Below is an automated transcript of our conversation. As it is automated, please forgive any grammatical errors.
[00:00:00] Brent Kochuba: Joining me today is Noel Smith of Convex Asset Management. And the reason I want to have Noel on today is because there’s all sorts of interesting things happening in the volatility landscape.
[00:00:08] And so I wanted to get a real practitioner on to help us kind of navigate some of those, things that we’re looking at. And just kind of try to get a better understanding of the landscape here.
[00:00:17] So Noel, how are you doing?
[00:00:18] Noel Smith: Doing good. It’s been a good day for us so far.
[00:00:21] Brent Kochuba: That’s awesome to hear. So, could you give us a little bit of background? I know from your Twitter bio there, you were a former market maker you’re at Noel Convex, by the way, so please check out his Twitter, but just tell us a little bit about yourself,
[00:00:31] Noel Smith: I started out as a floor trader on the floor of the CBOE a billion years ago, and I was one of those guys standing in the pit that would make markets and that kind of progressed for me, figuring out what time, you know, the market opened and then where the bathroom was to you know, doing okay, and then backing other traders.
[00:00:47] Then at some point we had really a trader in every pit, and then that kind of progressed into having guys, you know, in the Euro dollars and the notes guys on the Amex guys on the Phil X. And kind of, you know, backing a guy and wherever we thought there was some kind of [00:01:00] edge. And I grew that business to probably backed around a hundred guys in aggregate over the years.
[00:01:06] And then we were also the the seed capital behind what was Getco at the time. And that is now kind of morphed into Virtu. I have nothing to do with Virtu. But Getco bought Knight Capital when Knight’s algo went crazy. And then Knight kind of morphed into what is now Virtue.
[00:01:21] . But you know, market making market taking and, you know, kind of the evolution of all these things, you know, you start out as a market maker.
[00:01:27] And you just kind of give your bid in your offer. And then you kind of think to yourself, well, why is this individual trading with me? Or why is this pension fund trading with me? Why is there, why is there broker Goldman? Why is this other broker you know, Englander or something like that?
[00:01:39] Brent Kochuba: Right. That’s that’s fascinating.
[00:01:40] It’s, it’s I, I find that a lot of the guys now who seem to be with the best traders had that kind of floor experience. There’s something about just the nature of understanding. Kind of counterparties face to face. I think that you learn in a mentality, you learn that you kind of don’t pick up when you’re staring at a screen all day, ,
[00:01:54] Noel Smith: yes.
[00:01:55] And it’s also, it’s very hard to teach, you know there are, you know, there’s a finite amount of information you can learn [00:02:00] in the English language, right. But that doesn’t mean you speak well or in the options world. So you can learn whatever there really is to learn about options. But that doesn’t mean that you necessarily execute properly.
[00:02:09] Brent Kochuba: Right. That’s all. That’s the other thing. You have a great idea. As particularly in options, you just express it the wrong way and and you lose money. That’s probably the most frustrating thing about it sometimes. Totally. So tell us a little bit about Convex and what you’re doing now and a little bit of background there.
[00:02:25] Noel Smith: So convex is really the expression of something I’ve been thinking about since probably 2003, 2004, which is taking some of the best practices from the prop community in Chicago and really bringing them to investors. So the spirit of our hedge fund is to, you know, use ideas that investors don’t really ever get a chance to see.
[00:02:43] And most of our strategies are vol based, and you don’t necessarily have to express an idea that is vol based in volatility. Say you want to be long apple. Well, you can do that by being along the call, short the put. Or you can just be long apple and maybe you get your information to make that decision [00:03:00] from the options.
[00:03:01] So there’s just a million ways to make it a decision. And we tend to get our ideas from the options landscape, but it’s not always expressed in the options landscape. Now I can go into the strategies if you like, but depends on what you want to talk about. Sure. I
[00:03:14] Brent Kochuba: would say that that kind of hits home here.
[00:03:15] A lot of our subscribers are actually a future straighters. We get a lot of future straighter. They read the options market to understand, you know, where they want to. Put their stops out or where they want to buy and that kind of thing. And so your strategies, are you primarily, so you, so you trade all individual equities, S& P, kind of whatever goes?
[00:03:29] Noel Smith: Trade futures, options on futures, pretty much everything CBOE but a lot of products, you know, there’s some products that are hot for a day or two and you know, products that are hot all the time, you know, it’s a kind of fill in some of the blanks. So as a market maker. What you’re doing is you’re, you’re providing a bid.
[00:03:44] I’m dollar bid in a dollar 10 offer on this option. And then at some point, you know, it kind of dawns on you like, well, why is this guy paying a dollar 10? It doesn’t seem like it’s worth that much. And then you realize, well, he knows something or maybe he doesn’t know something and it’s just a really good trade.
[00:03:58] And then you have to kind of assess that through. [00:04:00] And then you think to yourself, like, okay, well, I can just, you know, I’ll pay a dollar five because these things are probably that my fair value Theo at a buck or five is probably wrong. Maybe it’s higher. And then, you know, the gears start to grind in the.
