Making Money from Market Chaos | Inside the Volatility World with Kris Sidial

[00:00:00] This is sort of your Super Bowl and everything else in life comes after. So it's like the world is flipped for you, right? You get paid when the world is not getting paid. That's really the whole game. So it's really about the selling risk back to the market when the repricing of risk occurs.

[00:00:17] The big value add in a tail hedge is really being able to remove that tail hedge and buy discounted assets because that's where you get the outperformance over time. Be understanding that anything is possible and be prepared for those type of worst possible outcomes.

[00:00:40] I think when people invest, you should naturally come into investing opportunistically because if you come in pessimistically, you'll just never make money.

[00:00:49] Welcome to Excess Returns, where we focus on what works over the long term in the markets. Join us as we talk about the strategies and tactics that can help you become a better long term investor.

[00:00:59] Jack Forehand is a principal at Validia Capital Management. The opinions expressed in this podcast do not necessarily reflect the opinions of Validia Capital.

[00:01:05] No information on this podcast should be construed as investment advice. Securities discussed in the podcast may be holdings of clients of Validia Capital.

[00:01:12] Hey guys, this is Jack. In this episode of Excess Returns, we talk all things long volatility and tail risk with the Ambers Group founder, Chris Sidial.

[00:01:19] Since this topic is outside my area of expertise, I brought in my good friend and Spot Gamma founder, Brent Kachuba, to help with the discussion.

[00:01:25] We discuss what long volatility strategies do, how they work behind the scenes, and how they fit into investor portfolios.

[00:01:31] We also look at some recent major market events and what went on behind the scenes during it.

[00:01:36] Chris is one of my favorite followers on Twitter because of his in-depth knowledge on volatility and market structure, and that shined through in this interview.

[00:01:41] As always, thank you for listening. Please enjoy this discussion with Chris Sid.

[00:01:45] Chris, thank you very much for joining us.

[00:01:47] Thank you so much for having me. I think we're going to have some fun today.

[00:01:50] We are. And Brent, thank you for helping me so I don't embarrass myself with my lack of knowledge in this area.

[00:01:55] Yeah, I'm on duty here to try to help you, which is, I don't know how much help I'll do, so we'll try.

[00:02:01] I'll lead it.

[00:02:02] So what we're going to talk about today is long volatility strategies and tail risk.

[00:02:06] And this is really an interesting area for me because I don't know a lot about it, but there's so much that goes on behind the scenes that's really interesting.

[00:02:12] So I'm really excited to dig into it.

[00:02:14] So we're going to talk about how these strategies work, what they do, how they might fit in investors' portfolios, and what it's like to run one of these during some of the major events we see.

[00:02:22] And that's where I want to start because I'm a value investor.

[00:02:25] I'm pretty boring.

[00:02:26] We buy stuff.

[00:02:27] We hold it for the long term, not too much excitement.

[00:02:29] It seems like what you do would be the exact opposite of that, especially when we were going through these periods where we got these major market crashes.

[00:02:36] So I was wondering before we start talking about the strategies, if you could just talk about what it's like to run one of these strategies when we're seeing one of these major market meltdowns.

[00:02:43] Yeah, yeah.

[00:02:44] So that's a pretty cool question.

[00:02:47] So one of my mentors back in the day really trained me to think about making money from anomalies.

[00:02:55] And the principle was really make a little bit amount of money when you're in normal markets, but then life-changing amounts of money when you're in abnormal markets.

[00:03:07] So I'm pretty thankful for that because I've done pretty well throughout my career, throughout all those crashes.

[00:03:15] And like take, for example, this year, we're nominated for volatility fund of the year because of the move in August, right?

[00:03:22] So I think my philosophy on trading has really shifted more so towards just how do you make money when vol is going crazy?

[00:03:31] And from a psychological aspect, it's interesting because it's like time slows down.

[00:03:38] Like every single tick feels very important and you could get sucked into those smaller moves that really may not be relevant in the grand scheme of things.

[00:03:50] Simultaneously, you become so emotional because your P&L is swinging at such a rapid rate, right?

[00:03:57] So during those moments, like you have to take a step back.

[00:04:01] Like I think about a year like 2020 or just like the process of that Feb and March.

[00:04:10] And there were moments during that where you wake up and the S&P is up 4%, vols down like five vol points.

[00:04:18] And you're like, ah, okay, it's over, right?

[00:04:20] It's over.

[00:04:21] You become so locked into that.

[00:04:23] Um, so if you don't take a step back from that, you could really miss the bigger picture about what the big dislocation is.

[00:04:30] But at the same time, the paradox is that you have to be so dialed into screens because if you miss any type of news or data, um, it could be completely changing for your P&L.

[00:04:43] So it's like, this is sort of your Super Bowl and everything else in life comes after.

[00:04:49] So it's like the world is flipped for you, right?

[00:04:52] You get paid when the world is not getting paid.

[00:04:55] So your social world is different.

[00:04:57] The way you're thinking is different, right?

[00:04:59] Your time constraints are different.

[00:05:01] Everything is different.

[00:05:02] So it's like, we're the, we're the complete odd guys in the room.

[00:05:06] That's what I would say.

[00:05:07] Yeah.

[00:05:07] And it's interesting because in a lot of ways, when the world's at its absolute worst, you have to be at your absolute best.

[00:05:12] So it's kind of the opposite of like those of us that are running like long value funds or something like that.

[00:05:16] It's the opposite.

[00:05:16] Like that's the most important time probably, I would guess.

[00:05:19] And you can correct me if I'm wrong.

[00:05:20] But like the most important time for you to be at your absolute best is when things are melting down around you in the world.

[00:05:25] Yeah.

[00:05:26] Yeah, totally.

[00:05:26] Which, which is again, like the psychological paradox, right?

[00:05:30] Because like everybody's panicking and you have to be very level-headed and very locked into screens and focused.

[00:05:37] And dinners look different.

[00:05:40] Breakfastes look different.

[00:05:41] Your body feels different.

[00:05:43] You're so zoned in.

[00:05:44] Like, yeah, I'm even thinking of back to like this past August when we had that, you know, four day stint where Vol was actually moving.

[00:05:52] Like all the team members were logged in like 24 seven.

[00:05:55] We were taking like bathroom breaks, you know, like guys switching on and up.

[00:05:59] So it's funny, but like I said, it's sort of like your Super Bowl.

[00:06:02] You know, you have to work during that time period.

[00:06:05] I'm just curious because this is something a lot of investors deal with is this idea of how to manage their emotions during the most stressful times.

[00:06:12] I mean, do you have like, do you have a plan going into that like in advance?

[00:06:15] So you kind of have a general idea what you might do or is it so dynamic?

[00:06:18] It's moving so fast that you really can't have a plan and you have to just adapt as it goes.

[00:06:22] No, you really do.

[00:06:24] We need to have a plan.

[00:06:24] I think that that was something like my old mentor taught me back in the day.

[00:06:29] It's sort of modeling out what your book would look like consistently.

[00:06:33] So internally, we run something called Shocks and Slides.

[00:06:36] And all it is is like a hypothetical saying, okay, if the S&P drops 5%, vols move up 10 vol points.

[00:06:42] What does this look like for your book, right?

[00:06:44] What does your delta look like?

[00:06:45] What does your vega look like?

[00:06:46] What does your gamma exposure look like?

[00:06:48] And you could have sort of like a shadow view there.

[00:06:50] And then the plan comes into play where you're like, okay, how much should I be thinking about taking off here?

[00:06:56] What does the world look like?

[00:06:58] Is there a reason why this is becoming super dislocated?

[00:07:01] So it's like a mix of like a quantitative framework, but also a discretionary framework.

[00:07:05] Because in the moment of all those things going on, like you have to be plugged in with certain like agency guys and certain brokers that are, you know, on the pit that are saying, hey, there's a million bucks of vega to buy at the close.

[00:07:19] You know, that's going to impact obviously our P&L, good or bad.

[00:07:23] So it's sort of like a balance where you have to have a plan, but then also be able to deviate slightly from the plan when, you know, the dislocations are occurring in a big way.

[00:07:34] I want to take a step back and just talk about these types of funds in general, because many of our audience may not be totally familiar with them.

[00:07:39] Can you talk generally like what is the goal of a tail risk or a long vol type fund?

[00:07:45] Yeah.

[00:07:45] So I think it could be summed up in a simple way.

