Calm Before the Storm or Fuel for a Rally? | Inside Options Flows Heading into the Election

[00:00:00] So people are worried about the future, even though the past doesn't really, you know, what's been happening in the market's been very quiet.

[00:00:07] So that there's a real dislocation there. So much about investing and trading is about flows, right? And there's truth in price and truth in price action.

[00:00:16] People are hedging the election event. So odds are like anytime you go into a big data print or the FOMC or another event, odds are that traders are hedging the event because they're hedging their tail.

[00:00:28] But odds are the event is going to prove to be less than people's expectations, right?

[00:00:33] Welcome to The OPEX Effect, a joint podcast from Excess Returns and Spot Gamma, where we take a deep dive into the world of options and the flows they generate in the markets.

[00:00:40] Join Brent Kochuba and Jack Forehand every month on Options Expiration Week as they look at the major developments in the options world and how they impact all of our portfolios.

[00:00:48] No information on this podcast should be construed as investment advice. Securities discussed in the podcast may be holdings of clients of validity capital.

[00:00:54] So I feel like I always say this at the beginning, but it's a really interesting time, I think, in the market right now.

[00:01:00] And you'll be able to maybe explain a little bit behind the scenes about what's going on.

[00:01:03] But I feel like there's been so much going on in the world recently. There's been geopolitical stuff.

[00:01:08] We got the election going. And on one hand, you're like, something should be going on here with the market.

[00:01:14] Nothing's happening. And on the other hand, I always say to myself, well, the market always climbs the wall of worry.

[00:01:18] So maybe that's what we're just doing again. But I'm interested to dig in behind the scenes here with you and talk a little bit about what we're seeing in the options market,

[00:01:25] because I see that dynamic at a high level and I really don't know what's going on behind the scenes.

[00:01:31] Yeah, I know what you mean. And sometimes I think, is it just that, you know, we're all so connected now that everything seems crazier or is this legitimately just crazy?

[00:01:39] And, you know, you look at the election coming up and that's all wild. And then, you know, these hurricanes and, you know, and all this other stuff.

[00:01:46] It's interesting times. But to your point, we are crawling, climbing somewhere in there, a wall of worry and markets up two and a half percent over the last five days alone.

[00:01:57] So, you know, equities are marching along irrespective of what's going on around us.

[00:02:02] Yeah, it's kind of an aside. But to your point, like we have so much, you know, part of this might just be we have so much information these days.

[00:02:08] Like, and it is thrown at us so quickly that maybe like what we think is always been going on, like forever.

[00:02:15] It's just it's just jammed in our face all the time. Like there was this Cliff Aspen has wrote this paper about like the efficient market hypothesis and stuff.

[00:02:22] And we've talked to Wes Gray about it on our podcast. But like there's there's an argument that basically all this information is made all of us more crazy in terms of how we act in the market and how we behave.

[00:02:31] Like we're just getting hit with all this stuff and it's not doing good things for us.

[00:02:35] Yeah. And it's funny is I've equated that to trading. Right.

[00:02:39] You see the explosiveness of zero DT options trading and short dated options trading in that, you know, it's half of the options volume now.

[00:02:46] And so there's this frenetic, you know, day trading happening for for, you know, to put in a bucket term.

[00:02:52] And a lot of that is just algorithmic. Right.

[00:02:55] I mean, you definitely have a lot of people sitting there pointing and clicking, but they're trading against algorithmic, you know, HFT type flow.

[00:03:02] And it's sort of either like you want to try to participate that or you should just zoom out a little bit and, you know, think slow, think deeper and go counter trend to being more connected and getting information faster.

[00:03:14] Seems in some ways to be maybe the more successful way to just live life and maybe invest.

[00:03:18] Yeah. I would think you don't want it. You don't want to trade if Ken Griffin is the other side of your trade, probably. Right.

[00:03:23] I mean, that probably doesn't end well for you.

[00:03:24] Or Cliff Asmus or. Yeah. I mean, those guys are billionaires for a reason.

[00:03:28] And so. Yeah.

[00:03:30] But anyway, so we're going to yeah, we're going to dig into all that today.

[00:03:32] We're going to talk about the election, which is interesting to me because I think maybe and we'll find out in your slides.

[00:03:36] But I think maybe the reaction to the election coming into the election is a little bit different this time than it's been some of the previous times.

[00:03:42] But you'll explain that more as we get in there. But we always start out talking about just how options impact the market in general.

[00:03:48] And you start out with the slide that we we use last time as well.

[00:03:51] And it's really interesting to me because it just shows how much the volume of options use has increased, especially post pandemic.

[00:03:59] Yeah. If if you're curious about how this options flow impacts markets, like you like you said, we last episode did a I won't call it a deep dive, but we did kind of a one on one class on that.

[00:04:10] And we started with this presentation of saying our slide saying, why do options markets matter so much to the underlying?

[00:04:17] And it's because the options volumes continue to grow.

[00:04:20] So you can see here in 2020, those volumes exploded, obviously, with the birth of electronic trading.

[00:04:24] You could trade on your phone basically from Robin Hood and commission free and all that.

[00:04:27] And now zero DTs have exploded.

[00:04:29] So daily expirations, that's half of options volume essentially now.

[00:04:34] And the exchanges are talking about adding zero DTE single stock.

[00:04:37] So right now, single stock just spire every Friday.

[00:04:39] But they're thinking about daily expirations.

[00:04:42] And why not? Because the exchanges make a lot of money doing that.

[00:04:44] So as these options volumes grow, they have to be hedged using the underlying stock.

[00:04:50] And that suggests to us or implies to us that more of that stock volume is going to be controlled by options hedging.

[00:04:56] Yeah. It's interesting to me. We just had Jim Crescent on the podcast a couple of weeks ago.

[00:05:00] And I was asking him about this because for someone outside the space like me, there's this tendency to say, well, there's this huge use of options.

[00:05:06] It's a massive risk to the market.

[00:05:08] And his answer to that I thought was a good one.

[00:05:10] And you can tell me whether you agree.

[00:05:11] But he was like, if not the increased use of options, it depends on how they're being used.

[00:05:16] And so at certain times, they can increase volatility during certain events.

[00:05:21] But at certain times, they also can be really dampening of volatility.

[00:05:24] So it's not like you look at just increased options on its own as some sort of risk to the market.

[00:05:28] It's about like how are they being used at any given time.

[00:05:32] Right. And it's, you know, one of the key elements of investing or speculation or anything, whether you're looking at, you know, beating babies or anything else is imbalance, right?

[00:05:43] If there's a lot more, you know, buying demand and aggressive buyers, that's going to drive the price up.

[00:05:48] And in a similar way, if you have only call buying in the options market, you know, that creates GameStop in 2021, for example.

[00:05:54] Or in March of 2020, there was unbelievable amounts of put buying.

[00:05:58] And that really exacerbated things to the downside, right?

[00:06:01] So I totally agree with his point there.

[00:06:05] Oftentimes, we have balanced volumes that suppress volatility.

[00:06:10] And then other times, you see it go the other way where, you know, panic either to the upside or downside exacerbates that volatility.

[00:06:17] That's what we talk about a lot as we get into your next slide is there is this options expiration cycle and how people are positioned or how people are using options as we move into these expirations is really important.

[00:06:28] Yeah, the key thing here is we have OPEX this week on Friday.

[00:06:31] We actually have VIX expiration tomorrow.

[00:06:33] So positions start shifting starting tomorrow, Wednesday, the 16th, into Friday, the 18th.

[00:06:39] And the idea here is that every 30 days is a big kind of material options expiration.

[00:06:44] That's where the bigger funds will keep their positions.

[00:06:47] And so what happens is the volume or open interest associated with that third Friday expiration builds up into the expiration itself.

[00:06:56] The associated options hedging positions build up in kind with that.

[00:07:00] And then all of a sudden, bam, all those expire.

[00:07:03] Those positions all go away.

[00:07:04] And then that frees up the options, the underlying movement, right?

[00:07:08] Because that hedging flow that was so dominant into options expiration suddenly shifts.

[00:07:13] And we've seen that create a lot of turning points in the market.

[00:07:16] We have a bunch of those noted here.

[00:07:17] We've flagged some of the most prolific bottoms in the last five plus years on this chart.

[00:07:24] It does work to the upside as well.

[00:07:26] In this case, we actually have some data, if I flip forward a couple of slides here,

[00:07:31] that shows us that around options expiration, 68% of the time we actually turn.

[00:07:36] So what does that mean if we rally into options expiration?

[00:07:39] 68% of the time we sell off after.

[00:07:41] So there's a lot of data and stats that actually back this idea that options can cause turning points or shifts in the market.

[00:07:49] And going back to your OPEX cycle slide, I mean, we can see some of these.

[00:07:52] I mean, the pandemic is obviously the most clear example of, you know, we had a bottom on an expiration.

