you know how to do it and i'm not going to walk through the math but a lot of guys on here i'm sure will figure it out you know you can you can price the relative to the curve right the event um you know move that's being priced in uh that's extra and you can do that with multiple events um depending on how you define a discrete event that's very important right you know what's an event what's not is is you know always a challenge um and so by doing this you know we're able to look and see uh in real time what the november's you know fourth election is relative to the things around it um and it's been very cheap uh like relative to in my opinion right we're running about 70 374 dollars in the s p 500 you know you're talking about essentially a two percent move um you know in in the in the underlying i think for something that's as big as it is uh that seems incredibly inexpensive um and it's particularly cheap and i think this is important um all the way out to november november 27th it's still very cheap relative to december and january implied ball and actually it's come in quite a bit and it's normalized but for extended period there i was it's still high but it you know relative to where it was it's normalized a bit uh it's been a very profitable trade for us but but you know for the longest time people were not were pricing at a massive secondary event which was uh this uh you know contested election world falls apart post election like the election passes we don't have any new information really and then there's a contested election and people are being like we don't buy them who wins we just care that somebody wins that it's safe right that the world doesn't fall apart or that there's not you know um you know and i think that got overblown uh actually i feel confident and obviously the the price movement has worn that out but essentially the problem with that you know in terms of a mental model is you know you know an election is going to happen you know there is a hundred percent uh probability that there's gonna be an event election and you know put a number on it but you know 75 to 95 depending on how you look at it uh percent of you know the time you're going to get the majority of the information of who the winner was right even if it's contested for you know on that election day yeah or within or the days following right within you know by the time the votes are counted now granted there's there's always risk right there's a five there's a five twenty five thirty eight.com five percent i think they're underestimating 20 chance that it's contested and and when i say contestant not just that trump or abiding contestant but that there's a realistic kind of argument that a supreme court or whatever would would here out to um you know to change the results right um and so if that that's a conditional probability you have to get past that first election right and let's say there's a 20 chance uh then there'd be a contested election you know then based on 20 what you know what are the moves that are going to happen you have to kind of dig through those probabilities when you're down to a 20 probability from a 100 probability regardless of how big that i mean not regardless at some point it'll be worth it but but if you're talking about you know five percent move under 20 likelihood right um that that's yeah it's a big move and it's scary but the odds of it happening are still one and five yes and so i think i think yeah and so the pricing just got like people were it was it was based on fear people were pricing like oh there's an 80 to 100 probability that we're gonna get a contested election and that it's gonna be you know a three to five percent move when it happened so they just they've all got priced too high um well come up with a uh a new greek for that like paula or something it's the amount of people increases every day the election doesn't get settled we'll we'll call it the the jam the jammer yeah well so anyway but uh but so that's that's kind of what happened uh the it has come back in the line quite a bit there's still an opportunity out there in this where you can um you know get short kind of some dece decent jan um you know ball and i won't get too discreet about where i'm doing it or how when you can be long some no which is two and a half weeks after the election for relatively cheap and you can do it in a way where you also get some convexity and mixed calls right and hedge and you have convexity and your flat gamma and flat vega and uh really kind of taking out a big like extra little bit of edge uh with you know a good really good risk reward position and and in the 80 plus chance that that it's resolved by november you make a lot of money uh and the chance the market goes down is stressful between now and then you're fairly hedged and you can you know you can move things around as necessary and there's a good chance implied volatility will increase regardless during that time in my opinion i can get into why i think that but uh you know really set yourself for a really nice risk reward exactly among other things and then so you get yourself into a nice risk reward position and that's kind of what we set ourselves up to do yeah just to me was i'd never considered right you know everyone knows about the electoral college but i never knew when they actually vote right summer 14th yeah right so now it became like an event absolutely bent risk yep that's exactly right but but again i think you have to realize that a lot of information will you know come out between now and then and look i've been through enough of these events i've been through brexit i've been through you know you know y2k i've been i've been through the in the trump election you know i could go on and on but those those first you know the trump uh that was i don't think nothing burger exactly but that's they almost all are right yeah even the ones that are so you have two kinds of events you have the kind that where nothing really happens right and it's a massive sale that's the easy one right but then you also have the one where the the most unexpected thing happens like the trump election like brexit right those were incredibly unexpected events and they've all resolved in a similar way now there's no guarantee that this will happen but again back to flows and positioning which is what really matters in terms of the probability of outcomes if we get a contested election this point is anybody really going to be surprised yeah no it's becoming the expected outcome yeah correct i mean it's not going to be a huge shock to the system it's not like a black swan that comes out of nowhere right two people are hedged because they're scared that flight ball is high because people are like afraid so what happens when the event happens people along this hedge and then you go down what do they have to do they got to monetize that