[00:07:48] Some people like to make it more complex than it is.

[00:07:52] But I think it's like your goal is to generate these type of explosive returns when markets are crashing.

[00:07:59] Right.

[00:07:59] Usually you have that one mandate and then minimize the bleed in an uncorrelated way that that that doesn't compromise the mandate when markets are not crashing.

[00:08:09] Right.

[00:08:09] So it's almost like you make money during market crashes and don't lose a lot of money during normal markets.

[00:08:16] But I think where our philosophy differs is that most people think about tail risk hedging as like a defensive thing.

[00:08:24] They strictly think about it like, OK, I'm going to put this in my portfolio.

[00:08:28] I'm going to put like two to five percent.

[00:08:30] And when markets go down and the majority of my portfolio loses money, this thing appreciates it offsets the losses and it's strictly defensive.

[00:08:38] Whereas I think a good piece of our investor base comes in to opportunistically think about vol.

[00:08:46] So if you think about something like VIX over the last three decades, right, you've had VIX going over 40, 11 times.

[00:08:55] And when you think about that in a generalized sense, you're like, OK, so there's 11 moments where you could make outsized returns.

[00:09:01] So I think we and our investor base thinks about it from actually profiting from the crashes, not just protecting against them from a defensive stance.

[00:09:11] And what are the what are the types of products these funds?

[00:09:14] I mean, I assume they primarily would use like option type products.

[00:09:16] But what are the types of products like in general that a tail risk type fund would invest in?

[00:09:20] Yeah.

[00:09:21] So, I mean, there's tons of things, right?

[00:09:23] Like for what we do, we just focus on vanilla listed equity derivatives.

[00:09:29] But you could go as far as thinking about like variant swaps, CDX stuff, interest rate swaps.

[00:09:35] Like you could get all sorts of creative.

[00:09:37] You could get very creative with this type of stuff.

[00:09:39] But I think for us, like the biggest principle.

[00:09:43] And I think that this is such a widely misunderstood principle, even from the large allocator space.

[00:09:49] Like sometimes we speak with pensions and endowments that even their like advisors are non-understanding of this simple principle.

[00:09:57] It's just you're trying to make money from the repricing of risk.

[00:10:00] So we get asked from people sometimes, well, how far out of the money should I buy this option?

[00:10:06] Right.

[00:10:06] Like like how deep should I buy this option?

[00:10:08] Like where?

[00:10:09] What's the delta that I should buy?

[00:10:11] And we have to explain to them like it has nothing to do with the option going into the money.

[00:10:18] It's about the repricing of risk that you get when vol is exploding.

[00:10:22] So what I mean by this is you could say maybe we're buying a 50% out of the money S&P put.

[00:10:29] So it's like a 0.005 delta S&P put.

[00:10:32] So now the S&P drops 20% in three weeks.

[00:10:38] The price of that option is going to be massive, right?

[00:10:41] Like so so you don't need to make money from the option going into the money, right?

[00:10:47] It's about when margin requirements are increasing, when people are scrambling for hedges.

[00:10:52] You are getting to sell that option back to the market at an extreme premium, whereas you bought it at an extreme discount.

[00:11:00] That's really the whole game.

[00:11:01] So it's really about the selling risk back to the market when the repricing of risk occurs.

[00:11:08] So you may not be able to answer this completely because I know everybody has their own secret sauce in here.

[00:11:11] But I'm just wondering, you mentioned before limiting the bleed is a really important thing.

[00:11:14] You want to have these convex payoffs when things go south, but you also want to limit the losses in between.

[00:11:20] Like how in general would a tail risk fund think about that problem?

[00:11:23] What might they be doing at a high level to do that?

[00:11:26] Yeah.

[00:11:27] Yeah.

[00:11:27] So we come from like the world of prop trading.

[00:11:31] And in that world, carry neutral tail risk hedging is not a novel idea.

[00:11:38] So if you think, right, stylistically, there are many traders on those type of desks that run a flat carry long vol book.

[00:11:47] And you can think about shops like Group One, Gelber, CTC, Peak Six, all of those.

[00:11:52] Right.

[00:11:52] And the idea is to trade around stuff with edge to make a little bit of money and then buy tails to have these type of explosive returns.

[00:12:01] The interesting thing, though, is that in the hedge fund space, this idea was novel.

[00:12:08] So coming from the prop side, we said, hey, it's interesting that this really doesn't exist in the hedge fund space.

[00:12:14] And we could bring that model over to the hedge fund space.

[00:12:18] So, so far, we've been very successful in doing so.

[00:12:21] So, but it's fascinating that most people traditionally think about tail risk hedging in the form where they just say, we're just going to go buy options and bleed and just do it over and over and over.

[00:12:32] And that's sort of the widely accepted approach to doing it.

[00:12:35] But I think for us, the fascinating part is, well, over the last five years, and Brett could speak to this quite well, better than anybody else too.

[00:12:47] The derivatives market has exploded in size across single stocks, across index vol, all of that.

[00:12:54] And what it has led to is this concentration of more price insensitive end users coming into the market.

[00:13:02] And what that has done is pretty much opened up opportunities for these short-term edges to exist.

[00:13:10] So if you think about short-term intraday trading today and the opportunity set versus 1995, it's like night and day.

[00:13:19] There's like so many opportunities to make money from those short-term edges.

[00:13:22] So for us, the way how we think about it is like, we have a few pillars that we build our book on, which is whatever we're doing to minimize the bleed, it needs to be uncorrelated from equity vol.

[00:13:39] It needs to have edge.

[00:13:41] It needs to have a form of capped risk.

[00:13:45] And mainly ran intraday so that it has higher turnover and you could control the variance better.

[00:13:50] And I think when you bring those pillars together, you have something that can offset the carry in a more effective way.

[00:13:59] Again, I'm sure there's prop guys that are listening to this that are like, ah, yeah, genius.

[00:14:04] Everybody does that.

[00:14:05] But again, on the hedge fund side, that's like not a commonality at all.

[00:14:11] So I think that's the differentiating thing.

[00:14:13] On the hedge fund side, you see tail risk products that just buy options, roll them.

[00:14:17] They accept the fact that there's a bleed.

[00:14:20] Whereas on the prop side, you have guys that will stylistically run a flat carry long vol book.

[00:14:24] So you obviously really succeed most in tail events.

[00:14:29] So like August was great for you guys, as you mentioned.

[00:14:32] How long does the average investor wait for without a vol event where they start getting kind of itchy and say, hey, you know, this carry has been great,

[00:14:40] but I'm sort of underperforming and, you know, people aren't patient these days.

[00:14:44] So do you think, hey, I need a vol event every six months or year or what, what, what kind of you start getting itchy for like a volatility event before?

[00:14:54] Yeah.

[00:14:55] Yeah.

[00:14:55] So I feel like we're probably a very bad litmus test for this because our investor base is pretty unique and sticky.

[00:15:03] Like we, I don't think we've had any issues with investors like cycling in and out of the stuff.

[00:15:08] Um, but I could say that just by tracking.

[00:15:12] So, so one thing that we do is we track a lot of the performance inflows, outflows, um, of shore vol funds, long vol funds, all this, because it paints a big picture of like what the ecosystem really looks like.

[00:15:26] And I would say that like after 2022, you had a complete obliteration of tail risk and long vol funds.

[00:15:34] Like they've shut down, you've had massive AUM pulls, um, the space has shrunk like tremendously.

[00:15:41] So I would say that on average, it's like, if you're not bleeding out, you know, investors could probably stick around for a year or two.

[00:15:49] But like when you're, when you have this type of extreme bleed, it's tough for investors to stick around.

[00:15:55] And some people will counter this.

[00:15:56] Some people will say, well, Chris, um, that's not true because when we're investing in a tail risk fund, we know what the allocation is going to be.

[00:16:06] We're comfortable with losing the money.

[00:16:08] Like that's okay.

[00:16:10] We've, we've, we've planned this out, right?

[00:16:12] We're okay with losing 3% over three years, but it's not true because hedging fatigue is a real thing.

[00:16:18] And I bring up the situation with CalPERS because like CalPERS had invested in, I'm not going to say the name, but a very famous tail risk fund, like six years before 2020.

[00:16:31] And the board knew exactly what they were doing.

[00:16:33] The manager followed the, the, the mandate down to a T.