[00:04:13] The ideas start to come and then you mature from being a bid offer guy, trying to sell out your, your hedges in the middle to thinking, okay, well, what if I take the market? What if I’m also a dollar 10 bid? What if I’m a dollar nine bid, as opposed to being at a dollar 10, and then I can kind of move my markets and then express my ideas that way.
[00:04:29] So to me, it’s, it’s the kind of logical progression of things. That’s
[00:04:34] Brent Kochuba: That’s fascinating. So, on your screens there in the background, I know you’re not making markets anymore, but you know, those are some pretty, pretty heavy duty they look like what I would see as kind of on, on Market Maker, certainly Volatility Traders desktops.
[00:04:46] Are you, there’s a lot of foundations of your strategy now, they seem like spurred on by the Market Making, you know, background you have. But if we kind of dig into the strategy just a little bit, just get a kind of overview. I know you said you run a variety of [00:05:00] different strategies, but are you primarily trading volatility then?
[00:05:04] Noel Smith: Yes, because I feel like you know, is again, if you’re trading Apple, just stock, right? You still even whether you do or don’t you, you have some kind of convexity component implied in your position. And from that perspective, even though you don’t necessarily have on a volatility component, I could easily argue that you kind of do on because you’re trading something for something else.
[00:05:23] So is it better to have a you know, zero data expiration option in Apple? Or is it better to have, you know, 10, 000 shares of Apple, you know, only you know so we’re trying to Algebraically solve for different variables. What we think is optimal, optimal for whatever it is. So to answer your question, you know, talk about the strategies.
[00:05:40] You said you had a lot of futures guy futures guys. So one of our strategies is we’re looking at bond volatility. So we’re looking at the 10 year notes. And you have a, a yield curve, right? That goes something like this probably. And then within the yield curve, we all know this. You have a volatility surface and we’re only focused on the volatility surface.
[00:05:56] So what we’re looking at is the Theos and the volatility surface. In the 10 [00:06:00] year notes, and then we create our own Theos relative to what the market has, and then we basically smash, you know, mountains and by valleys. That’s kind of the gig. And sometimes we’re right. Sometimes we’re wrong. So going into like a GDP.
[00:06:13] Or something like that, you know, you’d say, well, the bond market says that the straddle is worth, I don’t know, 20 ticks, it’s not dollars, it’s ticks. And maybe we think that it’s worth, you know, less. So we sell 20 ticks or the other way around. You’re making a market one way or the other. And the software behind me isn’t that different than market making software.
[00:06:31] We go out there and we express our trades in vol space, typically as opposed to price space. So if I want to buy a dollar option, well, that could be reflected in a 30 volatility. But the dollar is a function of the price of the, of the underlier. So I’ll say, okay, I’m 30 bid. I don’t really care if the stock goes up a buck or two, I’m still 30 bid in ball space.
[00:06:51] Right. And that’s kind of, that’s kind of how we would express that. Yeah. And that’s, that’s what a market maker would do there. You know, they’re not really dollar bid at a dollar 10. They’re 30 vol bid at 32 vol. Right.
[00:06:59] Brent Kochuba: [00:07:00] Right. And that’s, and that’s where I think a lot of people. I don’t think there’s enough of that understanding in, in the, in the retail side of the equation, right?
[00:07:07] Because everything is very price based when you’re looking at your interactive brokers, your thinkorswim or whatever it may be. And people are constantly thinking that price backs out to volatility, but really the guys setting the prices are talking in vol terms and that backs out to price. It’s sort of the back way that I think a lot of people kind of think about it.
[00:07:25] And that’s one of the big differences, I think, between the retail community and
[00:07:29] Noel Smith: the, and the professional, you know, and I guess another big difference in, you know, this is not something that, you know, I often talk about, but it’s kind of, you know, burned into your brain on the floor, at least whenever you buy something, your immediate next decision is what can I sell against it?
[00:07:44] So, you know, if I buy a straddle, I’m immediately thinking about where can I lay that, that risk off some, it’s never going to be risk free are, but some kind of ARB and, you know, I still carry that forward. So when I’m buying straddles in ZN future options, I’m then looking out in time in a different [00:08:00] tenor, where can I sell that?
[00:08:01] Volatility in a different thing. And I understand that there’s basis risk there, right? Like some of my vol can go crazy, the vol can go not crazy. Fine. But that’s a risk that I’m willing to accept.
[00:08:09] Brent Kochuba: Are you finding in this current environment that the sort of the relative relationships that maybe you’ve held for 10 years ago, you know, stocks go up, bonds go down, or vice versa, or vol goes up, and market goes down or whatever.
[00:08:24] Are those relationships, I mean, it seems like they’re probably getting stressed or they’re acting in different ways, behaving in ways that are Not really what we’ve seen over the last several months and years, if that makes sense.