[00:07:57] We had a top on an expiration and then we had a bottom on the next expiration.

[00:08:01] Yeah, that's exactly right.

[00:08:02] And then most recently we had bottoms in April and August of 2024 this year where there was bottoms.

[00:08:08] And, you know, you see in particular what happens in these situations is there's a lot of put buying.

[00:08:13] There's a lot of high volatility into the options expiration, right?

[00:08:16] When we're crashing, there's a lot of momentum.

[00:08:18] And then when you remove all these puts, the short hedges that dealers need to hedge those put positions, they don't need those short stock positions anymore, right?

[00:08:26] And so they could buy that stock back and that can lead to a rally, which crushes volatility, right?

[00:08:32] The VIX will drop if we start to get a rally and that fuels even more of a rally.

[00:08:36] So there's a lot of reflexivity in the nature of these flows, you know, that they kind of feed upon themselves.

[00:08:41] What I found as a long-term investor is sometimes I'm like asking myself, something's going on in the market and I'm asking myself, like, why is this going on?

[00:08:46] It doesn't make any sense to me.

[00:08:47] And a lot of times looking at these things is the answer.

[00:08:50] Like, for instance, when the – I didn't know this at the time, but like when the pandemic was really spreading, you know, when things were getting really bad in Italy, you just kind of saw it continue to expand and nothing was happening in the market.

[00:09:00] And it was really weird.

[00:09:01] And I'm like, why is the market not going down?

[00:09:03] And then we hit that expiration and like it was all over.

[00:09:05] Like it all fell apart.

[00:09:06] So obviously, to some degree, those options flows were holding up the market until that expiration cleared.

[00:09:13] Yeah, there was a ton of call positions into February 2020.

[00:09:17] And I, like you, remember, you know, videos of people collapsing in the street in China and we were tracking airplanes around the world.

[00:09:24] And they'll know, you know, it was clear this was getting bad.

[00:09:27] And then as soon as you hit that options expiration, that's the weekend that things fall apart.

[00:09:30] Like news suddenly mattered, right?

[00:09:32] Right. And you see that happen all the time in timing, entry and exit points.

[00:09:38] And you also see to the downside, right, where the market's crashing and you're saying to yourself, the world is going to end, right?

[00:09:44] Oh, my gosh.

[00:09:44] And then all of a sudden you'll see volatility, implied volatility will drop.

[00:09:47] And that's a sign that people are starting to sell their puts.

[00:09:50] And so, you know, so much about investing and trading is about flows, right?

[00:09:55] And there's truth in price and truth in price action.

[00:09:58] So sometimes you're emotional and you're thinking about investing implications, but it doesn't matter what you think.

[00:10:04] It matters what everyone else is doing, right?

[00:10:06] And I think outside of maybe like deep value investing where you're buying things for, you know, like under cash flow or whatever, then, you know, most of us are actually trading flows.

[00:10:16] Like you're trading the reaction of everybody else, two news and two events versus, you know, fundamentals in a lot of cases.

[00:10:23] As you can imagine, the deep value investing has not gone particularly well in recent years.

[00:10:27] But it's also interesting.

[00:10:29] No.

[00:10:30] Yeah.

[00:10:31] But this to the point of short-term frenetic information, right?

[00:10:33] Yeah.

[00:10:34] And also, like, that's one of the things I've learned throughout my career is even taking it a little bit longer term, like flows are what drive markets.

[00:10:40] I mean, fundamentals, which is what people like me use, they're important in that they drive, hopefully, over the longer term, you expect them to drive flows.

[00:10:48] If people don't care at all about fundamentals and they don't move, you know, they don't buy and sell based on fundamentals and they don't drive flows, then they're not going to matter that much.

[00:10:55] But you'd expect over the long term, since you're buying shares of companies, that they would.

[00:10:59] But that's one of the arguments you've seen a lot recently is that we are in more of a flows-driven market than a fundamental-driven market, you know, compared to history, at least.

[00:11:08] Yeah, I think that's true.

[00:11:09] And I guess, you know, you have Mike Green on all the time and, you know, passive inflows and inflation and 401ks and the asset gathering of the S&P and all that.

[00:11:18] And so, you know, there's a rising tide element to all of this, certainly.

[00:11:26] You know, that's for sure.

[00:11:27] Yeah, and one of the things I learned just before we get into the current expiration is, like, shaking your fist at the current market is never a good idea.

[00:11:33] Like, being the person who's like, well, the Fed is distorting the market and I'm, you know, I'm just going to rail against the Fed and I'm going to set my investment strategy so that when the Fed finally, you know, sees the light, it's going to work.

[00:11:42] That stuff never works.

[00:11:43] I mean, you've got to play like the field is in front of you.

[00:11:46] And if the Fed is going to distort the market for a decade, then you've got to invest based on the fact that the Fed's distorting the market for a decade or whatever else is going on.

[00:11:52] If options flows are having a huge impact, then you've got to understand that.

[00:11:55] Like, it's people like me that are fundamental investors have this tendency to be like, oh, this is the way the world should be.

[00:12:01] And I'm setting up my investment strategy, you know, to be in that world.

[00:12:04] And like, unfortunately, we've got to live in the world we're in.

[00:12:08] Yeah, that's totally right.

[00:12:09] And, you know, we had the August, you know, people were yelling at the Nikkei carry trade for crashing the market.

[00:12:14] And I was laughing the other day because we had the JP Morgan role, which we're going to talk about, was on the 30th.

[00:12:21] And Powell had happened to schedule a speech like two in the afternoon.

[00:12:25] And the market dropped like 40 handles in about 10 minutes.

[00:12:28] And all the macro guys were being like, Powell just told us the world is anything.

[00:12:32] And people had big followings, you know.

[00:12:34] But if you look at that time period, you know, the 15 minutes of the market dropped, we had a 40,000 lot, you know, trade printed.

[00:12:43] Huge trade, JP Morgan, Colorado, right at that low.

[00:12:45] And then the market bounced.

[00:12:46] So you could see these like microcosms of people, you know, putting their opinion in on macro or, you know, drawing macro conclusions from what was essentially just trade flow.

[00:12:58] It's always a little amusing when you see those kinds of things.

[00:13:00] Yeah, whenever you see it on CNBC, market falls because.

[00:13:03] Like a lot of times, whatever is after the because is not the actual because.

[00:13:07] As you learn more about markets, you see that a lot.

[00:13:11] And now that stuff is just written by algos, you know, it's so funny.

[00:13:14] You see like CNBC's headlines now are all just algo driven, you know, market up and then they have to assign some reason to it.

[00:13:19] And, you know, it's it gets more humorous as we get along here.

[00:13:25] You know, bots writing about what other bots are writing.

[00:13:27] We're just going to see more and more of that.

[00:13:28] Unfortunately, as the AI takes over here, we're going to see more and more of bots writing to other bots.

[00:13:33] And there's an AI piece to this presentation.

[00:13:35] So we're not too far off.

[00:13:36] We'll move forward so we can get there.

[00:13:38] But the next slide, we're looking at what we always look at, which is you're looking at the current expiration and what you're seeing.

[00:13:44] Yes.

[00:13:44] So the huge positions here, 5,800 to the downside, it's a very big strike in options expiration here.

[00:13:50] The way that we're looking at this market, we talked about balance.

[00:13:53] So in this screen here, you see orange, which is the value of call gamma and blue is the value of put gamma.

[00:13:59] And so the takeaway here is when these positions are balanced or we're maybe a little more call heavy,

[00:14:05] meaning there's more relative orange bars here or call gamma, the market's pretty stable in there, right?

[00:14:10] Kind of grind higher, drift higher.

[00:14:12] But we get into zones where we're predominantly put positions.

[00:14:15] That's where volatility really tends to pick up.

[00:14:17] And so we mark those areas as risk off.

[00:14:20] So in this case, we're trading right now around 5850 in the S&P, almost on the dot.

[00:14:26] And so if we break below 5,800, we're going to get kind of in a neutral stance, we say, where we'll reduce our long exposure.

[00:14:33] And then under 5750, we're going to be looking to short this market.

[00:14:36] And that goes from obviously today out into really the election period because that is where put positions really will pick up is under 5750.

[00:14:46] And in this market, we're going to be talking about the election.

[00:14:48] There's a lot of tail hedging on.

[00:14:49] Most of that tail hedging is down around the 5,500, even down towards the 5,000 strike.

[00:14:54] So these are true tail hedges.

[00:14:57] And they have value right now.

[00:14:59] But as we're going to talk about when we get into the election, those positions could lose value really very quickly.

[00:15:04] And that could have a market impact.

[00:15:05] So we'll be talking about that shortly.

[00:15:06] Is this a big expiration?

[00:15:10] As we see here, decent size.

[00:15:12] So this is December.

[00:15:13] December is a quarterly expiration.

[00:15:14] September was also that we just had.