[00:16:37] Um, but two months before one of the largest crashes in history, which was March, 2020, they pulled the allocation.

[00:16:43] CalPERS exited the allocation.

[00:16:44] This is public information, by the way.

[00:16:46] Um, and you say, well, why would they do that?

[00:16:49] Like why in the world would they pull it right before the crash?

[00:16:52] You know, just because hedging fatigue is a real thing.

[00:16:55] When you look at your statements every few months and you see, ah, down again, down 50 basis points, down a percent, down 2%, down 3%, right?

[00:17:02] Like investors just say, okay, we, we can't take this anymore.

[00:17:07] And when you're losing in other areas of your portfolio, the first thing that goes is the fixed costs, which again, tail risk hedging could be the fixed costs.

[00:17:15] Right.

[00:17:16] Do you think that a lot of the drawdown in long vol AUM was in 22 was just because it didn't perform like we would expect it to, or it was just that hedging fatigue?

[00:17:25] So, you know, it's kind of a, there's a difference there, I guess.

[00:17:29] Yeah.

[00:17:29] Yeah.

[00:17:29] So I think 2023 was like the, the hedging fatigue, but I think 2022 was definitely the underperformance of long vol because that move was so well telegraphed.

[00:17:40] And I know it's easy to say that in hindsight, um, but like in 2021, you have to think that the fed was signaling about, uh, hiking rates, hiking rates, hiking rates.

[00:17:48] And then people were repositioning, reallocating.

[00:17:51] And then, yeah, because the move was so telegraphed vol just never, you know, people weren't caught off sides and vol never really performed.

[00:17:58] But I would say 2022 was due to the under performance.

[00:18:02] 2023 was like hedging fatigue where you see an obliteration in the space.

[00:18:06] Yeah.

[00:18:06] So, so like it didn't work and then, then even after it didn't work, it just never paid off.

[00:18:11] It's just kind of diffed.

[00:18:12] Yeah.

[00:18:13] Yeah.

[00:18:13] Yeah.

[00:18:13] It's interesting on the CalPERS thing.

[00:18:15] Like this is something I say to our individual investor clients all the time is like institutions aren't immune to the same things.

[00:18:19] You're you have the same problems you have, you know what I mean?

[00:18:22] You institutions, when things aren't working, like they don't realize, you know, they have this whole idea of line item risk.

[00:18:27] They look at that one line item, even though their portfolio is doing really well.

[00:18:29] And they say, well, that's underperforming.

[00:18:31] Let's get rid of it.

[00:18:32] You know, individuals and institutions really do the same things.

[00:18:34] Yeah, absolutely.

[00:18:35] I mean, you, you would be surprised.

[00:18:38] Oh, I mean, you guys know, but I'm talking to the viewer.

[00:18:42] Like the viewer would be surprised that sometimes you sit in some of these meetings and you talk to some of these very large institutions and you're like, yeah, they're not sophisticated at all.

[00:18:51] Right.

[00:18:51] And they spend a lot of money on, on their analyst team and whatnot.

[00:18:55] But it's kind of, and I learned this like three years into running, you know, our, our firm was that it's kind of like, it should be unexpected that they don't know every asset of every, you know, every niche esoteric asset class.

[00:19:12] Um, so that was sort of my, uh, bad expectation was thinking that people would know all about this.

[00:19:18] Whereas like, that's actually not true.

[00:19:20] And I think too, like the Holy Grail investing is like this linear payoff that has no deviation to it, you know?

[00:19:26] And, uh, and I know we talked to a lot of retail traders on a daily basis and they all want to sell, you know, put spreads or sell call spreads because I make money, you know, nine out of 10 times.

[00:19:35] And, and I think that's the general mentality of people.

[00:19:38] And so saying, Hey, we're going to sit here dormant for possibly a year, but when we get paid, we're going to get paid.

[00:19:43] And then they're very hard for people to, to wait for that, you know, that point in the future.

[00:19:48] So it's an interesting sales process you have to go through for that.

[00:19:52] Yeah.

[00:19:52] Yeah, totally.

[00:19:54] Um, um, it's, it's been interesting to see like a lot of the hedge fund strategies that are out there have slowly been making their way like in the ETF space.

[00:20:00] And I'm just wondering, like, do you think long-term the type of thing you do could exist in the ETF?

[00:20:05] I mean, there are some tail risk ETFs, but they're just rolling puts and doing some of the things you talked about before.

[00:20:09] Like, is this something that could someday be an ETF that your average investor can invest in?

[00:20:14] Or is this something that's just not really a fit for that type of product?

[00:20:17] No, unfortunately it's, uh, it's just not available to, to be in an ETF structure.

[00:20:22] Um, and I also, you know, we tell this to people all the time.

[00:20:26] Like, I think one of the reasons why we've been able to be successful at what we do is because a big focal, a big focus point for the, for the team are these capacity constraint edges.

[00:20:37] So like, you know, there's, there's good amounts of alpha in these capacity constraint edges that most larger market participants wouldn't care to participate in.

[00:20:46] So we know that, you know, we're, we won't be the $10 billion powerhouse, uh, in the space, but, you know, can we be a smaller and efficient participant in the space?

[00:20:58] We think that that's really where our niche is.

[00:21:00] So yeah, unfortunately ETFs, not, not really in our, uh, in our future.

[00:21:06] On that, on that point, um, the, the growth of these ETFs, particularly derivative based ETFs, uh, you know, obviously they're growing like wildfire.

[00:21:15] And can you talk for a second about any distortions that you see in the options or, you know, volatility surface or whatever it may be from a, from big funds?

[00:21:24] Do you, do you see things that you could take advantage of as, as a, as a manager?

[00:21:28] Sure.

[00:21:29] Yeah.

[00:21:30] So, I mean, I think everybody knows about like the JP Morgan collar and, you know, all these types of programs.

[00:21:34] I think that, uh, the market makers that have been handling some of these orders are starting to become a little more creative with how they're like pre hedging or pre planning for this type of stuff.

[00:21:46] So like, you know, whatever two, three years ago, um, or let's say two years ago, it was easier to spot that flow because the market makers would put it up.

[00:21:55] You know, like five, 10 minutes and then hedge, hedge off the risk.

[00:21:58] Whereas like now you're having this like slower process where they're hedging off the risk one week in advance.

[00:22:05] Right.

[00:22:05] And you're taking a little more directionality in terms of where they believe that that risk is going to lie.

[00:22:10] So it's like with everything in markets, you know, when something happens and everybody catches on, then it like adapts and becomes much more dynamic.

[00:22:18] But I still think that the opportunity set across, you know, just being able to trade in a short term fashion for these like price insensitive flows, like example, like those large ETFs that do those, those dogmatic processes.

[00:22:32] I still think that the opportunity set is really great.

[00:22:35] Like you just have to be creative with, with how you think about going about with it.

[00:22:39] And I'm sure you get asked a lot about, from people about how this type of strategy might fit like in an overall portfolio.

[00:22:45] How, how do you explain that?

[00:22:47] Yeah.

[00:22:48] So for, for us, I think it's more so about taking a small piece of your portfolio and allocating it to, to something like this, which is, you know, a tail risk edge.

[00:23:01] And generally what we, what we discuss internally is about a 5% piece of an individual's portfolio.

[00:23:09] And this kind of goes back to like tail risk hedging principles 101, where it's like portfolio, the overall portfolio loses money.

[00:23:18] You know, your tail hedge makes money and it offsets the losses.

[00:23:20] But I think where we go a step further, sort of like what I mentioned before is that our investigation and us personally, we like to actually make money from those crashes.

[00:23:32] So not just offset that, but like outperform during those moments, because the big value add in a tail hedge is really being able to remove that tail hedge and buy discounted assets.

[00:23:46] Because that's where you get the outperformance over time, right?

[00:23:50] So, so Jack, you as a value investor, like this is the part of tail risk hedging that you would appreciate.

[00:23:55] And you and I will definitely see eye to eye on it's like when things are down tremendously, stocks are down 30, 40%.

[00:24:03] And you've made a bunch of money on, on this tail hedge, you rebalance the tail hedge and buy those discounted assets.

[00:24:10] And then over a 10 year or five year market cycle, you look back at your portfolio and like, wow, the portfolio is outperformed just, you know, buy and hold.

[00:24:18] Why is that?