[00:08:35] Noel Smith: So there’s, we could talk about that for an hour, but we have four strategies and the point of us having four strategies, we can kind of toggle because I don’t think that you know, any one strategy.
[00:08:45] Maybe other than high frequency trading works all the time. So if you have a dispersion trade on, or you have a relative value trade on or whatever else say you’re the lumber guy, you know, a year and a half ago, well, your lumber trade is probably really hot, but that doesn’t mean that that lumber is inherently a better [00:09:00] product than gold or hogs.
[00:09:01] You just are in an environment where lumber is going crazy. And now it’s your time to shine. But once that stops. Maybe that paper dries up and your opportunity set really dries up. So that’s kind of why we have the ability to toggle through several strategies because, you know, like correlation trading is something that we do, you know, we, I did that years ago and then it kind of died and then then we kind of revived it and it wasn’t really the trade, it was the marketplace.
[00:09:27] So to answer your question more, more directly, you know, these relationships, like, you know. Bonds go up when stocks go down or rates do this, do that. Those relationships have been around for a long time. So it really threw a lot of people for a loop when those relationships that are like maybe, you know, anti correlated started becoming positively correlated.
[00:09:43] Stocks and bonds both down at the same time for a long period of time.
[00:09:47] Brent Kochuba: Right, right. So that’s, it’s a beautiful segue into kind of one of the first things that I wanted to, to get your opinion on here. And that is correlation. And I’m going to try to bring up my screen here. I’m [00:10:00] working on trying to say lists.
[00:10:01] I realize when I edit my own videos that I say it entirely too much. Let’s see here. All right. So one of the things that we’ve been talking about, which sinks into a couple of different things that I, I really want to get your opinion on. This is the SIBO correlation metric. And maybe you think that this.
[00:10:16] This correlation metric by and of itself is kind of useless and I’d be happy to hear that. But we have some interesting things happening in the volatility space and this is correlation which is at lows not seen since. You know, basically 2000 late in 2017. What do you, what do you kind of make of this as a, as a guy who runs a correlation strategy?
[00:10:34] I, I’ve had a hard time estimating one, how, how big the dispersion flows are, how big the flows related to sort of correlation are. Are they enough to really impact the market significantly? Or is this measurement kind of a reflection of just other behaviors in the market? So what do you kind of make of this in general?
[00:10:49] And, and do you have any insights you can? Shoot over to
[00:10:53] Noel Smith: us. Sure. So I am not here to talk my book, but talking a little, a little bit about it, [00:11:00] we’ll kind of explain the answers to your questions. So when correlation is really low like this, another, another strategy that we trade. is basically being short vol or short VIX.
[00:11:10] So when nothing is going on, what do you do? It’s a good time to collect premium. So what do you do with correlation down here in 2017, using 2017 as a, as a template or as a map if you pick off the position at the bottom in the 2017, on your chart, you missed a lot of opportunity. It’s it continued to work really until January.
[00:11:32] So. A lot of people basically didn’t add enough size or they took off their book, trying to time it and they, they, they really threw away about six months worth of PNL and that PNL did reverse in January going into 2018 into Valmageddon, but the correct way to look at it was really more in isolation.
[00:11:53] It’s so easy for you to look at. Where was something relative to something else, which is the point of a chart. But if you look at where’s realized [00:12:00] vol relative to where it’s implied, whereas realized correlation relative to where it’s implied, it’s probably still a do. And we actually added some size yesterday, which a lot of people would be like, why would you add size down here?
[00:12:14] You know, but, you know, going back to 2017, if you sold VIX at 11, a lot of people would tell you that you’re reckless and crazy. But what if I told you that VIX or S& P vol was realizing six? It was still a do. That spread was still wide enough that you could mathematically and mechanically trade that for profit.
[00:12:33] Brent Kochuba: It’s a it’s a, it’s a great, sorry, my screen’s kind of gone wacky here. You bring up a fascinating point in the realized correlation between versus sort of the implied correlation. This is actually from our, our founder’s note this morning, right? This daily note. And, and this is sort of what they call the variance premium.
[00:12:48] You know this better than better than I do. Basically one month realized volatility versus the VIX. And that was sort of the point that we made this morning is that realized is at a nine. And. [00:13:00] So the VIX at, you know, 13 or 14 or whatever it was yesterday, if you look at a long held relationship and say, okay, three kind of points difference between realized volatility and the VIX, then the VIX should be at 12.
[00:13:11] That’s reasonable. That’s kind of the exact same thing you’re saying just in this correlation space.
[00:13:16] Noel Smith: Yeah, if you’re just saying that Y trades over X by by Z, right, maybe that number is three and a half. Maybe it’s 30 doesn’t matter. And then you just say, okay, I have some kind of boundaries around this, you know, so if, if Y trades, you know, five, that’s too high, I’m going to sell some wise, why trades one, that’s too low, I’m going to buy some wise, because that function is the spread.
[00:13:34] And whenever you’re doing something in wall space. Not always, but often, it’s relative to something else. And the relative trade there is still good enough for me to say that you should have it on.