[00:15:16] It was a quarterly expiration.

[00:15:17] So those were twice as big probably as this.

[00:15:19] What you take away from this options expiration is it's very call weighted.

[00:15:24] So in this case, we have call delta.

[00:15:26] So that really measures the stock equivalent value.

[00:15:29] Huge call positions relative to put positions.

[00:15:31] Not surprising, again, given the market rally here.

[00:15:34] And so this, when we have a call imbalance and expiration, it tends to tie into this statistical idea that we reverse course after expiration.

[00:15:44] Because the hedges associated with these call positions will unwind and that could allow us to give some back, essentially, get some consolidation.

[00:15:52] So there's some downside risk.

[00:15:53] Because it's a little more call heavy, there might be a little more potential for downside once the expiration clears.

[00:15:58] Yeah, that's definitely what we're looking at.

[00:16:00] And we're really leaning on 5,700 as a short-term low kind of into options expiration into this chart.

[00:16:10] So we have the 5,750 level, which is this short-term metric.

[00:16:14] And then that will have to zoom out a little bit on that after options expiration as we clear some positions out.

[00:16:19] I don't think we would really get down too far under 5,700 given the dynamics that we see here.

[00:16:28] So right now, that doesn't sound that far.

[00:16:30] But that's a good 2%, 3% pullback is really what's kind of in the cards, I think, post-expiration.

[00:16:35] And then we're going to move into the selection period, which we're going to talk about here in a moment.

[00:16:38] It would be fair to say you're not seeing anything extreme here.

[00:16:40] I would assume some of these expirations, you see extreme call imbalances.

[00:16:43] And those are the ones that maybe are the most risky.

[00:16:45] That's not what we're seeing here?

[00:16:47] Yeah.

[00:16:48] I mean, this is an extreme call imbalance, meaning that the positions and calls are so much larger relative to puts.

[00:16:54] But the overall size of positions, it's not a top-percentile expiration.

[00:17:02] We're not bigger than September.

[00:17:03] We're not even bigger than December, which doesn't expire.

[00:17:05] It'll come for another couple months here.

[00:17:06] So it's a decent-sized expiration.

[00:17:08] And the call waiting tells us that, OK, we're looking for a little bit of a pullback and consolidation next week into the end of November.

[00:17:15] And on this next chart, we're seeing we move more and more to the right here.

[00:17:19] We're seeing lower predicted volatility and lower actual volatility.

[00:17:23] Right.

[00:17:24] So we measure dealer gamma, and then we forecast, OK, given today's dealer gamma position, what happens the next trading day?

[00:17:31] And what you can see here is the larger gamma gets, the more positive it gets, the tighter one-day returns are, forward one-day returns are in the S&P.

[00:17:40] And you could extrapolate that a little bit farther in time as well.

[00:17:43] But what you see here is essentially we're in a very positive gamma position.

[00:17:47] That suggests that we have really low volatility, and we're going to touch on this in a second.

[00:17:51] But the deal is that after expiration, we should drop in this gamma index, excuse me, because we're losing a lot of call positions.

[00:17:58] And that decreases positive gamma in the dealer hedging position associated with those calls.

[00:18:03] And that should allow for more volatility into the end of the month.

[00:18:07] So is the idea on this chart, like we always look at this chart right before options expiration.

[00:18:11] But if we were to look at this like a few days after options expiration, we would always ship left relative to where we are here?

[00:18:18] Yeah, yeah.

[00:18:19] And I think this is one of the things that is most interesting here because with options expiration, you know positions are going to expire, right?

[00:18:25] It's a fact.

[00:18:26] These contracts expire on a day.

[00:18:28] We all know the open interest information is public.

[00:18:29] So the market, I don't think, always prices us in, right?

[00:18:33] So we have this very low options prices right now, particularly if you look at very short dated options.

[00:18:38] And so if we move past expiration, we know these positions are going away.

[00:18:43] And that is generally associated with lower call gamma or lower positive gamma, I should say, is associated with higher volatility.

[00:18:49] And that's what this is telling you.

[00:18:51] So we know we're going to lose positions on Friday.

[00:18:53] So therein, we should have higher volatility after OpEx as a result.

[00:18:58] I wonder, has anybody ever looked at like the data on that?

[00:19:01] Like I would assume the week after options expiration should be a more volatile week in general than the week of options expiration.

[00:19:06] Is that right?

[00:19:08] Yeah, yeah.

[00:19:09] And that's what this data here is essentially telling you, that the distribution changes.

[00:19:12] And the trick here is that, you know, this works for the market going down as well as the market goes up, going up, right?

[00:19:18] So you can have volatility expanding in OpEx and then it collapses or vice versa.

[00:19:22] Volatility can contract into options expiration and then it can expand.

[00:19:25] So it does really work both ways and there is statistical evidence for that.

[00:19:29] So in this next chart, you're looking at some of the price action in recent OpExes.

[00:19:33] Yeah.

[00:19:34] And the thing I wanted to highlight, we're going to talk about this momentarily, is, you know, Brett, you'll go, okay, guys, well, you really highlighted recent, you know, five years of history.

[00:19:42] But if you look here, you can see there's a huge June quarterly expiration.

[00:19:46] Clearly, the market reacted to that.

[00:19:47] In July, VIX expiration, which occurred three days before OpEx, same as this month, right?

[00:19:53] VIX expiration tomorrow morning leads us into October expiration.

[00:19:57] The morning of VIX, OpEx marked the July high and that was the market all time up until recently.

[00:20:04] You know, admittedly into August, OpEx, hard to mark a clear turning point there.

[00:20:09] That wasn't a particularly impact vlog expiration.

[00:20:11] And then we moved into September OpEx expiration.

[00:20:14] I'm going to touch on this shortly, but when you look at the JP market collar trade, something that's kind of been beat to death in my space in terms of people talking about it.

[00:20:22] I think macro investors here will find it interesting.

[00:20:24] So we're going to touch on that.

[00:20:25] But you'll see the fingerprints in recent months, days and months, of how the options market really affected price action.

[00:20:32] And I think that's really going to be true into options expiration here, but more so into the election on the 5th.

[00:20:41] So as we move forward here into our projections from last time, this is one that you actually corrected me on when we talked about how important NVIDIA is.

[00:20:49] And I said, well, it's important, but it's not that important.

[00:20:51] And then you proved to me after that that it is exceptionally important, especially when you consider what's going on in options.

[00:20:57] Yes. And we talked, I mean, the whole presentation, it was called the NVIDIA Options Complex.

[00:21:02] And I recommend that everyone goes back and watches that presentation or you can Google Spot Gamma NVIDIA Options Complex and you'll see that presentation.

[00:21:12] Because we talked about the flows associated with NVIDIA and how that would drive the entire market.

[00:21:18] And we saw the evidence of that into September expiration.

[00:21:21] And in this chart, you see the SMH really leading all other stocks into September options expiration.

[00:21:28] And so we said, you've got to really key off of this.

[00:21:31] Now, NVIDIA through the end of September into early October didn't perform very well.

[00:21:39] But the last 10 days, as we're going to show you, it's been ripping.

[00:21:42] And that's really correlated with this market going up.

[00:21:44] So we were talking before we started here about surprising how strong the market is right now, right?

[00:21:49] Well, there's a couple of reasons for that.

[00:21:50] And NVIDIA is one of them.

[00:21:51] So, you know, watching NVIDIA as a telltale for the market was one of the things we said was critical.

[00:21:56] And there's some evidence that that proved true again here over the last month.

[00:22:01] And that's related to the leverage associated with NVIDIA.

[00:22:05] There's over 500 ETFs that incorporate NVIDIA.

[00:22:08] NVIDIA is the largest options volume stock in the U.S.

[00:22:13] Huge call volumes.

[00:22:15] Huge short-dated options volumes.

[00:22:17] It's, you know, it is really the driver in a lot of ways of the U.S. market.

[00:22:23] Yeah, and it's crazy.

[00:22:24] This is a total aside from options.

[00:22:25] But, like, I was just listening to some podcasts recently where they interviewed Jensen.

[00:22:28] And just thinking about, like, the moat NVIDIA has and, like, how involved they are in everything that's going on in AI.

[00:22:34] And not just, like, chips, but the software that runs the chips.

[00:22:37] I mean, it's pretty crazy, like, how important NVIDIA is to that entire AI complex.

[00:22:44] Yeah, and I listen to that as well.

[00:22:47] And I didn't put any slides or any touches on those points because I'm not a macro analyst.

[00:22:51] But, you know, he seems to tell you that we're only in the beginning stages.

[00:22:55] And, you know, I think all CEOs want to say, hey, we're positioned for explosive growth here.

[00:23:01] But there's something that maybe rings a little bit more true about that in this case.

[00:23:07] Again, I'm not a macro guy, so I can't tell you that.