[00:24:19] And it's because you were able to buy, you had the capital to deploy when everybody else did not have the capital to deploy and were forced to sell.

[00:24:30] It's interesting because this is always the example I give people when they, when we talk about the benefits of rebalancing in a portfolio, because when you, when you want to talk about that, you want to give like the most extreme example.

[00:24:37] So I always give the example of, let's say there was a theoretical tail risk fund that had a long-term return of zero and you add a 60, 40 portfolio that has a return of seven.

[00:24:46] That tail risk fund can a hundred percent make that 7% return higher.

[00:24:50] If you were rebalancing into the assets that are down when it's paying off.

[00:24:53] And like, people don't get that.

[00:24:55] They don't understand like, wait, this fund could have a lower return than my portfolio, but could actually add to my long-term returns.

[00:24:59] But I think this is a great example of that concept.

[00:25:02] Yeah, a hundred percent.

[00:25:03] So that, that's usually, that's like the value add that we try to bring to, to people.

[00:25:08] And then, I mean, you still have some folks that are like, oh, well, that's, that's not true.

[00:25:12] That, that could never exist.

[00:25:13] Right.

[00:25:14] There's no way you could have like, you know, free tail risk hedging.

[00:25:17] Like the world would, would not work that way.

[00:25:19] Like, and I, and I get where they're coming from, but like, it's almost like you going to those institutions that have been, you know, Chicago derivative prop firms for 19, 20 years and being like, oh, all your P&L is fake.

[00:25:31] Like that's, there's no way you could outperform the market.

[00:25:33] There's, that's absolutely not true.

[00:25:35] Right.

[00:25:35] It's like, it's kind of audacious to say that.

[00:25:37] So, but, but that's exactly what you said is like what our value add proposition is, is trying to be able to deliver this more cost efficient way of hedging against those type of extreme events.

[00:25:52] And then allowing, you know, investors to be able to deploy that capital so that they can outperform over that, that horizon.

[00:25:58] So we're recording this on Tuesday the 5th.

[00:26:01] So we won't know until at best tomorrow.

[00:26:04] Jack is a cup, glass half full kind of guy.

[00:26:07] So he thinks we're going to know who the president elect is tomorrow.

[00:26:10] I think it may take a couple of days till, till we get there.

[00:26:14] Obviously we have just to set the stage, the VIX is, as we speak, is at 20.

[00:26:19] Market is rallying a little bit today.

[00:26:21] But if you read some of what some strategies are saying, they feel like there's this idea that if the election goes off without a hitch, then we have the FOMC and the FOMC is kind of benign.

[00:26:31] Then that could lead to something of a volatility crush and the market can sort of rally.

[00:26:36] How do you think, Chris, about that positioning?

[00:26:39] Do you adjust for times where you think the market may rally or is it more about limiting your carry costs into these events?

[00:26:46] And also, as you just talked to us generally about how you think about hedging tails into a known event like this.

[00:26:52] Yeah.

[00:26:53] So for what we do, it's all process driven.

[00:26:57] So it's like being very disciplined and process driven, doing the same thing over and over.

[00:27:02] So we don't change anything that we do, whether it's election, FOMC meeting, like nothing changes at all.

[00:27:10] Because you have to operate under the view that anything can happen.

[00:27:14] So like we have to operate with the view that, OK, tomorrow the S&P could be down 20 percent.

[00:27:18] There's no way we could not have a large return during that.

[00:27:22] Right.

[00:27:23] Because then we'd just be out of business.

[00:27:24] Yeah.

[00:27:24] So so when you're operating with with that few, your positions generally, you know, look, look the same.

[00:27:33] So never really changing anything on that front.

[00:27:35] But I think what's interesting about this election cycle is really the fact that after the August move, you started to see.

[00:27:46] So so what happened in August?

[00:27:47] Obviously, you guys know vol went up.

[00:27:49] Right.

[00:27:49] And you had actually some more short vol exposure actually come back in.

[00:27:52] But then what ended up happening was that that short vol exposure dissipated over that eight week time frame to till today.

[00:28:02] Right.

[00:28:03] So so what you've seen is this rotation of hands where a lot of the positioning seems to be leaned towards more of a long vol positioning.

[00:28:13] And I think that it's because it was so telegraphed that we're going into such a crucial time period, similar to what we were talking about with 2022, where, you know, Fed hiking rates was was well telegraphed.

[00:28:27] The election was well telegraphed and that positioning churned.

[00:28:29] So short vol has sort of churned out.

[00:28:33] All right.

[00:28:34] And vol has remained stickier because there's been more active buying there.

[00:28:38] And now you have a lot of heavy positioning that's long vol.

[00:28:42] And you could look at like like VIX futures reports and stuff like that.

[00:28:48] And you could see that some of the speculative positioning is historically way more on the long vol side.

[00:28:54] So I it kind of I know the like the status quo or like the the bet that everybody's on is that vol is going to get crushed post the election.

[00:29:07] And I know that sometimes it feels cool taking the other side of that or being like, ah, that's not going to happen.

[00:29:13] But for for like, you know, everybody loves fading the consensus bet, you know, but but this is one of those cases where it's like the consensus bet might just really hit because positioning is just super, super extreme on that side.

[00:29:26] So. So so when you think about that, we talk about tail risk hedging, you know, we're mostly thinking about, OK, market is having a big drawdown and and, you know, VIX is is going to 50.

[00:29:37] Do you ever look at sort of the opposite tail, the right tail and say in this situation, if we do get this long, we have this long ball position and in the market here and that could actually lead to a substantial rally.

[00:29:49] Is there ever a situation where you guys are looking at trying to sort of monetize the right tail instead of the left tail?

[00:29:54] I think that just becomes a byproduct of like some of the Delta that we hedge off.

[00:29:59] So, like, you know, if you're hedging off Deltas, you could get creative with like how you hedge off that slide risk.

[00:30:04] You could say, OK, instead of, you know, buying S&P futures or something directly, you could say, OK, let's buy some.

[00:30:11] Let's buy one third of it in S&P futures.

[00:30:14] Let's buy one third of it in in 25 Delta S&P calls and then let's buy the other third in like 10 Delta S&P calls.

[00:30:22] So our convexity profile picks up as the market goes that way.

[00:30:25] So you could be more creative with how you hedge off that slide risk as the market moves to the upside.

[00:30:31] But it's just a function of hedging off Deltas pretty much.

[00:30:34] You mentioned August Fit.

[00:30:35] Can you talk a little bit more about that?

[00:30:36] Because for someone like me who's outside of your space, it was a really weird day because we saw I mean, the S&P was down and I think like 2 percent or something like that.

[00:30:43] But the VIX move was way bigger than you would have expected for the S&P down 2 percent.

[00:30:47] So what were you seeing behind the scenes in terms of I mean, did the VIX really hit 60?

[00:30:51] Was it some sort of mathematical thing?

[00:30:53] Like what were you seeing behind the scenes that day?

[00:30:55] Yeah. Yeah. So I could add some color on that.

[00:30:57] So so one thing that I'll point to is in I think 2022, we wrote this paper that's called Is the VIX Becoming More Leptocurtic?

[00:31:05] Simply stating that we thought that the relationship between the S&P and the VIX would showcase more extremity in both directions.

[00:31:15] And what that means is that if I'm just using some hyperbole here, if the S&P drops 1 percent, maybe the VIX goes up 10 vol points instead of one.

[00:31:23] Or if the S&P goes up 1 percent, maybe the VIX goes down 10 vol points instead of one.

[00:31:29] Right. So just thinking about the extremity and the relationship with that.

[00:31:33] And it was kind of refreshing to get to see that that that thesis come to fruition during that day.

[00:31:39] But exactly what transpired was you obviously had this situation going on in Asia with the yen.

[00:31:46] And there were some Asian participants that could not get out of the risk entirely in that market.

[00:31:54] And what they started to do Sunday night was pile into anywhere that they could find hedging risk.

[00:32:02] So there's been a new phenomenon that went on is that SPX options are now traded overnight, you know, whereas historically that was not the case.

[00:32:12] So you have just a few market makers that trade in the overnight session.

[00:32:17] And we know this because we actually know the firm that's like the predominant market maker in the overnight SPX session.

[00:32:23] So when that big Asian participants started coming in to try to find those hedges in the overnight SPX market, the market makers really stepped away and the spreads got really, really wide.