[00:13:48] Brent Kochuba: And this this is the long term realized volatility, one month realized volatility is in green. Sorry for that background noise there.
[00:13:54] And, and in October of 2017, we hit the, what I think is [00:14:00] the all time realized volatility low. I think it was 3. 5. There are, there seems to be a seasonality to this and, you know, to your point later, you missed a lot of P& L. I got a lot of questions coming out once here. Do you see a reason for the seasonality where Realized Ball seems to kind of hit its lows in the October timeframe, you know, November timeframe?
[00:14:23] I mean, you can see the cycle here, right?
[00:14:25] Noel Smith: There’s two quick analogies. You can think of, you know, you know, gamblers at a table. I live in Vegas, but ironically I don’t gamble because I can’t, I can’t, I can’t stand giving up edge. It’s just, that’s the traitor in me. So when I know the table has an edge, I can’t do it.
[00:14:36] But anyway, so if you populate your table with people that are there to likely mathematically lose, then they do all lose in time, which everybody does, then they go away, either they run out of money or they’re pissed off and they leave and. Then you wait for new people to come in and that’s the ebb and flow cycle of this stuff.
[00:14:55] So, you know, and again, if you have no book on because you’ve lost your book, [00:15:00] who cares about the hedge, right? So puts and hedges in general in the last 18 months have been terrible. They’re not even bad. They’re just straight terrible. So a lot of the money that has been allocated toward the hedge book.
[00:15:14] Has it been evaporated? So a lot of people took it off. And so that’s, that’s part of those two cycles, right? You need more suckers at the table to engage. So you need the Varswap community to sell Varswaps. You need the the VAL ETPs, VXX, XIV that doesn’t exist anymore, or the NERFT SVXY. You need those products to need to add more notional vega so that those things can become dangerous again.
[00:15:37] And they’re not, they’re more dangerous now than they were a year ago, but they’re nowhere near at the levels that they were in February, 2018. So the needle is not banked in the red. In other words, if VIX goes up a hundred percent and the inverse products will not go down by the same magnitude that they did.
[00:15:53] Because of force covering in the last 15 minutes of trading in February 5th, 2018.
[00:15:59] Brent Kochuba: [00:16:00] Right. And I, you had an interesting chart on your Twitter feed about that. I think it was Morgan Stanley put out a, a no, a vague and notional kind of exposure which. Brings me to another question. Also, if anyone does have questions, I see someone just put in the chat, if you do have questions, put them in the Q& A button there and we’ll hopefully have some time at the end to kind of get over to this.
[00:16:19] VIX, so VIX call open interest at the moment, this isn’t related to the ETPs necessarily, or ETNs rather. VIX call open interest, I don’t have the chart up here, but it’s at, you know, record highs or it’s rivaling 2017. There’s also a tremendous amount of S& P put open interest. And I don’t think you can explain.
[00:16:37] All of that through kind of just zero DT and shorter data options. But what do you kind of make of that size that’s built up in the VIX? I mean, what do you think is the. The driver of that open
[00:16:47] Noel Smith: interest. There are two separate questions. Cause VIX is it more of a VAR swap and S& P puts are more of a, they have a strike component, right?
[00:16:55] So if you, if the market’s trading at 4, 000, if you want to hedge, you know, at the 3, 900 [00:17:00] strike, right? Then you go out and you buy your 3, 900 puts. But if the market then goes to 4, 500, your 3, 900 puts are worthless. So you have a component that is. Diminishing and a diminishing at an accelerating rate versus in VIX space.
[00:17:13] You can say, well, VIX at 20 is, is, is a certain percentage of the standard deviation of the moves to the next year, and it will be in three months. So it’s a cleaner way to, to buy that vol than just saying, I’m going to buy the 3, 900 puts because of the strike erosion, which speaks to the, you know, the charm and the Vanna concepts that I know that you also talk about.
[00:17:35] So there is a difference in those two, because if vol goes to 20 and you own the 20 calls, that’s different than if you own the 3, 900 strike puts and the SMP. We’re at 4, 500. So they’re not ever probably going to work. So those things are probably just going to go to money heaven. So those two things are different.
[00:17:54] And the reason there’s so much open interest is because those levels have come down a lot. And a lot of those puts that are there as a legacy [00:18:00] are an artifact of previous hedges. And they also have to, they’re now they were bought for four bucks and now they’re four cents. And so if those things do get reinvigorated, they will act as a vol suppressor on the way up.
[00:18:11] Hmm.
[00:18:12] Brent Kochuba: And, and so when you, I mean, it seems like there’s a fair number of chunky VIX call positions that go up and, and I, and I take those to be, you know, the kind of 50 cent guy, right? Where, you know, for those of you who don’t remember 50 cents, you would buy these 50 cent these calls that cost 50 cents, right?