[00:23:09] But I can tell you that the amount of flow linked to NVIDIA stock and then you see call options come in.

[00:23:16] And, you know, it's very easy to lay out how this stock can literally control the entire market.

[00:23:22] And that sounds hyperbolic maybe a little bit.

[00:23:24] But you look at charts like this where there are indeed 528 NVIDIA ETFs, huge institutional ownership.

[00:23:33] And we had basically said that, look, when you have all these entities, not just huge institutions, but people who want to own NVIDIA stock,

[00:23:42] that the tradable float of that stock is really a lot smaller, I think, than we all believe.

[00:23:47] And then you add on to that this options flow.

[00:23:50] And the options flow dictates that market makers may have to buy underlying shares of stock.

[00:23:54] Well, they're forced to buy that stock into deteriorating NVIDIA liquidity.

[00:23:58] And that can mean that there's a lot more underlying volatility, right?

[00:24:03] Because there's a smaller piece of the pie that people have to buy up.

[00:24:06] And I think that, you know, this is something that we see, I think, through the market because, you know, it's amazing.

[00:24:10] You could have a $3 trillion company move 4, 5, 6, 7, 8% a day.

[00:24:18] It's pretty wild, right?

[00:24:19] The value that is swinging around there.

[00:24:21] And so, again, you see these fingerprints all the time.

[00:24:24] And I'm going to show you here how that even is existing today.

[00:24:27] Yeah, and that's been the big lesson of doing this podcast for me is, like, you want to try to attribute –

[00:24:32] when NVIDIA is moving in these days, you want to try to say, oh, they announced this or they announced that.

[00:24:35] Like, a lot of times, that's not what it is.

[00:24:37] A lot of times, this behind-the-scenes flow stuff is really what's driving that.

[00:24:41] And it's important, like, as a long-term investor to at least understand that.

[00:24:43] I mean, you might not be doing anything with it, but, like, if you attribute it to the wrong thing, that can be bad.

[00:24:50] Yeah, that's exactly right.

[00:24:52] And everything is about supply and demand.

[00:24:57] And there's not much supply in NVIDIA, and there's a ton of demand for the stock.

[00:25:02] And so, you know, as the story gets better, you know, and themes get stronger and Jensen Huang comes out and keeps saying, you know,

[00:25:12] customers are fighting over our chips and, you know, all these other things and there's no other competitors and blah, blah, blah,

[00:25:17] then the theme stays pretty strong.

[00:25:19] And if this stock is going up, I fully, wholeheartedly believe that the rest of the market is going to go up because of it.

[00:25:26] And, you know, we all have to bow down to our kind of AI masters, I guess.

[00:25:31] I think we're going to be doing that eventually anyway, so we might as well get started.

[00:25:35] So what are you looking at with rates on this next slide?

[00:25:38] Yeah, the other thing we touched on was this idea, we were approaching the FOMC.

[00:25:43] So our last options conversation was before FOMC.

[00:25:46] We got a 50-bit straight cut.

[00:25:47] And what was funny is longer term rates actually went up, which was different than I think some of us, you know, me not being a macro guy expected.

[00:25:56] And there was a lot of rate volatility around the FOMC.

[00:25:59] And so we had talked about the idea of before this rate cut, you couldn't really hedge yourself with bonds, right?

[00:26:05] You couldn't hedge equity positions with bonds.

[00:26:07] This is like kind of a 60-40 portfolio.

[00:26:09] And in 2022 and 2023 and even early 2024, like there was essentially no alternative to stock.

[00:26:15] And so the argument is now there is an alternative to stock with the rate cuts.

[00:26:22] However, now suddenly the long-term, you know, 10-year or longer dated bonds, rates have actually gone up to 10 years back over 4%.

[00:26:32] And so I think, you know, this is one where I maybe waded a little bit too into the macro side of things because it seems like we're assuming that whoever gets elected is going to be inflationary.

[00:26:42] Which probably is true, by the way, on both sides.

[00:26:46] I think unfortunately they're both looking to spend some money.

[00:26:48] By the way, I look to sneak this now.

[00:26:50] As we wade into some political conversation here, anyone that has any issues with any of the statements today, you can email Jack.

[00:26:57] We'll flash my email address up on the screen here.

[00:27:01] I love getting more hate mail than I already do.

[00:27:04] Yeah, so I'll make some real agitating statements and comments here just to get to see some of my train mail.

[00:27:08] Yeah, I think you should.

[00:27:09] Definitely.

[00:27:09] I'll enjoy it.

[00:27:12] And then the last thing, you know, we talked about this key level, 5750, at September options expiration.

[00:27:19] We said that was the level you had to watch out of OpEx.

[00:27:22] And I don't state this to, you know, I admitted we took an L on this Tina, the rate thing, and that was interesting.

[00:27:29] But this one, you know, 5750 was the JP Morgan collar strike.

[00:27:33] They were short that call.

[00:27:34] And I have another side on this momentarily.

[00:27:36] But we had some volatility out of the FOMC.

[00:27:39] And then we moved right to that 5750.

[00:27:41] And we stayed there until September 30th.

[00:27:44] And then at September 30th, that position expired.

[00:27:48] And then we really started to move.

[00:27:52] Volatility really started to come in and we released that level.

[00:27:55] And so, you know, you talk about longer term investors and that's quarter end and stuff.

[00:27:59] And these are the levels that I think you can use to help you to allocate, right, when you're looking to buy or looking to sell.

[00:28:04] You can watch these options dates to take advantage of the relative movements and kind of allocate around those, around the timing of those big trades coming in.

[00:28:14] Just for people who are familiar with the JP Morgan thing, it's basically, you could explain it better than me, but it's a huge fund, right, that has a massive hedging trade that they rebalance at the end of every quarter.

[00:28:23] Is that like a high level what it is?

[00:28:26] Yeah, so they own a bunch of stock, right?

[00:28:30] They have a formula they use to buy mostly large cap stocks.

[00:28:35] And it's a $30 billion fund, so it's very large.

[00:28:38] And every quarter they roll a collar trade.

[00:28:42] So a collar trade is they sell a call, 3% to 5% of the money call that expires for the next quarter.

[00:28:46] And then they use that to buy a put spread.

[00:28:48] So generally what that looks like right now is they, at the end of September, they sold a 6,000 strike call, 6,055 specifically.

[00:28:56] And they use those funds to buy a put spread.

[00:29:00] And the idea is that if there's a huge tail event, right, the market really crashes, they have this hedge.

[00:29:05] If you look back at the history of that trade, that put doesn't go in the money ever.

[00:29:09] So, you know, it's unclear that this is actually benefiting anybody.

[00:29:15] But in theory, if we add kind of a doomsday event, then I guess it might.

[00:29:19] Because they don't ever close the position early, right?

[00:29:21] They leave it on to expiration.

[00:29:23] So that kind of limits the value of the position, right?

[00:29:26] Because if we crash, the put that they own could make money, but they don't hedge it or do anything to monetize that position at all, right?

[00:29:33] And so what happens into the end of the quarter, it becomes a hedging event to this talk on flows where there's a dealer who's short these puts, right?

[00:29:40] So if we're testing that downside put strike, the dealer's short the put.

[00:29:43] They don't want that put to go in the money.

[00:29:45] And so if you look back in 2022, that put strike was tested a few times, and we literally closed like five handles above it.

[00:29:52] So the put expires worthless.

[00:29:54] The dealer doesn't have any pain, and the JPMorgan fund didn't make it in their position.

[00:29:58] So it's kind of funny to watch.

[00:30:00] But in this case, we pinned that new strike is 6,050.

[00:30:04] And so that is a big year-end target for a lot of people, right, that 6,000, 6,055 level.

[00:30:10] You see a lot of banks targeting that for a year-end move.

[00:30:13] Just briefly, I'm just curious.

[00:30:14] Is it less important now?

[00:30:15] I mean, I remember hearing a lot more about it because people know about it.

[00:30:19] Or is it less important to the market than it used to be?

[00:30:22] No.

[00:30:24] We'd run through the collar strike a bunch of times.

[00:30:26] So what matters is the proximity to the strike as we get into expiration, right?

[00:30:30] And so it absolutely controlled the market over the last – at the end of September.

[00:30:36] And you can see that in the pinning.

[00:30:37] You can see that in the way the market moved.

[00:30:40] I mentioned that the macro guy is freaking out about the Powell comments on September 30th.

[00:30:46] Well, that was the day the trade rolled, right?

[00:30:48] So we had this big intraday volatility.

[00:30:50] People go, oh, it's macro, it's macro.

[00:30:51] And it's not.

[00:30:52] It's this big fun getting rolled.

[00:30:54] So the fingerprints of that trade are seen when we're near that strike.

[00:30:58] And there's some path dependency to how we get there.

[00:31:01] But the trade definitely matters when we're near it and kind of how we approach it.