[00:32:38] Now, where this affects VIX is that VIX is calculated over the bid as spread on a 15 second rolling interval of the SPX options.

[00:32:51] So when those when the Asian participant was coming in, coming in and the SPX market maker was widening, widening, widening.

[00:32:58] This now led to this, let's call it artificial VIX number that started to come out, which is why when the futures market started going and Monday morning, you saw the futures and VIX moving up.

[00:33:15] The futures found a ceiling, but VIX kept recalcing higher and higher and higher.

[00:33:20] So the futures only got to the high 30s and then VIX started pricing into the 50s and then 60s.

[00:33:26] So that was like a huge, like mechanical error.

[00:33:31] When the market opened up, it was like a storm on top of a storm because CBO had a data error where guys on the pit would not trade.

[00:33:41] So like I remember this, we were calling guys on the floor.

[00:33:44] We're like, hey, you know, what's the market on this?

[00:33:47] And like no market for like seven minutes.

[00:33:50] Right.

[00:33:50] So they're going in and out, in and out.

[00:33:51] And you could pull up a chart of VIX that day.

[00:33:55] If you pull up like a one, like a one minute tick chart of VIX that day, you'll see it looks spotty because of that, that data dissemination error.

[00:34:03] So when everything finally started getting working, like 15 minutes in VIX calc somewhere in the 40s, which was much more of the, the, the appropriate calc when things settled down.

[00:34:15] So long story short, yeah, VIX on your chart, it may show that it went to 60, but it was really a mechanical error.

[00:34:24] It wasn't a real 60 print.

[00:34:26] I was listening to a, uh, uh, interview with another vol fund who didn't, who, who anticipated doing very well in an event where, so let's say VIX goes over 40 or 50.

[00:34:37] Uh, and they didn't, and they alluded to the fact that the volatility surface seems to be sort of, I guess, shifting in different ways than it used to.

[00:34:46] Uh, maybe off other back tests from prior, prior events, for example.

[00:34:50] Um, and they alluded to the fact or the idea that, you know, there's the zero DTE is such a large component of flow and that may be shifting the way that, that sort of volatility reacts.

[00:35:02] It, can you kind of comment on that idea?

[00:35:04] Is it something that you agree with that, you know, with the kind of growth of derivatives and particularly short dated options that, that the volatility surface maybe reacts in different ways?

[00:35:13] Or is that not really something you see?

[00:35:15] I think it's, uh, yeah.

[00:35:18] So, so I would say yes and no, this is a tough question to answer.

[00:35:21] Yes.

[00:35:21] Because on days where you're certain, where you're seeing certain events, um, more vol centric funds are using zero DTE stuff to hedge off their gamma risk.

[00:35:33] And you're seeing that from the dealer community too.

[00:35:36] So like something like FOMC where that flow would usually go to like a, like something like a, let's say a three week option.

[00:35:43] It's now going into the zero DTEs.

[00:35:46] So, so vol centric shops are using that flow to hedge off their, their gamma profile significantly better.

[00:35:52] Where, where I don't think that it's really changed the bowl surface too much is that if you're a $10 billion institution and there's a nuclear bomb that goes off in the next five minutes, you're not going to hedge your, your book with zero DTE, right?

[00:36:09] You're going to use like a one month strip of options or, you know, two, three months or, or something like that.

[00:36:13] So that, um, that focus in that area and that tenor will always be there.

[00:36:21] And that's why if you look at the volume in SPX 30 day weighted options, it's never fell off, right?

[00:36:29] Like it's actually increased in size.

[00:36:31] So, so the theory is that, well, people are going to use zero DTEs to hedge more than social VIX is not going to be reactive.

[00:36:38] But if that was the case, then the 30 day SPX strip would, would have lost its volume.

[00:36:43] It's only increased its volume.

[00:36:45] So I would say that, I mean, the zero DTE market is a humongous beast and it's evolving like every single day, like literally every few weeks, there's a new player coming in.

[00:36:57] You know, the, the ecosystem looks different, um, positioning switches quite fast.

[00:37:03] So it's really an evolving beast.

[00:37:05] I want to ask again about, about August 5th.

[00:37:07] Um, one of the things you alluded to is in certain areas, there weren't bids at least for a period of time.

[00:37:11] And that gives us something, a lot of the more bearish people in the market talk about all the time, which is this idea that beneath the surface in the market, there really is no liquidity.

[00:37:18] And so when we get some sort of major event, like it's going to be a lot worse because that liquidity that's always been there is not there.

[00:37:24] And I'm just wondering, since you're behind the scenes and you see this all the time, do you think that's an accurate thing or do you think that's really not true?

[00:37:29] So about four years ago, if you asked me, I was on the camp that yes, market makers would pull, um, they'd pull their quotes.

[00:37:41] And because that, because the market maker community has become so much more concentrated than, you know, 20 years ago, think about it.

[00:37:48] 20 years ago, you had like 30 different groups making markets.

[00:37:51] Whereas like now it's like 10 main people control markets and index fall, which is insane.

[00:37:56] That's like really, really insane to think.

[00:37:58] Um, so I would have leaned in the fact that yes, people would step away from their quotes and like, there is not real liquidity there.

[00:38:05] And then I would say two years ago, I switched.

[00:38:08] I was like, no, you know, I think the liquidity is there.

[00:38:10] The balance sheets are there.

[00:38:12] I think some of the regulatory things have made it so that the liquidity provisions need to be there.

[00:38:17] And then what we saw in August made me switch back.

[00:38:20] So like, so, so, so I've been, yeah, I've been playing hopscotch with that, with that whole thing.

[00:38:26] But now I'm back on the side where like, no, hold on the, there is this like shadow liquidity that, that does exist because, um, if, if the liquidity really was there, you wouldn't have had what happened over that three day frame.

[00:38:42] Like you got to see in live, like a pure live time, what it looked like when market makers didn't know where the flow was coming from, couldn't understand the flow and backed away from the flow.

[00:38:54] And that's why you got the VIX count error.

[00:38:58] And there's this, this idea that there's this short, and it's probably true, but there's this massive short volatility trade out there.

[00:39:03] And I'm wondering, did, first of all, do you, is that true that like relative to history, there is a really massive short volatility trade right now?

[00:39:08] And second of all, did August 5th clean that out at all, or did they just start shorting volatility or right the next day?

[00:39:14] Yeah.

[00:39:15] So, um, I was definitely one of the people that was, was pushing the fact that the short vol trade was really growing in size, like earlier last year, where we looked at, we model out sort of like the Vega notional that we believed was put up from short vol trades.

[00:39:30] And then there's like other ways to do this too.

[00:39:32] I tell this to people that like, you could just have a simple understanding of who are the main short vol hedge funds and look at their AUM growth.

[00:39:40] And that will tell you like everything you need to know.

[00:39:42] You don't need to like get super fancy with this type of stuff.

[00:39:45] So we're certainly on the side that that short vol trade has become massive.

[00:39:50] And during the move in August, what really shocked us was that people doubled down, not in exact Vega notional terms, but like the short vol trade didn't get taken out at all during that August.

[00:40:06] Um, and you saw it in the, the, the weeks after when you looked at some of the numbers.

[00:40:10] So you could have looked at like some of the short vol hedge funds and their AUM inflows versus outflows and the performance.

[00:40:18] Nobody really got carted out.

[00:40:20] I think there were like three or four funds that did really bad.

[00:40:24] One fund, uh, shut down and opened another fund because they had such a good investor base.

[00:40:29] So like there wasn't this massive catastrophe that, that took place and they really survived.

[00:40:36] Now the irony to that is that that short vol exposure has come down, but it's not because of the move in August.

[00:40:44] It's because of the election vol thing.

[00:40:47] So people were like cycling out of that vol exposure.

[00:40:50] So that short vol has come down where I'm curious to see is five weeks from today.

[00:40:58] Are all those participants just going to come right back in and, and, and understanding where that exposure was.

[00:41:04] So if I have to like draw like a line graph, I would say this is where we were, you know, before August and then August comes and we're still sort of there.

[00:41:14] And then the weeks coming, we're doing this, we're going down, down, down.

[00:41:17] So now once we pass the election, I want to see, are we going to get right back to that?

[00:41:21] Are we going to be more at these lower levels?

[00:41:23] But the summary is August 5th really didn't wipe out short vol sellers.