[00:18:29] And, and he basically just kept repeating it until one day finally things broke and, and VIX, you know, spiked and made a whole bunch of money and then he kind of went away, right? Are those the, those the type of trades that you, are they speculative trades in your view? Some of those hedges or, you know, are they more, are they actually hedges rather than speculation, do you
[00:18:45] Noel Smith: think?
[00:18:47] Well, I know, so I don’t have to guess. Oh, they are hedges. Okay. So when you, when you have a you know, a 20 billion book. And you go out and you buy, you know, a hundred thousand [00:19:00] 50 cent calls is spending 5 million worth it. If you can use that as a marketing adjunct to your investors for your 20 billion book.
[00:19:10] Yeah,
[00:19:14] Brent Kochuba: that makes sense. And, and that, how do you, so I guess one of the things that I have a hard time kind of like cross referencing in my head is, is the record open interest, which, you know, I think in general, when I feel like there’s high open interest, you would say, okay, that, that it seems like there should be, Yeah.
[00:19:29] You know, larger amounts of notional exposure. I don’t know if you’re familiar with what’s on your screen here. It’s the Nation Skew, Skewdex, and it looks at put skew. I think it’s a one, it’s a one month at the money put versus a one standard deviation down out of the money put. And so, you know, when you look at this this implies that, Obviously puts are just getting sort of trashed and those put values are and those charts are kind of making the rounds I don’t know some people are saying well, you know rates are higher and it’s not apples apples and all those kinds of things I mean, how do you look at the the relative price of [00:20:00] volatility now?
[00:20:00] I know before you talked about, you know realized it implied but Do you, do you think that this is unnatural kind of, if that question makes sense or there, there, there is a level here of exposure where we’re sort of pushing on a string based on the fact that these put values are all, are all sliding so much lower?
[00:20:15] Noel Smith: The, the component here that’s often not discussed is time. So if you look at price, you can say, okay, well, these you know, these VIX calls are cheap because they’re a buck and, you know, they haven’t been this cheap, which is, you know, call it a 15 vol. You know, that is as cheap as they’ve been in the last 18 months.
[00:20:32] But what happens if our dollar doesn’t move for the next 30 days? It’s magically turned into zero yet again. So it’s not just price as a function of where it’s been. It’s also a function of time. And most people know that vol has a stickiness component. It tends to cluster that goes into the GARCH modeling, right?
[00:20:48] So you say something like, well, what’s the weather like tomorrow? It’s probably like it is today. It might rain, but probably won’t if it’s not raining today. So that is that kind of concept is, this is mathematically borne out into [00:21:00] this, which is to say that vol could be sticky at low levels, which is that a 12 vol is not necessarily cheap.
[00:21:07] It’s cheaper than what it was last month or last year. Fine. But as a function of time, it’s probably fair.
[00:21:15] Brent Kochuba: That makes sense. And so the way that turning that slightly, then if we were to just get a. A small brief sell off here, you know, God forbid we go down a couple of points. That vol is going to relatively spike, right?
[00:21:28] And, and if I understand what you’re saying, obviously there is these kind of feedback loops that, that are occurring and, and help to push volatility lower and lower. And so if we were to get a move down here and the VIX kind of just jumped on us a little bit. That would mean that that volatility is, granted there’s a bunch of other factors, but that volatility is relatively rich, right?
[00:21:48] And so you’re likely to get a response from, you know, volatility sellers or whatever based on that volatility clustering that would kind of suppress the first move, if that, if that question makes sense.
[00:21:59] Noel Smith: It does make [00:22:00] sense. I think your answer is embedded in your previous question, which is if we have a lot of VIX open interest, that means people have these calls, right?
[00:22:06] So if you own the 20 calls and you bought them for 3 months ago, and now they’re worth 3 cents and then, you know, the VIX spikes and you’re like, wow, my 3 cents turned into 50 cents. I’m pretty happy about that. So now I’m going to go out there and hedge some of this, take some of my money that kind of got gifted back to me.
[00:22:22] And that ends up being another reflexive loop. So. It’s a function of the, you know, the behavior of crowds, which is something you can learn really easily on the floor. I know that, you know, you weren’t talking about yourself, but this speaks to the whole, like gamma suppression and charm. And whenever you let me think about this more clearly, if you’re a floor trader, right, there’s 10 guys in your pit and you’ve been on vacation.
[00:22:45] And for the last five days, brokers have come into the pit and done nothing but sell volatility and you haven’t been there. So now there’s nine guys in the pit. That all are just soaked with gamma. They have tons of it. So they keep lowering their price and now you [00:23:00] walk in after being on vacation and you’re like Gamma is really cheap.
[00:23:03] I’m going to buy some. So you don’t have the same problem that they have because now they have to carry that theta every day from a higher level. And you can walk in advantageously and buy at the best prices or the flip side, sell at the best prices and knowing their position or knowing the, the, the open interest of the nine guys around you is helpful.
[00:23:24] It’s not necessarily, doesn’t mean you can make money necessarily, but it’s statistically more likely. Event than having just no awareness or being guy number eight,
[00:23:35] Brent Kochuba: it’s the, it’s the positioning aspect, right?