[00:31:07] So as we move into our what is move section here, we are on NVIDIA because, again, it's the most important thing out there.

[00:31:14] Yeah, we're on NVIDIA here.

[00:31:16] And this is the JP Morgan trade.

[00:31:18] So you can see 5750 right here.

[00:31:20] And you can see this green and red candles when the day after the position expires.

[00:31:25] So all of a sudden we moved from FLMC.

[00:31:29] We locked into that 5750 range for about a week to 10 days.

[00:31:32] And then as soon as that position expired, we kind of wrenched our way out from that position.

[00:31:37] We're talking about positive gamma, right?

[00:31:38] That 5750 trade, when the dealers are long that call, 40,000 contracts to that call, it's a massive amount of positive gamma, which means that market makers are buying dips and selling rips around that strike, right?

[00:31:52] And it pins us there.

[00:31:53] So when that trade goes away, the market starts to shift and move around.

[00:31:57] But we were looking at, hey, it seems strange that the market would have this rally right now given the geopolitical backdrop.

[00:32:04] We had some flare-ups in the Middle East and that hopefully is calming down now.

[00:32:11] And then we have the election coming up and then the rate volatility.

[00:32:15] And essentially what you have here is you can mark the day that NVIDIA started to really rally, which is October 4th roughly.

[00:32:22] And the stock is up 10% to 12% roughly over these last five days.

[00:32:25] And at some point, the market just gets shoved up by that.

[00:32:28] And you can see that here.

[00:32:30] And if you look back anecdotally, you can see other points wherein this has occurred, right, over the last couple of months, where NVIDIA rallies and the rest of the market just ultimately gets dragged up by this, right?

[00:32:40] It's like you're holding yourself onto a car.

[00:32:42] If the car is going forward, well, you're going to get dragged down the street.

[00:32:45] And that's kind of the way that this shapes up.

[00:32:50] The other thing that's really fascinating about this dynamic is you look at the VIX, right?

[00:32:54] And the VIX is at 20 roughly, you know, 1997 today ahead of VIX expiration.

[00:33:01] Realized volatility at a one-month basis.

[00:33:03] So how much the S&P has been moving is at or near lows.

[00:33:07] We really don't get much lower than where we're at right now, which is roughly 9% realized volatility.

[00:33:12] So on a daily basis now, despite the risks that we all feel like are in the market, the S&P is really not doing anything, right?

[00:33:20] We're just grinding higher every single day.

[00:33:25] And, you know, yes, we're up 2% over the last five days, but that's occurring because we're just doing like 40 bps a day, right?

[00:33:31] So there's not a lot of market movement here.

[00:33:33] And what matters for this reason is because we talked about options expiration, suppressing volatility, right?

[00:33:39] So we have realized volatility, which is so the market's not moving at all.

[00:33:44] We have these big call positions that are built up into options expiration and VIX expiration this week.

[00:33:49] And this is all timing to say, okay, well, the market is moving about as little as it possibly can.

[00:33:56] We're going to remove all these options positions that are suppressing that volatility.

[00:34:00] And then we have this kind of election event looming in a couple of weeks.

[00:34:04] So this is a great recipe for a short-term correction in the market because there's essentially nowhere else for the market to go, in my view, right?

[00:34:12] We're basically pushed down on the floor in terms of how much the market is moving.

[00:34:15] And it's, you know, there's nowhere else to go.

[00:34:17] We're on the floor already.

[00:34:18] And so when you move these positions, we should have volatility expand.

[00:34:21] And I think, again, that leads to a correction in the market.

[00:34:25] Is that gap between the VIX and realized?

[00:34:26] Like, I would assume that's pretty wide relative to if you, like, carry it out throughout history.

[00:34:31] Yeah, that was a psychic question that you asked there, Jack.

[00:34:35] This is variance premium.

[00:34:38] So Yuan Sinclair has a great options mind, and he posts a chart like this in one of his books that basically says if you compare the VIX to one-month realized volatility,

[00:34:48] so that's the green line on this chart.

[00:34:50] So the VIX right now is at 20.

[00:34:51] Realized volatility is at 10.

[00:34:53] So there's a 10-point spread essentially there.

[00:34:57] And what you can see in this blue line is that's pushing up near the upper bound of the spread here.

[00:35:02] What does that mean?

[00:35:03] That means that the market is pricing in a lot more volatility than we've been getting.

[00:35:07] That's essentially what that's telling you, right?

[00:35:08] So people are worried about the future, even though the past doesn't really, you know, what's been happening in the market.

[00:35:14] It's been very quiet.

[00:35:16] So there's a real dislocation there.

[00:35:19] Generally, you only will get spreads this big during times where the market has crashed, and then you'll see a lot of fear come to the market.

[00:35:29] So, you know, an August 5th scenario, for example, where all of a sudden put demand or demand for hedges, you know, makes the VIX move up excessively, and people really freak out, right?

[00:35:38] That's where you get that kind of bigger spread.

[00:35:40] In this case, you know, people are hedging the election.

[00:35:43] So that is keeping the VIX and implied volatility bid up because we're obviously hedging that event.

[00:35:49] But the market is moving not at all.

[00:35:52] So usually what happens is this premium will collapse.

[00:35:56] And what you can see here is this blue line, which is around, call it 10, is going to move down to the long-term average, which is a three-point spread.

[00:36:02] You can see that here.

[00:36:03] And usually it'll overshoot a little bit.

[00:36:05] So we'll head to where maybe the VIX and realize volatility get a little bit closer.

[00:36:09] When that happens, the market generally rips, right?

[00:36:12] So when the market rips, the VIX gets sold.

[00:36:15] The VIX comes down.

[00:36:16] The VIX doesn't get sold.

[00:36:17] But options implied vol gets sold.

[00:36:19] Vol gets sold.

[00:36:20] And the VIX drops, right?

[00:36:21] And that pushes the stock market higher.

[00:36:23] And I'll explain how that works in a minute.

[00:36:25] So when these separate like this, I mean, I guess it could be – does it tell us anything in terms of how it gets resolved?

[00:36:31] I mean, it could get resolved in two different ways.

[00:36:32] And it could get resolved by realize going up or it could get resolved by the VIX coming down.

[00:36:37] I guess both of them are possibilities.

[00:36:40] Yeah.

[00:36:41] Excellent point there, Jack.

[00:36:42] And so in the short term here, I mean, it's very hard for the equity market to sustain realized vol of 16 to 20.

[00:36:54] We were doing it in 2022 a little bit where there was so much, you know, large daily swings.

[00:37:00] But unless we actually get a risk off event here, like, you know, more missiles start flying or rates materially jump or, you know, God forbid some event happens in the election or the election is just a mess and no one knows what's going on.

[00:37:13] Like we need a trigger for realized vol to actually sustain moving 1% daily moves, right?

[00:37:19] And 16%, you can use it as a benchmark, 16% annualized vol is 1% daily moves.

[00:37:24] So if the VIX is 16, that tells us that the market's pricing in 1% daily moves.

[00:37:28] Or if, you know, one month realized vol is 16%, that tells us we're getting 1% daily moves.

[00:37:34] So right now we're getting 50 bips, 60 bips daily moves.

[00:37:38] Not all that much.

[00:37:39] So to your point, either the VIX can hold 20 and we can have realized vol move up so that we start getting 1% moves.

[00:37:46] And I think in the short term, we could get bigger daily moves because the options expiration is going to drive volatility, right?

[00:37:53] We'll see some pickup.

[00:37:54] But what we have here is event volatility.

[00:37:59] People are hedging the election event.

[00:38:01] So odds are, like, anytime you go into a big data print or the FOMC or another event, odds are that traders are hedging the event because they're hedging their tail.

[00:38:10] But odds are the event is going to prove to be less than people's expectations, right?

[00:38:16] People are worried that, you know, we're one way or the other going to end democracy at this election, for example.

[00:38:22] Odds are the democratic process will work.

[00:38:25] Someone will be elected.

[00:38:26] That person will take power in January and we'll all move on with their lives, right?

[00:38:31] So, you know, as a betting person, you probably want to bet on that type of outcome.

[00:38:34] And so in that case, we may have some short-term volatility here.

[00:38:39] And then around the election, we're going to get some volatility because we'll have a result and the markets are going to react to that.

[00:38:45] But when you start projecting into, you know, mid to late November, markets are probably going to be pretty calm.

[00:38:51] They're going to start to calm down and that VIX is really going to drop, right?

[00:38:54] We're likely to see kind of like a 15 VIX and 10% realized vol into the end of the year.

[00:39:00] Hopefully that makes sense.

[00:39:01] It does, yeah.

[00:39:01] Your next slide gets at this idea of the election event premium.

[00:39:04] And this is one of the big lessons for me because if you look at the two previous elections, you had the first one where Trump won.

[00:39:10] And there was all this concern about, like Trump was obviously very, the word unconventional is probably the word to use, very different than anybody else.