[00:41:29] Behind the scenes, do you see like when a trade like that, because one of the things I noticed about the short vol trade is I think back to 2017 and volatility was so low and everybody was saying, no, it can't go any longer.

[00:41:38] And then it went longer and then it went longer and then it went longer.

[00:41:40] And then we had XIV.

[00:41:42] Like, do you see behind the scenes, the signs of something like that about to break when it breaks?

[00:41:46] Are you able to, to some degree, see it coming?

[00:41:49] Or is it really something that often comes out of nowhere?

[00:41:52] Yeah, I would say it kind of comes out, like you have the signs that are there.

[00:41:56] And like, I would say that prior to this like election thing, like what I was just mentioning, the signs are still there that like there's a lot of short vol exposure out there.

[00:42:05] The difference in today's environment versus that environment was that it was easy to see that in the, like the 2017 market, because you could just see the AUM of those ETPs.

[00:42:20] And then you could see in the VIX futures market, right?

[00:42:23] The reportable numbers and open interest and whatnot.

[00:42:25] So it was very easily identifiable.

[00:42:28] Whereas today that Vega has just transferred into the SPX market.

[00:42:33] And like sort of what Brent was talking about with the zero DT stuff, the zero DT options don't have much, you know, Vega to them.

[00:42:41] Um, but people use them as a form of selling, you know, income generating streams or things like that.

[00:42:47] So because the SPX market is just such a ginormous beast, it's not easy to spot that flow anymore.

[00:42:56] Whereas like the ETPs previously were.

[00:42:58] So, yeah, I mean, it's, uh, the conditions are, are, or let's say a few weeks ago, we're certainly still there, but you could never have that certainty.

[00:43:10] It's almost like, it's like conditional probability where all these things could line up and it could be the perfect storm.

[00:43:16] But like, if nothing, like if the match doesn't get lit, then nothing's going to happen.

[00:43:21] And there've been, yeah, exactly.

[00:43:23] The trigger, right.

[00:43:23] And there have been environments like this, um, over the last few years where you're like, damn, if the S&P drops 3% next week, this could get like super nasty because, you know, Brent, you could explain better than everybody, right?

[00:43:36] The gamma, the gamma profiles, you know, ballooning and that sort of stuff.

[00:43:40] But, um, that's as far as you can go.

[00:43:43] It's just thinking like, well, if this happens, then it could really like cascade.

[00:43:47] Uh, but you could never be with search super sure that like, okay, this vol event's happening, you know, over the next two months.

[00:43:55] Was it obvious, like back in 2017, 2018, like in terms of timing, was that something that like people in your space, did you, did you see like XIV, this is going to be a blow up pretty soon?

[00:44:05] Is it something like you knew eventually it was going to come or was this something like it was pretty obvious this was coming soon?

[00:44:09] Yeah.

[00:44:10] So the people did know, like people in the vol space were talking about this for, for, uh, I would say a good year and a half to two years.

[00:44:18] There's this like famous thing where, um, the, the, the issuer of one of these products at EQD, which is the equity, equity derivatives conference.

[00:44:28] It got into a huge fighting, you know, a huge shouting battle with, with another portfolio manager, um, you know, about this who was, who was saying like, hey, this thing's going to blow up.

[00:44:39] So like people, people definitely knew, um, during that time and it was sort of being chatted about in the space, but it, it just took, it took a while, right?

[00:44:51] It took like a year and a half, I think from that point before it eventually triggered off.

[00:44:56] You talked earlier about how the increased use of options by retail traders produces some opportunities for you in different areas.

[00:45:02] I'm wondering, how do you think about that on the reverse side in terms of one of the things people say a lot is because option activity has gone up so much, it's a huge risk to the market.

[00:45:10] And when we get a down event, like all that options activity is going to magnify any decline we get.

[00:45:15] I mean, do you think that's accurate?

[00:45:16] Do you think that's a fair thing that's for way to, for people to look at it?

[00:45:19] You have to be careful because like, you don't want to go onto this, this path where you, you become a, a, a perma beer or, you know, you're just sadistic about like everything because you just become super pessimistic and you'll never make any money at all.

[00:45:33] Awesome.

[00:45:34] But, but.

[00:45:35] Or Twitter followers though.

[00:45:36] Yeah, exactly.

[00:45:37] You get a ton of Twitter followers, right?

[00:45:38] But you, you, you won't do well.

[00:45:40] There's tons of views on YouTube by the way as well.

[00:45:42] Yeah.

[00:45:42] Yeah.

[00:45:42] The channels that do that, like blow up the ones that have the fire burning in the cover and all that.

[00:45:46] Like, yeah.

[00:45:46] Yeah.

[00:45:46] Yeah.

[00:45:47] We don't like to do it, but they do.

[00:45:48] The ones that do it do blow up.

[00:45:49] Yeah.

[00:45:49] Yeah.

[00:45:50] So, so yeah, there, there, there is that, but like the reality is, is that the derivative ecosystem has grown tremendously and there's a form of reflexivity that's attached to this.

[00:46:02] So I always like to, to correct people when they say, well, for every buyer, there's a seller because although that's true, the seller and the buyer have different motives at different prices.

[00:46:17] And that's what creates these dislocations and movements and asset prices.

[00:46:22] So for example, if one guy sells a million bucks of notional and the other guy sells a million bucks of notional, all right, this million bucks, maybe 50% of that guy's entire book.

[00:46:34] This million bucks might be 0.00001 basis points, right?

[00:46:39] So if this moves up a little bit, this guy's going to sell the whole thing.

[00:46:43] If this moves up, this guy's not right.

[00:46:46] So forced buyers and forced sellers in areas where they become or market participants become forced buyers and sellers, that's what lights this whole thing up.

[00:46:57] And in the derivatives market, there's a lot of that, right?

[00:47:00] There's like this, this shrinking and growing, shrinking and growing at different times, at different tenors, different strikes of that dynamic.

[00:47:10] And that's why it could be problematic if markets start to slide down, dealers are forced to hedge their book, other market participants are forced to hedge that exposure, and then it could sort of lead to a cascade.

[00:47:25] Is that part of running like a long vile strategy is looking at who's out there and what their positions are and whether they would be forced buyers and sellers?

[00:47:32] Is that part of what you do is looking at that positioning and seeing what might happen?

[00:47:35] Yeah, 100%.

[00:47:37] So when we think about the tail side of our book, right?

[00:47:43] We have a lot of the prop trading on the intraday stuff, and then we have the tail side of our book.

[00:47:47] So when we think about the tail side, it boils down to two things.

[00:47:51] One, really good low latency execution.

[00:47:54] So being able to buy these tail options for really good prices and areas that we think are undervalued.

[00:48:02] And then the second thing is modeling out where those payoffs could be.

[00:48:08] So an example I like to use on this is think about the year like 2018.

[00:48:15] Everybody thinks about 2018, and they think about volmageddon, but they forget during December 2018, the market dropped about 20-something percent.

[00:48:24] The market dropped 27 percent when the Fed was talking about hiking rates.

[00:48:28] And the highlight to vol guys, if you're a vol guy and you traded during that time, it was brutal because if you didn't have exposure to downside S&P puts or sector ETF or single stock puts, and you just had VIX calls, you made no money at all.

[00:48:45] And that's because the exposures were short on the S&P side and the single stock side from a vol perspective.

[00:48:53] Nobody was short VIX calls because after volmageddon, all those guys got blown out.

[00:48:59] So then like 10 months later, there was no supply and demand imbalance that would have escalated that further.

[00:49:08] So for us, this is why this is so important is understanding where on the vol surface, which tenors, which strikes would force market participants or have a general idea to force market participants to become better buyers of that protection.

[00:49:24] Because if you don't have that, then like the hedge is not going to pay off in the way that you want it to pay off, which is also why when you speak to the pensions and the endowments and they run these 30-year back tests, it's kind of silly because you can't tell me buying a one-month S&P put is always going to be the optimal hedge.

[00:49:46] Right. There's no way that's true. Sometimes VIX calls will be appropriate. Sometimes S&P puts will be appropriate. Sometimes certain single stock puts will be appropriate.

[00:49:54] But it's about understanding where on the vol surface, what tenors, what strikes people can potentially be off sides and taking bets on those areas.

[00:50:04] Is that the primary way you decide to monetize positions that are going in your favor?

[00:50:09] So, for example, you're sitting there August 5th and VIX is 65, so it feels fairly easy.