hedge they got to do it quick right but so what happens in these side of that is like hey we're calling in the tanks to suppress illinois or something right like anything can happen nothing is risk-free i'm not sitting here saying like hey just go sell ball at all events always like you'll you'll be fine don't worry about it like don't worry about the tank right but my point is there are ways to put on good relative value trades yeah relatively game asymmetry broadly those events tend to be overvalued and if you can do it in a way that you know you're relatively protected you're gonna win eight nine out of ten of those and and uh you know that's those when these things come around they're big opportunities uh for people who kind of get what's going on but there's a feedback loop when we talked about vana and charm when you have a really high implied volatility for an event and the event happens regardless of the outcome that ball has to decline like the information is out the thing happened vol declines what happens in baltic lines people are short put dealers are short put long call same thing right well i think every first time option traders experience that right of like buying a call into earnings and it beats earnings and the call price comes down you're like what correct the trump election was a great example market went down five percent overnight right that's kind of the gamma effect right but then all these people who are long ball right market opens they've got to monetize that ball and vaughn got compressed and the second ball comes from like a really high level to a low level all at once the the flood of stock buyback that has to happen in order to kind of monetize this is is huge and so there's a natural underpinning reflexivity that actually tends to make these events you know non-events if it's an expected event it tends not to be an event um and so again you never know i'm not saying like again full disclosure don't don't come sue me if you sell ball i'm not telling you to sell them all right like uh jim said there'd be no tanks so anyway but that's that's the broad concept and and you know so this is working this works for you on lots of different levels it's a really uh kind of um you know cute little training opportunity and then they don't come around that often so when they know and i think it's a good insight into how your brain works and how you structure the trades as well [Music] let's finish up with uh some quickfire questions here you ready yep favorite jam favorite jam strawberry strawberry uh mine as well my sister just got i had to email her the other day i'm like stop she did a homemade jelly of the month thing for last christmas so i've been getting them like every month i'm kind of low carb i'm like stop sending me sugar jellies please so we used to go to turkey every summer my grandmother used to make her own jam she'd sit out in the sun like on the windowsill like five different containers so jam is very dear to my heart all right favorite favorite croissant croissant i didn't know there were different kinds yeah we can get the almond one the chocolate oh oh yeah ham and cheese yeah pawn shook a lot i don't know if you can call that uh but that's all right um favorite city you've lived in it's been a while you guys yeah i mean istanbul istanbul's the coolest coolest city on the planet if you haven't been you gotta go i haven't just the history the the mix of people uh it's it's a crossroads of you know of history and of culture it's amazing yeah all right putting it on the list um fav now you say you're biking as a hobby what what kind of biking road yeah i mean uh i don't want to overstate it like uh you know it's not like i'm out mountain biking every weekend but uh you know i love biking with my kids i like to work every day um it's a good way to kind of get exercise and your own bike is the weather no my own bike my own bike yeah and i you know and i like to kind of haul a little bit you know when i when i'm out there just try and try and beat uh beat all the traffic when you're in so nice watcher nah sure yeah i mean it's not necessarily my uh my first work but i love i love biking in general and definitely uh competitive biking is pretty cool favorite tour de france writer got one lemon greg lamont all right regular mom baby um i would go uh julian ala philippe i can't say lance armstrong anymore i know he was great um what so constantinople istanbul can i call it constantinople sure uh favorite if i go favorite tourist thing to do there uh favorite tourist thing to do um i mean the aya sofia it's it's kind of you can't you can't overstate it it's uh you know it was a a temple then a church than a mosque from a church then a mosque again and the layers of history they just peel away you know the this was created in 400 bc yeah i mean we're talking 2600 years of history and it's still standing it's an amazing structure that's just mind-bending to think of that they built it when they did and that it's still kind of um standing and just just seeing history kind of that whole area uh you know around the the golden horn which is kind of the original um you know constantinople it's just uh you know it's an outdoor museum it's amazing yeah we uh we put that song on the pod once for uh jason buck i think he worked in a istanbul rug market or something and when he started there might be giants right yeah there might be giants maybe we'll throw it in here as well i love that song and last one we asked all our guests favorite star wars character oh uh bubba fat boba fett i love it uh not django boba the original the original yeah he was the coolest at the time i used to have like the millennium falcon i probably had like 200 star wars i was a huge star wars kid oh yeah our uh our guy who does the audio on this pod has a in his work from home when we're on the zoom he's got all his old star wars characters in a frame behind his zoom thing i just it's the best i went to uh prep school and i came home uh one one day like a year in and my mom had donated all my star wars stuff to a friend a friend of the family but like i could never i it was a huge i still don't i still don't really forgive her yeah i had a similar thing happen it's divorce hi jim well thanks so much has been fun um absolutely looking forward to seeing you in person around chicago and we're back back in action we'd love to thanks for having me corona all right take care [Music] you've been listening to the derivative links from this episode will be in the episode description of this channel follow us on twitter at rcm alts and visit our website to read our blog or subscribe to our newsletter at 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Channel: RCM Alternatives

Views: 21,051

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Id: 8awiGrquYXI

Length: 92min 23sec (5543 seconds)

Published: Thu Oct 15 2020