[00:39:17] And there was all this concern about what he would mean for the country.

[00:39:19] And so there was tons of hedging going into that one.

[00:39:21] And then the next one, everybody was worried about the disputed election.

[00:39:24] You know, he's not going to leave the White House.

[00:39:26] So there was tons of hedging there too.

[00:39:28] So I'm interested to think about like this election relative to those in the context of what you're seeing in the options market.

[00:39:35] Yeah.

[00:39:36] And the implied volatility around this election was initially higher, meaning that it seemed like there's a little more risk priced in the market.

[00:39:44] And now it's flattened out a little bit.

[00:39:46] So I don't, you know, it doesn't seem to me to be the same risk that we saw priced into the market.

[00:39:54] I'm going to show you why that is.

[00:39:56] But what is most interesting to me on this is that, you know, to your point, when Trump was elected in 2020, I remember at two in the morning watching the futures market and thinking, this is the craziest thing I've ever seen.

[00:40:11] You know, like the market freaked out at first and also to just rally back.

[00:40:15] And it was like, at the end of the day, if you just slept through the election and woke up and you only cared about markets, I was like, OK, today's, you know, whatever day it is, Wednesday.

[00:40:23] And couldn't go about my investing day as opposed to getting ready for the end of the world.

[00:40:29] So in this case, what's so funny is implied volatility.

[00:40:32] So this is S&P term structure.

[00:40:33] So each one of these dots is the at the money implied volatility for all expirations.

[00:40:38] And you can see for post-election expirations were elevated.

[00:40:43] So we're about, you know, 15, 16 percent implied vol, which is pricing and 1 percent daily move.

[00:40:47] But before the election, the implied volatility is incredibly low.

[00:40:53] That cone there is 90 day values.

[00:40:56] And so we're at the bottom of that cone, which essentially tells you that markets are pricing in no market movement from now until the election.

[00:41:04] I think that is incorrect because of options expiration.

[00:41:07] We're going to start moving.

[00:41:08] The other thing about this is that when when people are projecting very low volatility, right, we saw the zero DTE straddle the other day priced at 40 bps, meaning that the market was pricing in just 40 bps of movement on the day.

[00:41:23] It's very easy to move more than 40 bps, right?

[00:41:26] It's up or down.

[00:41:27] That's not a lot of volatility at all.

[00:41:29] So when we price volatility at the floor, which is what we're doing now, if you get anything more than the lowest expectations, right, we have very low expectations.

[00:41:37] So we get just a little bit of volatility, like a 50 or 60 bps market movement.

[00:41:42] Then suddenly everyone has to reprice and that itself causes volatility.

[00:41:46] Does that make sense?

[00:41:46] Like you're anticipating a 40 basis point move, which is essentially nothing.

[00:41:50] And you get a 60 basis point move.

[00:41:52] Well, that's pain for you, right?

[00:41:54] You got to cover your trade.

[00:41:55] And that short ball cover causes volatility in and of itself.

[00:41:59] Yeah, it makes sense.

[00:42:00] It makes sense.

[00:42:00] Yeah.

[00:42:01] So it's a volatility cycle.

[00:42:03] We're at the low of implied volatility for short term options.

[00:42:07] We're at the low of volatility in terms of realized volatility, how much the market's been moving.

[00:42:11] We've had a big rally.

[00:42:13] And now we're going to trigger some position shifts starting with options expiration Friday and VIX expiration tomorrow.

[00:42:21] And so, you know, whatever the data points are before the election, there's some jolts numbers in here and GDP and blah, blah.

[00:42:28] Nobody cares, right?

[00:42:29] Just nobody cares.

[00:42:31] That's what this is telling you.

[00:42:32] Everyone's just kind of focused on the election.

[00:42:34] But we're so close to the election now that if we get a little bit of volatility, that volatility pricing is going to get sticky because the election is just two weeks away or three weeks away.

[00:42:43] So that's the catalyst here to have a pretty healthy correction, I think, over the next one to two weeks.

[00:42:48] If we had looked at the same chart, like for the previous two elections, I'd assume the spike would be bigger in the chart, right?

[00:42:53] People were hedging more for the election than they are now?

[00:42:56] Yeah, a little bit bigger.

[00:42:58] I think this has come down over the past week or two.

[00:43:03] I think that the implied vol will go up again as we get towards the election itself.

[00:43:08] So, you know, this is very dynamic.

[00:43:09] And I think when we get towards like November 1st, we'll see vol pick up because, you know, the election is really front and center.

[00:43:16] Yeah, and I think that's what we've seen with some of the other ones too, right?

[00:43:18] Like it picked up before and then everybody was worried, like once the election cleared, we were going to have this major downside event.

[00:43:24] And that's where these flows kicked in and we actually went up in both cases.

[00:43:28] Yeah, and there's a lot of hedges.

[00:43:30] There's a lot of tail hedges on right now.

[00:43:31] Again, I mentioned before, if you look down in the, you know, 5,000 area of the S&P, if you look at VIX calls, like people have hedged this event and the hedges are sitting there.

[00:43:41] And so, you know, they don't necessarily need to do anything more.

[00:43:45] Again, I think some people will just hedge, you know, the week before the election event itself because the argument is why carry, you know, the hedging, why carry that hedge over the next two weeks?

[00:43:56] That probably hasn't profited a lot of people very well, you know, because there's drag, right?

[00:44:00] There's carry costs with that.

[00:44:03] So, you know, we'll see what happens.

[00:44:06] I mean, you know, we're always one headline away from, you know, who knows what happens in this type of environment, unfortunately.

[00:44:13] So we'll likely see implied vol lift up for those post-election periods as we get closer to November 5th.

[00:44:20] So what are we seeing on this next slide with the election twist?

[00:44:23] Yeah, well, one of our core views was that we didn't think there would be a strong equity market rally into the election because implied volatility was likely to remain elevated into the election itself.

[00:44:35] And we also had the issue of, you know, this was we were thinking about two weeks ago, you know, the Middle East situation was not going in the right direction.

[00:44:42] And then rate fall, as I mentioned before.

[00:44:44] And so the idea is that there's this concept of VANA flow.

[00:44:48] And VANA is essentially telling us, like, look, when VIX or the volatility index goes up or implied vol goes up, that pushes the market down and vice versa.

[00:44:57] When VIX or implied volatility drops, it pushes the market up.

[00:45:00] And that's related to hedging flows.

[00:45:02] I'm going to tell you why that is in a second.

[00:45:04] And so the idea is without that VANA flow, right, without implied vol dropping, we didn't have this mechanism to shove the market up.

[00:45:12] What's interesting here is that in the last really two weeks, not even 10 days, we've seen people suddenly start to get worried about the right tail of the market and starting to sell off the left tail.

[00:45:25] So what you see here is this is for November.

[00:45:28] This is what we call November skew.

[00:45:30] So this is from 10-1 in gray.

[00:45:32] And 10 and today is in blue or teal.

[00:45:35] And what you see is put implied vol, so the implied volatility for downside strikes has dropped.

[00:45:40] So that tells us that the downside hedging pressure has eased or demand has declined, whereas the upside, and this is kind of the 20 delta calls, 10 delta calls, is starting to lift.

[00:45:51] So as the market has kind of rallied here, maybe because of the market rallying or people positioning, they're sort of linked.

[00:45:59] But we're seeing the put side get sold and the call side get bought.

[00:46:05] So the relative level of implied vol remains high, but we were literally just kind of rotating from what's called a put skew to more of a call skew, right?

[00:46:12] The calls are starting to get a higher implied vol than the puts, which is telling us that people are, for whatever reason, starting to position for a post-election rally.

[00:46:27] I am not here to say, you know, I have a few theories as to why that is, to the point on sending your hate mail to Jack.

[00:46:34] I would laugh about this a little bit because, you know, you don't know what the reason is.

[00:46:40] And I don't necessarily think it's that Trump is starting to pull ahead in the polls.

[00:46:44] I actually think this is more of an NVIDIA thing.

[00:46:45] But I put in this chart, this shows the, this is from Polymarket and Trump's odds of winning in Polymarket and some of the other betting markets has really increased recently.

[00:46:55] So green is Trump and purple is the spider close.

[00:47:00] And, you know, okay, it's only the last 10 days, but you can see the skew really moved at the same time.

[00:47:07] Correlation is not causation.

[00:47:11] I don't put this on as a, as a, any type of pro-Trump or, you know, pro-Kamala statement.

[00:47:20] Just showing that it was just kind of funny.

[00:47:22] There's this little correlation.

[00:47:24] And I think the reason I really want to show is because I actually don't think it matters in the short term.

[00:47:30] So I'm talking to the end of the year, who wins the election?

[00:47:32] I think as long as it's a clean election, we know who the winner is.

[00:47:35] We can all move on with our lives in the short term.

[00:47:37] There are these flows that are going to move the market higher.