[00:50:15] But the market was already down into August 5th about 5%, and the VIX was around 20%, which was a high, relative high for a few months.

[00:50:22] So how do you decide for the retail community that's listening this year?

[00:50:28] How do you decide when to monetize your positions versus rolling them down versus saying, hey, VIX 20 is not it.

[00:50:33] It's we're going, you know, VIX is going higher.

[00:50:36] Yeah, yeah. So as I mentioned, it's a bit of a quantitative framework and also a little bit of discretionary.

[00:50:43] So you sort of have a game plan as to what your book looks like if that scenario happens and how much exposure you're looking to remove.

[00:50:50] And then you kind of analyze it from a discretionary standpoint and say, eh, maybe I think that vol is going to go higher.

[00:50:55] Maybe I think vol is going to go lower. And that affects it a little bit. Right.

[00:50:58] But keeping this framework allows you to not fall in the doldrums of these two traps, which is one, vol goes up and you make no money.

[00:51:08] That's like the worst case. Right.

[00:51:10] Or two, vol goes up, you take off so much exposure and it continues to go off.

[00:51:15] And then, you know, you don't make what you should have made.

[00:51:17] So this is why this approach is a much more, in our opinion, robust way of doing things.

[00:51:24] But from a quantitative standpoint, where I think retail investors could get some good value is understanding those relationships historically.

[00:51:33] So like for us, one of the biggest things during the week of August was removing all of our VIX exposure in our August and September bucket.

[00:51:44] And the reason why we did that was because historically we looked at that relationship and we said, this is way too extreme.

[00:51:52] These 30, whatever now, let's say 30 Delta VIX calls are worth massive amounts that they should not be worth.

[00:52:00] These five Delta VIX calls are worth insanely amount.

[00:52:03] They historically have never showcased this type of pricing before.

[00:52:06] So why would we sell our six month S&P puts?

[00:52:11] You know, like when we're moving, that makes no sense at all.

[00:52:14] So that's kind of the quantitative framework that can help guide, you know, retail participants is understanding that relationship historically and the pricing of these options historically and the vol pricing historically to give you some guidance to say, okay, this is the area that I should be getting off.

[00:52:31] Because maybe it does go further, but if it does, the other area, the other pieces of my book would pick up.

[00:52:38] How much do you have to evolve your strategy over time?

[00:52:40] Like that's, we run totally different types of long-term strategies, but that's something I've learned over my career is you can have this thing, you know, in the factor investing world that works for a really long period of time and then something changes and it doesn't work anymore.

[00:52:50] Is that something you see in your space a lot where you have to evolve your strategy and some of the things you've relied on in the past don't necessarily work in the future?

[00:52:58] Fortunately, we have not had to deal with that.

[00:53:00] And I think it's because the edges that we have focused on have been durable for a really long time.

[00:53:08] So like there are edges that I have taken from, you know, my first boss, you know, like guys that have showed me stuff way, way back in the day.

[00:53:17] So they're durable edges.

[00:53:19] So what has evolved is like things like our risk controls have evolved tremendously, right?

[00:53:27] So like aggressively reducing risk if a strategy is underperforming.

[00:53:31] Because strategies go through periods of underperforming.

[00:53:33] You just don't make money every single day.

[00:53:35] But it's becoming much more robust about how are we identifying this?

[00:53:39] Do we have six different ways to identify this and reduce that exposure?

[00:53:43] And then simultaneously, if the strategy is doing well, identify when the strategy is doing well very fast and then increase slow sizing in that.

[00:53:52] So I would say that that's where our process has really evolved as opposed to like thinking about new edges or like the strategies decaying and having to bring in new edges.

[00:54:06] That fortunately for us, that really hasn't been the case.

[00:54:08] So one of the things that was really interesting this year before we went into August was these measurements like the CBO correlation index was hitting all time lows.

[00:54:15] And you had NVIDIA and particularly the semi-stocks really moving.

[00:54:20] And it was those those stocks were kind of, you know, stock up, ball up, which is a little unnatural.

[00:54:25] And the S&P vol was hitting lows.

[00:54:30] We also see at the same time massive amounts of options volumes, particularly call volumes and short dated options volumes in the mega caps.

[00:54:38] How do you think that how do you think about when to choose trading the index vol versus single stock vol?

[00:54:44] How do you think that that the kind of proliferation of these mega cap options volumes are are shifting the way that guys like you would would react to or trade the market?

[00:54:57] Yeah.

[00:54:58] Yeah.

[00:54:58] Yeah.

[00:54:58] So what I would say as an absolute fact, and I know this because we know where some of this flow comes from, we have good color where some of this flow comes from.

[00:55:08] But one dynamic that you've seen over the last, let's call it year and a half is that long, short hedge funds are now taking directionality bets on stocks via options.

[00:55:21] So you've seen that a lot more with like the big seven names, whereas you would think that most of that flow would be eaten up by vol focus shops.

[00:55:31] So for the viewers, think about a two and a half billion or five billion dollar long, short equity hedge fund now is saying, OK, if we're taking this bet on Tesla, we could just use a Tesla call as a stock replacement.

[00:55:49] Right. So we could go long Tesla call and we could go long NVIDIA put right to take this type of relationship trade here.

[00:55:58] And there's capital efficiency that works, especially as a long, short hedge fund where you're running GMV, right?

[00:56:07] Your gross marginal value that matters tremendously.

[00:56:11] So instead of you putting up a million bucks, you could put up 50,000 bucks and get the same type of exposure and the same type of bet there.

[00:56:19] So that's a that's an increasing thing in the space is more non focus, non vol focused shops are using the single stock options to take these type of directionality bets.

[00:56:31] In addition, on the vol side, and I'm going to say the magic word because everybody's heard this word.

[00:56:37] And, you know, at this point, they're disgusted with it.

[00:56:40] Dispersion trading is just still exactly what it is, right?

[00:56:43] Like, um, you've had, uh, these, these, these big giants in the dispersion space that continue to trade in the dispersion trade dispersion space, which usually gravitates over towards the, the, the mag seven names.

[00:57:01] So, yeah, I wish I had a better story there, but like, it's just dispersion guys continue to do that.

[00:57:08] And then, you know, some of the long, short hedge funds making directionality bets.

[00:57:11] Do you have a, you left Nancy Pelosi out of your long call buying on head mutation, but, uh, she's, she starved that.

[00:57:17] Um, do you have an idea roughly kind of what assets are in dispersion, like related strategies if you had to like, even just ballpark it?

[00:57:25] I would, I would really have to think about it.

[00:57:26] I have to think about it from two different terms.

[00:57:28] So one from like a Vega, Vega notional term, it's way more than it was previously.

[00:57:35] And I would say that maybe now it makes up 10 to 15% of the vol market, um, which is really, really high.

[00:57:47] I might be even overshooting that, that, that 15%, that might be high, but, uh, really, really high compared to like back in the day.

[00:57:54] And a lot of it is because of some of these prepackaged QIS programs.

[00:57:58] They've had a good amount of inflow.

[00:58:00] So like, you, you have to think that even the big dispersion desks, like, uh, like a desk, like, I don't want to say their name, but like, it starts with a C.

[00:58:10] Um, like a big dispersion desk like that.

[00:58:13] Um, and it's not Citadel, by the way, if people are thinking it's not Citadel.

[00:58:17] Uh, but a big dispersion desk like that is overshadowed by like a big QIS program at one of the tier, you know, top tier banks.

[00:58:27] Um, so, so there is some disparity in that.

[00:58:30] Do you, is that, is that generally focused in like these shortage stated tenors where they are trading, you know, a million Nvidia calls that expired this week?

[00:58:39] Is that, I mean, what, what is the tenor of those types of strategies?

[00:58:43] I don't have a great view into that.

[00:58:46] Yeah.

[00:58:46] So, uh, from a dispersion standpoint, you get a lot of like one month basket stuff that goes up.

[00:58:50] You have one month stuff, you have six month stuff.

[00:58:53] Um, but yeah, you, you do get a lot of like, now you're seeing like two weeks type of baskets go up.

[00:59:01] Um, definitely not like zero DT stuff.

[00:59:04] That's, that's not really it, but like I'd say two weeks, one month, three months, six months are usually the dispersion baskets.

[00:59:12] And then anything like one year stuff, you start getting into structured product stuff.