[00:23:37] Noel Smith: Yes. So if there’s, if there’s a ton of open interest in VIX and everyone’s long a bunch of these calls that are almost worthless Or if they become worth something yet again, hedging activity will come and act as a valsal pressure yet again
[00:23:49] Brent Kochuba: and then Until something sort of breaks that cycle which you know, obviously in 2017 You had the issue of every time we got like a little kind [00:24:00] of local volatility pop, right?
[00:24:01] Then everyone said oh great Finally I can sell this vol because you know, we’ve been we’ve had a vix of nine So a vix of 12 is really great. I can I can sell you know These etns against it and then and then finally that that positioning just broke things, right? Yes.
[00:24:15] Noel Smith: So I would argue that. So a lot of people think that it was the notional Vega that caused it.
[00:24:21] You know, so I was trading it live in real time and the, the best contemporaneous indicator I had at the time wasn’t really the volatility or the Vega on it. It was the, the borrow aspect of the product. So in the, in the broker community, they were shopping around the risk reversal or the reversal.
[00:24:37] Right. So. What was happening was, you know, reversal is really a function of interest rate and how much the borrow cost is going to be. So the market was like 0. 25 and then it was being shopped at 0. 27 and then 0. 32 and 0. 40, etc. So if you know kind of how options in the create redeem process works within ETFs, you know that shares are getting more difficult to borrow and therefore the reversal is starting to expand [00:25:00] and then people are trying to buy it.
[00:25:01] So what that means intuitively is that this thing is going to become more volatile because there’s less of it.
[00:25:08] Brent Kochuba: Do you, do you think I hadn’t, I hadn’t actually really heard this angle. So it’s really fascinating. But do you think there was, I’d always thought that, you know, it was, it was known certainly by the institutional community that there was this level at which I think the VIX doubled.
[00:25:21] But basically in the perspective, it says, look, VIX doubles product XIV is gone, right? Yes. So, I’ve, I’ve long thought that, hey, people knew this was existed. There are a lot of people who held, you know, basically very deep, you know that were betting on the extermination of that product, that product sort of imploding.
[00:25:39] At what point, or maybe this point didn’t exist, but at what point do you think it was like, Hey, you know, this, the, the, we’re almost at that level where this, this XIV thing is going to blow up. Like we can just give volatility or the VIX kind of a little bit of a shove here. And, and spark it a little bit higher.
[00:25:53] Is that. I mean, is that something that occurred, do you think, or is that just my kind of conspiratorial mind working?[00:26:00]
[00:26:00] Noel Smith: I don’t know is the super duper real answer, but I think that it was a little bit of both. I think that there was a very strong awareness of what that tipping point would be. And I don’t know that anybody specifically did the tipping, but I think that once the tipping started, everyone put their finger on the scale.
[00:26:19] To just whale on it. So if you could, if you were looking at the net asset value in XIV or SVXY, you could see it in real time. These things is like, you know, 90 bucks, 70 bucks, 40 bucks, 10 bucks, you know, and these things are just getting whaled on. And you’re just like, you’re watching this thing like, what?
[00:26:36] And this is happening in the space of like 15, 15 minutes. So if you remember that day, the products were all down very large going into the clothes, but they didn’t die until after the close. So everyone knew how much in the front running community knew how much futures needed to trade in order to rebalance these things.
[00:26:53] And they just front run it. They just, it was just, it’s an obvious and easy trade if you’re poised to do it.
[00:26:59] Brent Kochuba: Right. [00:27:00] And like when, when
[00:27:01] Noel Smith: I’m sorry, I said, when, when oil went negative you know, if you called up your guy at Cushing and said, Hey, listen, you know, I need to take physical delivery of a few. You know, million barrels, you know, I soak up some space.
[00:27:14] If you were able to, to to figure out physical space, you could buy as much oil as you had space for a negative 35 bucks. It’s great money for you
[00:27:23] Brent Kochuba: to store it
[00:27:24] Noel Smith: where you’re going to put it. Great. Here’s your oil. Now,
[00:27:28] Brent Kochuba: that’s too funny. I, so I want to pivot slightly back to, to dealer game and, and we had some notes that, you know, we sent over and talked about, and, you know, that’s a lot of kind of how we model things or look at the world and good, bad, or indifferent.
[00:27:44] I wanted to get your sort of. Take on how you look at that kind of positioning gamma and you know, you’re well aware of all the other metrics that get put out here. What, what sort of, where do you think it holds weight and, and, or doesn’t, or what are the [00:28:00] aspects of that you may pay attention to? Or is it just kind of in general, something that’s like.
[00:28:04] Nice to know, but you know, what’s your, what’s your sort of feeling on that? And I, and I duck with this question, cause you know, maybe you’re going to like, this is all useless nonsense. And but you gotta ask the question.
[00:28:16] Noel Smith: Yeah. And I think that it honestly, it speaks to your you know, your willingness to, to, you know, cause we didn’t talk about this ahead of time, so nobody knows what I’m going to say and your willingness to kind of be pushed back on.