[00:47:40] And so I don't know if the market is starting to like Trump policies and, or, or say, okay, we know what Trump is.

[00:47:46] And so like, let's all get long equities.

[00:47:49] Cause I think everybody assumes he's going to do what he can't move the equity market up.

[00:47:52] I really don't know.

[00:47:53] Uh, but if this, this slide upsets you, uh, Jack at OPEX.

[00:47:57] Yeah, exactly.

[00:47:57] But I also wonder if maybe people are like onto this election thing.

[00:48:01] Like, you know, we, we've had everybody worried in these last two elections and then we've had the rally after.

[00:48:06] So, I mean, I wonder if people positioning themselves more in calls as a function of like, they're trying to learn from these previous elections.

[00:48:11] I mean like, all right, everybody's always going to be worried in the election and we always get these rallies.

[00:48:14] Um, and maybe that makes it less likely we actually get the rally, but it's just interesting to me.

[00:48:18] Like maybe, maybe that plays into it.

[00:48:21] Yeah.

[00:48:21] And, and, um, you know, we're, we're talking about inflation before.

[00:48:25] And, you know, I think that one of the macro feelings I have is that, uh, both candidates and kind of all politicians are going to support inflation and pay policies.

[00:48:37] And so, uh, you know, if that's the outcome of this whole thing is that we're going to get more inflation than, than you got all in stocks, I guess.

[00:48:43] I don't know.

[00:48:43] Yeah.

[00:48:44] And, you know, I was mentioning this before we recorded and who am I to know anything about this, but like, I personally feel like the market probably wants gridlock.

[00:48:51] Um, they probably don't want either party to have complete control to do whatever they want.

[00:48:54] Like gridlock is, is a pretty good status quo outcome for the market probably at this point.

[00:49:00] Yeah.

[00:49:01] And I think you're, I think I, that's true, right?

[00:49:04] At the end of the day, as investors, we want, um, a relative level of certainty.

[00:49:09] Right.

[00:49:09] Right.

[00:49:09] And, uh, and as long as we know what, what the deal is, even if we don't necessarily like the policies, well, we can invest around those policies.

[00:49:16] Right.

[00:49:17] And, and yes, you want, you know, uh, you want good uncertainty.

[00:49:20] Like how many chips will Nvidia sell?

[00:49:22] That's some uncertainty.

[00:49:23] But at the end of the day, like give us a stable environment, uh, stable policies, things that we can, you know, count on.

[00:49:29] And, um, you know, I, I think at least in the short term, like I said before, regardless of who wins, we're going to have a couple of months of, you know, uh, who cares, right?

[00:49:40] Uh, there's still another president, um, in office and policies won't be changing anytime soon, kind of regardless.

[00:49:46] So as long as we get a clean election and we don't have one of these kind of hang, hang chad scenarios, uh, you know, then, then great.

[00:49:53] And, you know, the other thing that's just sad about this, about this world is, is I was thinking, you know, about assassination risk.

[00:50:01] Right.

[00:50:02] And, um, and it's just such a weird thing that we have to worry about that in, in this market.

[00:50:06] And, uh, you know, there, there was a headline that came up that said Trump was asking for F-15s.

[00:50:11] Never been, uh, I sort of like halfway, you know, wave my hand and laugh at that, but, you know, that, those is crazy things that you have to hedge in this event.

[00:50:19] Right.

[00:50:19] And, and, and that, does that drive some hedging demand just because you gotta, you know, these outcomes that just seemed improbable or have a small probability.

[00:50:27] I mean, it's, it's really, uh, it's a little bit of a crazy world.

[00:50:31] So if we can get a clean election, we get a new person in office, uh, either way, then, then the market can, can say great and move on with its, uh, move on with its day.

[00:50:40] So yeah.

[00:50:41] And let's hope for all our sakes, that's exactly what we get.

[00:50:43] Um, you know, because yeah, this is obviously a lot bigger than whatever's going on in the markets.

[00:50:46] And, you know, hopefully, uh, yeah, hopefully whatever it is, we, uh, we, we get a clean election and everyone accepts it and we move on.

[00:50:54] Yeah.

[00:50:54] Yeah.

[00:50:54] And, uh, again, Jack, uh, Jack is open for email.

[00:50:57] So if you, if you assume as a betting man, I'm just going to assume that the, you know, uh, that the outcome is we get an election.

[00:51:07] We know who the president is within a reasonable amount of time and, and the market resumes its rally.

[00:51:12] Now what's funny is 10 days ago, everyone was circling 6,000 as the year end rally.

[00:51:18] Right.

[00:51:18] And that seemed fairly far away.

[00:51:20] It was five ish, six, 7%.

[00:51:22] Now suddenly we're trading 5850 and 6,000 is not so far away in the S and P.

[00:51:28] And what's catches my eye there is there's this humongous call strike there.

[00:51:31] There's a ton of call positions.

[00:51:33] The JP Morgan call position is also at 6,055.

[00:51:36] Um, but that's pretty close, right?

[00:51:38] We're, we're not all that far away from that strike right now.

[00:51:41] Only 150 points.

[00:51:42] So 3%.

[00:51:43] Um, that is going to be very easy to make if there's a clean election and vol gets crushed and the market moves up at 3%.

[00:51:50] So I think 6,000 is very achievable.

[00:51:53] What I, if I was going to project, what I think happens is we pull back a little bit and then that 6,000 level, you know, is the, is the target when we're down around 5,700 ish.

[00:52:03] Right.

[00:52:03] Um, so that, that means we need a little bit more of a substantial year in rally to get into that zone.

[00:52:08] But for right now, you've got to watch these upside strikes of 6,000 to 6,055 as kind of a, an upside target area.

[00:52:15] And, um, the reason that we think that that is achievable is, uh, because of this volatility crush that we see coming.

[00:52:24] This, uh, um.

[00:52:25] This next one gave me a little bit of nightmares though, because, uh, going back to my CFA exam here, you've got the, you've got black shoals on here.

[00:52:30] And, uh, like option, option pricing was my biggest weakness on that, on that exam.

[00:52:34] Like it just, it made me so angry.

[00:52:35] It wasn't necessarily black shoals, but it was this other one.

[00:52:38] I don't even know what to use in the real world.

[00:52:39] This thing called the binomial option pricing model.

[00:52:42] Um, like I hated that thing.

[00:52:44] Like that thing was like, so you brought all that back up here with your, with your black shoals chart here.

[00:52:51] There's a lot of different models that are, are used by people.

[00:52:53] And, uh, you know, a lot of models have different strengths and weaknesses, but I, I just Googled, uh, black shoals calculators.

[00:52:59] I just want to make this as simple as possible.

[00:53:01] So, um, what I did here was I priced a reasonable, uh, kind of tail hedge, right?

[00:53:08] I just kind of plugged in, in an option, for example.

[00:53:10] So this is a 5,500 put, uh, that expires in, in about, uh, four months.

[00:53:16] So, you know, I just did a third of the year out.

[00:53:19] And what I wanted to show was, and I, and I just use this as an example, right?

[00:53:24] And it's a little bit of an extreme example to kind of belabor the point.

[00:53:27] So the reason that I highlighted Delta here is because Delta tells us from a basic level, how many shares of stock you need to hedge an options position.

[00:53:35] Okay.

[00:53:35] So let's just say for sake of argument, I bought this put and the market maker is going to sell me that put, right?

[00:53:43] So Jack, let's say you're the market maker.

[00:53:45] You sell me this put.

[00:53:46] But so Brent is long the put because he wants to hedge the election.

[00:53:49] Jack, you're short the put and you say to yourself, I don't want to be short this put.

[00:53:52] Uh, I need to hedge this out.

[00:53:54] So what do you do?

[00:53:55] We're just going to say for sake of argument, you sell 30 shares of stock, right?

[00:53:58] Because that's what the Delta is.

[00:53:59] And, and just to belabor the point here, 30 shares of stock is what you're short against your put.

[00:54:03] It makes sense.

[00:54:05] So that's with volatility at 30.

[00:54:07] And, and I just chose a near term kind of high round number, uh, depending on what option you choose and, and the expiration, 10 or all that, that volatility changes.

[00:54:16] So again, we're just trying to make a very simple example.

[00:54:19] So vol is at 30.

[00:54:21] Vol is at 30.

[00:54:21] The day after the election, let's just say, uh, candidate X wins, whoever your candidate is.

[00:54:27] And everyone's like, great candidate wins.

[00:54:29] What happens to volatility the next day?

[00:54:31] It sinks.

[00:54:33] Why?

[00:54:33] Because we have the clean election outcome.

[00:54:36] Everyone knows who the winner is and we can move on with our lives.

[00:54:38] It works the same way when you have an FOMC or a CPI data print or any other event that the market's waiting on.

[00:54:44] If the event goes off without a hitch, there wasn't some tail outcome.