[00:59:17] So if you had to guess, like who trades the bulk of those kind of zero DT single stock options?

[00:59:25] Each FT just kind of pure, the annotative, like unball related kind of?

[00:59:30] Uh, so it's a mix.

[00:59:31] So, so you have more like income, income programs that have went up across the RA community.

[00:59:38] So like if, if you're in a, uh, let's say a single RA or something like that, and you have $10 billion, uh, you're thinking about more creative ways to generate income.

[00:59:50] Um, and previously, if you wanted to sell options, you know, you had to wait till quarterly expiration, then monthly, right?

[00:59:58] Now you have weekly, uh, and now you could do like zero DT.

[01:00:02] So when you're doing zero DT, it eliminates the path dependency for just selling like a quarterly option.

[01:00:07] So it allows you to spin the roulette wheel multiple times, do it over and over and over again.

[01:00:12] So you've had a big focus from some of these RIAs with their own internal programs, but saying, Hey, here's a few more creative ways where we could help you generate 10% a year.

[01:00:24] Look at this, right?

[01:00:25] We're going to sell zero DT one week, one month, and it's going to be a strip.

[01:00:29] And that's how much we do.

[01:00:30] So I'd say a decent chunk still comes from those types of programs.

[01:00:34] Then you probably have, um, another chunk coming from retail, taking just directionality bets.

[01:00:42] Um, and some of that is not just retail, but it's like some, like I mentioned the long, short equity hedge funds that are thinking about, uh, capital efficiency.

[01:00:54] They've been participating in those types of directionality bets there.

[01:00:58] So it's like, well, why do we need to trade, you know, uh, futures more?

[01:01:03] Why do we need to trade, uh, the S and P when we could just buy this 50 Delta S and P call because it's going to take our, our directionality bet as well.

[01:01:12] So more people reaching for the capital efficiency.

[01:01:15] Um, and then you have a small piece.

[01:01:17] So I'd say 25% is divvied up between the market maker community and I would say the vol vol focus shops.

[01:01:27] So like, think about like the, the vol arbitrageurs that are out there that actually trade in and out of this.

[01:01:33] So about 25% of the flow comes from, from a mix of those two things.

[01:01:36] So we, we have a couple of standard closing questions we ask.

[01:01:39] We're in the process of transitioning from one to the other.

[01:01:40] So we're going to ask you, uh, both of them.

[01:01:42] Okay.

[01:01:43] Um, the first one is what is one thing you believe about investing that you think the majority of your peers would

[01:01:47] disagree with?

[01:01:48] Yeah.

[01:01:49] So I actually think that this is a really, really good question.

[01:01:53] So, uh, trading psyche in our opinion is extremely important, but a lot of guys in the vol space are,

[01:02:00] are like quant based and they tend to shit on that quite a bit.

[01:02:07] Um, and I, I don't understand why, because I think if you go back and you look at some of the great

[01:02:13] traders, uh, that have come across, you know, all these years, guys like Paul Tudor Jones at Dorp,

[01:02:19] um, Drucken Miller, all those guys talk about like how important your trading psyche needs to be.

[01:02:26] Um, so it's probably a controversial take with like the, the nerds in the space, but probably

[01:02:32] an uncontroversial take with the people who actually have done well.

[01:02:36] Yeah.

[01:02:36] That's something I took from this conversation with you is it's definitely, you have to blend

[01:02:39] the quant with the discretionary in your space.

[01:02:41] Like your space doesn't seem like a place where pure quant would be the way to go.

[01:02:45] Yeah, totally.

[01:02:46] Totally.

[01:02:46] I think a lot of pure quants have failed in the vol space.

[01:02:49] Um, on both, on both sides, on the long vol side and definitely on the short vol side,

[01:02:53] there's been good, uh, good data around them not doing well.

[01:02:58] And our second closing question is based on your experience in markets, if you could teach

[01:03:01] one lesson to the average investor, what would it be?

[01:03:04] Yeah, I would say be understanding that anything is possible, um, and be prepared for those type

[01:03:12] of worst possible outcomes.

[01:03:14] I think when people invest, you should naturally come into investing opportunistically because

[01:03:20] if you come in pessimistically, you'll just never make money, right?

[01:03:24] You'll be the guy who's just always trying to short every dip in the S and P. Um, but when

[01:03:32] you sort of become too optimistic, that's when it could be hazardous.

[01:03:35] So you have to be understanding that like, yeah, every position that you put on should be with

[01:03:40] the intent that it could go completely wrong.

[01:03:43] Um, and that's not just from like a long vol or a tail risk perspective, but it's just

[01:03:47] trading in general.

[01:03:48] Um, it could be boiled down to as simple as that.

[01:03:51] Um, is there, is there anything in your radar right now that you're watching as a potential

[01:03:56] flare flare point?

[01:03:57] I mean, there's ones that are obvious that we're all watching, but anything kind of interesting

[01:04:01] that it's off people's radars?

[01:04:04] I don't think so.

[01:04:05] I don't think I have, uh, anything interesting.

[01:04:08] Um, I know, you know, there's the OCC margin requirements are still up in the air and

[01:04:15] sort of dynamic.

[01:04:16] I think the other thing that people should consider is, is something like, um, you know, this morning

[01:04:24] I, I, I heard these reports on interactive brokers limiting, uh, calls on DJT.

[01:04:30] And then I heard from a couple of other like smaller independent self-clearing brokers are

[01:04:35] doing the same thing.

[01:04:37] And I think that's pretty crazy, right?

[01:04:39] That like brokers could just determine, you know, oh, you can't trade this.

[01:04:44] You can't trade this because we, we, we said you can't trade this.

[01:04:46] And it's like, well, that's, uh, that's, that's.

[01:04:50] Well, it's like, I mean, they did that in the, like the nickel exchange did that too,

[01:04:54] right?

[01:04:54] They, they, they broke trades.

[01:04:56] And, and I think in, uh, uh, the flash crash, there was a bunch of trades that were broken

[01:05:01] and that were busted.

[01:05:02] Right.

[01:05:02] And that you're, you're right there.

[01:05:04] There's that weird week.

[01:05:06] It's not a regulatory risk.

[01:05:07] I don't know what you call that, but clearing risk, I guess.

[01:05:09] Well, it's the house rules changing so fast.

[01:05:12] So I remember during like the, the GameStop thing, uh, I think Robinhood started limiting

[01:05:17] trading on American airlines.

[01:05:19] It was AL was the name that the, uh, you know, the, the, the Redditor started to become

[01:05:25] very crazy about.

[01:05:27] And, and I looked at that and I said, how messed up is that, that at any given point in time,

[01:05:33] the brokers could just come in and, you know, kind of unfacilitate trades.

[01:05:38] Like your job is to facilitate the trade.

[01:05:40] So, um, and facilitate is a new word.

[01:05:43] I like.

[01:05:44] Yeah.

[01:05:45] Yeah.

[01:05:46] Yeah.

[01:05:47] So, so that's, uh, I don't know if that's like a hazard, but it's something I think people

[01:05:51] should be watching for because, uh, they can't just keep popping up like that.

[01:05:58] Well, thank you so much for joining us.

[01:05:59] This has been awesome.

[01:06:00] I've learned a ton.

[01:06:01] Um, if people want to learn more about you, if they want to follow you, where can

[01:06:03] they go?

[01:06:04] Uh, yeah.

[01:06:05] So they could go to ambersgroup.com or my Twitter, which is K S I D I I I.

[01:06:11] And, uh, I really appreciate you guys having me.

[01:06:13] Yo, it was, it was really a fun discussion.

[01:06:15] Thank you, Chris.

[01:06:15] Really appreciate the time.

[01:06:16] And thanks for Brent for preventing me from embarrassing myself.

[01:06:19] Hopefully.

[01:06:19] Oh, you did better than I did, Jack.

[01:06:20] Thanks for having me.

[01:06:21] It was fun to talk to Chris.

[01:06:23] Thanks guys.

[01:06:23] This is Justin again.

[01:06:24] Thanks so much for tuning into this episode of excess returns.

[01:06:28] You can follow Jack on Twitter at, at practical quant and follow me on Twitter at, at JJ

[01:06:33] Carboneau.

[01:06:34] If you found this discussion interesting and valuable, please subscribe in either iTunes or

[01:06:39] on YouTube or leave a review or a comment.

[01:06:42] We appreciate it.