[00:28:25] Yeah, exactly. So your willingness to do this live really speaks to your integrity. I think that the. The structure of the trade has merit. It’s not, you know, it’s not working all the time. We both know that sometimes these things don’t work. And what percentage of the time does it work relative to how you would model it is the real question, I think, you know, like, so if you go out and buy a straddle and you say that my straddle should hold something like one standard deviation of the time, that’s, that’s, that’s a more specific question that I think.
[00:28:54] That’s where I think the root of this should really be. So if you’re saying that there is this probability, [00:29:00] there’s a probability cone around this event happening, and that I don’t think that the cone will be violated to the up or down, and then you assign some number of events to that and number of events, I think that is where the value starts to be added.
[00:29:13] And so you’re not saying this can never happen, or that will never happen. You’re saying this is the more likely event in all else being equal. This is what’s probably going to happen. And I think that’s where it does add value. Because if there is, you know, extraneous, exogenous news all bets are off, right?
[00:29:27] There’s new information. Or maybe there is a shift in the Fed Fund futures. And then allocators start coming in and, you know, just VWAPing a stock all day long, or VWAPing the spoofs all day long. And they don’t care about your gamma levels, right? They’re just, they, they need to go out and buy a hundred, you know, 10 billion worth of stuff and your gamma levels be damned, but in absence of those types of macro events or news events and nothing else is going on and guys are just kind of just doing their own little thing.
[00:29:53] They do act as a sticking point. Going back to my pit example, if everyone has. A certain amount of gamma in the pit, and [00:30:00] I don’t, and I know that they’re going to hedge around this certain level because they all have to cover their theta. So if the collective theta in the pit is 100, 000 a day, so I can mathematically compute that at the stock down or up 100, 000 in break even P& L, there will be some hedging activity because guys can’t afford to waste that theta.
[00:30:21] I can reasonably do something at that inflection point. And that’s really pitch rating one on one, maybe one on two. And it’s, it’s the same concepts, but with different words.
[00:30:33] Brent Kochuba: That makes a lot of sense. So if I was to give you, you know, a single stock example, I’d be curious to how you’d look at this. You know, you talk about me mania and gamma squeezes and all these kinds of things.
[00:30:43] How, how would you sort of, and I think it’s harder now because it’s all electronic, obviously, but, but how do you sort of know, or how do you measure? My guess is with implied volatility, but how do you sort of measure like, okay, this is a situation where clearly, you know, one of the dealers or whatever short [00:31:00] gammon, you know, Chipotle or something like that.
[00:31:03] And, and, and the chase is sort of on what are, what are some of the signals you may look at or go like, Hey, this is a, this is kind of a long volatility situation based on positioning of.
[00:31:13] Noel Smith: So again, I don’t have to speculate. I can just tell you what I did in real time. That might probably be more entertaining and certainly more specific.
[00:31:20] So using GameStop and I had other positions in the meme stocks other than GameStop and using that as a template, I was short GameStop at 32. I covered for a loss. I was short game stop at 47. I covered for a loss and a short game stop at 67 covered for a loss, bought it at like 70 something and wrote it to the top.
[00:31:39] And then I sold puts when the straddle was like 400 bucks. So it was a gigantic winner for me, but I had no idea. So exactly answering your question, when things become so irrational, whereas you start to figure out people are blowing out. Then you pile on and that’s when it gets extra violent. That’s what, you know, the, the counterparty goes from having like a bad day or maybe a bad year to [00:32:00] being out of business.
[00:32:01] Brent Kochuba: Hmm. Yeah, I, I, you know, I think it is pretty amazing that through all that, you know, cause there’s, there’s only six or seven now large, you know, options, market makers, and I think Citadel is like half the flow. Right. And, and. And it’s pretty remarkable that through all that, you know, wild, crazy times, like the sort of those entities never seem to really come, come under stress.
[00:32:25] At least it was never sort of publicly made there. Right. And I do think that’s kind of a testament to how good those liquidity providers are. I mean, I think a lot of people, you know, admonish them a little bit, but it is pretty impressive that that things work pretty smoothly through
[00:32:38] Noel Smith: a lot of that industry.
[00:32:38] Ev everyone thinks that they have everything figured out at all times, and I am in no way denigrating these people because I know a lot of them. They are smart people. But to assume to assume that any organization or any group of small group of people have everything figured out is also giving them too much credit.
[00:32:54] You know, some of these organizations definitely lost money the first day of GameStop. And that’s why you went, you saw the [00:33:00] straddle expand from being high to being insanely high. Right. So in order for you to continue to make money in GameStop, I think it had to break a thousand dollars or something like that.
[00:33:08] And so basically the attitude on the market maker standpoint was, you got me once, here’s your new price. You’re not going to get me again. Yeah. And
[00:33:16] Brent Kochuba: I, do you think that sort of the echoes of that, I mean, it feels like that to me, that the echoes of, of that meme mania kind of persists today where it seems like there’s, there’s a lot more jumpiness in pricing, like the vol of vol seems to be, or the vol of volatility pricing.