[00:54:47] Vol immediately collapses.

[00:54:49] So all I did, the only difference between these two boxes is I switched vol from 15% to 15%.

[00:54:55] And that shifted the delta from 30 to 20.

[00:55:00] So Jack, you were short 30 shares of stock before against that short put.

[00:55:06] But just because the election went off, forget underlying stock movement, time passing, nothing else.

[00:55:11] All that happened there was the event came and volatility dropped.

[00:55:14] So now instead of owning or being short 30 shares of stock, you only need to be short 20 shares of stock.

[00:55:19] So how do you go from short 30 to short 20?

[00:55:22] You're buying.

[00:55:23] You buy 10 shares.

[00:55:25] So if you think about the hundreds of thousands of puts that are owned right now, and even VIX calls in the same way, right?

[00:55:31] There's all these tail hedges on, millions of positions, right, contracts.

[00:55:39] All of them are going to be repriced after the election, right?

[00:55:41] Vol is going to crush all of those put positions.

[00:55:45] And vol is going to come for sale, right?

[00:55:47] And that's the odds-on outcome.

[00:55:48] And so you could see through this illustration, then, when you extrapolate this from one single contract and 10 shares of stock having to get bought,

[00:55:54] suddenly you can say, okay, there's a lot of flow that could have to be generated, right,

[00:55:57] to the tune of possibly billions of dollars worth of flow.

[00:56:01] And that is the reason that we think that a clean election just knee-jerk responds by forcing the market higher into year-end as a result,

[00:56:10] just as an offset of the flows.

[00:56:12] And you could scream about so-and-so's various policies and things like that,

[00:56:15] but in the short term, I argue, you know, talking about into the end of the year or the kind of into, you know,

[00:56:21] November, end of November, this is the dynamic that is going to be most dominant in the market.

[00:56:26] And this is great because we talked about the previous two elections where everybody was panicked and the market rallied.

[00:56:31] I mean, this is using numbers and showing exactly why the market rallied.

[00:56:36] Because, you know, dealers had to buy when the event went through and we didn't get the bad outcome or didn't get the worst case outcome.

[00:56:42] Dealers had to buy, and this is why the market went up.

[00:56:45] Yeah, that's exactly right.

[00:56:46] And we have some more, you know, complex models at spotgamma.com for people interested in this,

[00:56:51] but I wanted to just show the most basic example of why this matters.

[00:56:55] And we think about the VIX at 20, and we were talking about that premium, right?

[00:56:58] The spread between VIX and realized vol.

[00:57:01] You know, that tells us how much vol can really collapse, right?

[00:57:04] So the VIX with a 10-point spread, right, if we go back to that chart here, oops, went too far.

[00:57:09] At a 10-point spread, you know, if you're talking about where we are a month from now,

[00:57:13] we're probably at like a three to, you know, two-point spread, right?

[00:57:17] And that's telling you that vol premium that's going to come out of the market, right?

[00:57:20] That's going to reprice those puts.

[00:57:22] It's going to reprice those VIX calls.

[00:57:24] Vol is going to be probably shorted, right, implied volatility.

[00:57:27] And that's all fuel to push the market up.

[00:57:31] So we're going to close here where we close a lot of time here, which is NVIDIA.

[00:57:34] Close where it started.

[00:57:35] Yeah.

[00:57:36] And I do recommend people go check out that NVIDIA industrial complex.

[00:57:40] You can Google Spot Gamma, OPEX Effect, NVIDIA.

[00:57:43] The links will come up.

[00:57:45] NVIDIA over the last same period.

[00:57:47] So, you know, I was admittedly sort of trying to agitate people to email you around the Trump polling thing.

[00:57:54] I don't know if that's the actual impact, but what I do know is an actual impact is NVIDIA.

[00:57:59] And you can see here right around the second or third, the stock really started to take off.

[00:58:03] You know, the NVIDIA CEO has made some pretty amazing claims about the demand that's coming up and the like.

[00:58:11] And in regards of if that's the reason or not, the stock is up about 18% over the last month.

[00:58:18] And the S&P is up about 4% over the last month.

[00:58:21] And so if this stock continues to move higher, I think that the rest of the equity market is just going to continue to go up as well.

[00:58:29] And, you know, the CEO is laying out this case to suggest that, you know, even though it's at all-time highs now, that there's plenty of room to grow.

[00:58:38] And the thing that I think that is most interesting about this is that even though we've rallied 18% over the last, really most of those gains were made in the last two weeks.

[00:58:47] There are times where we see the call options complex is so bid up, and we've talked about this in previous episodes, right, where the call skew is so elevated that you go, look, these calls can never pay off.

[00:58:57] This is way overbought and due for a correction.

[00:59:00] We saw it in Chinese stocks recently where call implied ball gets so elevated that you can buy a call and be right in that the stock goes up and you still lose money, right, because the calls are so expensive.

[00:59:11] Calls for Nvidia are very cheap.

[00:59:14] This is January option skew.

[00:59:17] The shaded cone is 90-day skew, and the teal line is where we are right now.

[00:59:22] And what catches my eye here is we're at well under 90-day levels, and this is with the stock up 18% over the last, you know, what is it, two weeks, which you think would generate a lot of demand.

[00:59:36] And so people have not started to flood back into the steam in the options space.

[00:59:42] And as long-term investors, if you watch where call volumes just get excessive and implied volatility for those calls gets to be extremely high, that is a signal that the stock has overbought, right?

[00:59:54] That is a signal of excess returns, I will say.

[00:59:57] And so what is fascinating to me right here, and we've been talking about this theme for the last few weeks, actually, is that, you know, you look at Nvidia, and if the market's going to go up, Nvidia, I think, will lead the charge.

[01:00:11] And I think that these calls suggest that people have not yet begun really to pile into this idea.

[01:00:18] And so if we get a broad market rally, we're likely to see ultimately kind of this positive gamma complex come into, say, the S&P, and it's really going to kind of throttle how fast and far the S&P can go up.

[01:00:29] But we're likely to see the opposite for Nvidia, where call buying demand forces market makers to actually buy the stock as it goes higher, whereas the S&P market makers may sell stock as the S&P goes higher.

[01:00:41] This all ties back into the themes that had dominated this year earlier, right?

[01:00:45] Correlation and dispersion were these big factors a lot of people were talking about, because Nvidia and the semis were going up, you know, 2x versus the Spiders.

[01:00:56] And I can't help to feel like these calls are very cheap and a very nice way to play a year-end rally, because if we do rally, you know, looking at semis or Nvidia,

[01:01:11] I think those would lead the charge and could prove to really help lift this, to really be profitable to own these Nvidia calls versus the index as a whole.

[01:01:21] And I would also say, you know, as a partisan kind of trade, you know, if Trump wins, we see long-term vol in Tesla be quite low as well.

[01:01:31] And, you know, Elon has made, obviously made it clear that he's shodding with Trump there, and the vol in that stock is pretty low as well.

[01:01:40] So two very interesting ideas, I think, there until the end of the year.

[01:01:43] Obviously, the next time we talk, it's going to be November OPEX, so hopefully we know who the election, who the president is, and we'll see exactly how the market reacted.

[01:01:51] Yeah, it'll be interesting to look at, like, post-election and see what we actually, what we thought might be happening relative to what did happen.

[01:01:56] Do we get the same pattern as the other elections, you know, where we get that rally in the backside, or do we not?

[01:02:00] It'll be interesting to talk next month and see what happened.

[01:02:03] Yeah, absolutely.

[01:02:04] And so hopefully this kind of laid out, you know, the dynamics here.

[01:02:08] And, you know, I hope everything kind of goes off without a hitch.

[01:02:13] And then we see vol get crushed in the market rally, so we can have some positive checkboxes in our column.

[01:02:19] Thank you, everybody, for joining us.

[01:02:20] Hopefully we can keep the hate mail coming to me at least to a minimum.

[01:02:24] But either way, we will see you next week.

[01:02:27] And maybe we'll start, remember Jimmy Kimmel used to have, like, the mean tweets segment, like, on his show.

[01:02:33] So maybe we'll have, like, mean emails to Jack's segment that we could put on as part of the OPEX effect going forward.

[01:02:39] I support that, yeah.

[01:02:41] That'll be fun to do, for sure.

[01:02:44] All right, we'll see everybody next month.

[01:02:46] Thanks so much, Jack.

[01:02:47] This is Justin again.

[01:02:48] Thanks so much for tuning in to this episode.

[01:02:50] If you found this discussion interesting and valuable, please subscribe in either iTunes or on YouTube, or leave a review or a comment.

[01:02:57] We appreciate it.

[01:02:58] The opinions expressed in this podcast do not necessarily reflect the opinions of Olivia Capital.

[01:03:02] No information on this podcast should be construed as investment advice.

[01:03:05] Securities discussed in the podcast may be holdings of clients of Olivia Capital.