[00:33:30] I don’t know if I’m saying this right, but it just seems to happen a lot quicker. Like, okay, this name looks like it’s going to squeeze. And then suddenly like, you know, calls go from, you know, 20 vol to a hundred, a hundred percent or something like that. Is it, do you think that? There’s that echo in place still, or, or do you think that the price reaction to movement is more or less the same as it’s
[00:33:51] Noel Smith: been?
[00:33:51] It is definitely not. It is discontiguous. That’s where the Black Scholes model really falls apart. And if you think about this from an intuitive standpoint I’ve used this [00:34:00] analogy before, but I think it’s a decent one, you know, say that you Brent are a you know, a BMW wholesaler. Right. And I call you up and I’m like, Hey Brent.
[00:34:06] And I’ve got two BMWs to sell. And you’re like, okay, fine. I’ll pay 50 Fine. Now you own two. And I call you back up 10 minutes later. I’m like, I got five more. You’re like, you know, what’s your bid now? You’re like, I don’t know. I just paid 50 for two. I’ll buy four for, you know, 48. Fine. Now you own six. And now I call you back up 10 minutes later and I sell you 10 and you’re like, dude, why didn’t you just tell me you had all these cars?
[00:34:26] And then I call you up an hour later. I’m like, I have 10, 000, you know, so your price isn’t going to be 50, right? Your price is going to be 50, 49, 45, 35, 2, because at this point you think that all BMWs are radioactive or whatever else. You have no idea what’s going on, but you’re, you’re making a market such that you feel like you can’t lose.
[00:34:47] And market makers do the exact same thing. Right.
[00:34:51] Brent Kochuba: And I, and it. The number of new products coming on, and I guess this is translating, we’re transitioning now to kind of zero [00:35:00] DT, which I wanted to ask about. There seems to only be new products and more access and all these things, which I think is great for the average trader but it all sort of.
[00:35:08] Serves to provide a tailwind to that, to that volatility or that was wild BMW prices. I guess
[00:35:17] Noel Smith: there’s a lot of embedded questions in there. I, so we, we trade zero data expression options. I’ve been trading expiration options for 25 years. So that part is, isn’t new. The, the volume is insanely new. That’s all crazy.
[00:35:29] The fact that you can do it on a daily basis in the index is, is very new. Now, I think it’s great to be honest with you. And I don’t feel at all that it’s the systemic risk that I’ve seen in the media for a variety of reasons. I just, I think that if you look at the hedge book and the market makers that are their counterparties for this stuff in general, they’re going to make money from it.
[00:35:46] And if you, the chance is that you are going to buy a million options and, you know, you’re going to simultaneously wreck Susquehanna, Wolverine. You know, virtue Citadel and everybody [00:36:00] else, it’s just never gonna happen. Yeah. You know, those guys are hedged to other d other parts of their book and the chance of you getting all of them at the same point and just wrecking the entire landscape.
[00:36:09] I just don’t see it. Yeah.
[00:36:11] Brent Kochuba: And the, and the, the, the, the JP Morgan study itself that they were talking about is they, they basically lock the market and, and assume that no one would ever take off any of their exposure. And I think that is, Holy and accurate, because if you’re sitting here in the marks down 3%, you’re gonna start closing some puts at least some people would write and that would really, you know, kind of your topic, kind of back to what you’re talking about before where you’re in the pit, you know, people are going to cover that.
[00:36:35] There’s going to be a cover scramble there, which is, which is the main reason that I thought the JP Morgan didn’t make a lot of sense.
[00:36:41] Noel Smith: And by the way, I think that I don’t usually talk about the pit that much, but a lot of the trade logic really does apply. So if you think about if you’re in a pit and you have a million dollars in your account and that’s all you have, right.
[00:36:52] And you know, you’re getting close to your, you know, still problem, you might get fired or whatever else, you know, what do you do? Well, in real life, what [00:37:00] happens is dudes just leave the pit. And the electronic version of that is they just pull their quotes or they widen their spreads such that they don’t really trade.
[00:37:07] And that’s just the electronic version of literally leaving the pit. Hmm, it,
[00:37:12] Brent Kochuba: it, it it makes a lot of sense to just done like electronically. On, on the screen here, and I don’t know if you have any insights on this is kind of a little bit of a curveball question, but the, but the white line, while there’s a lot of noise here, the white line is zero DTE volume as a percentage of SPX.
[00:37:26] You know, it increased significantly in, in early 2022 as the, I think it was the Thursday or Tuesdays were announced first and then the Thursdays, whatever. So basically by October we had, you know, full daily expirations in the SPX and full daily Qs. One of the things that I think is interesting is that the percentage of volume has been very stable and I think only once it’s, it’s broken kind of the 50% of volume level.
[00:37:55] As you can kind of see here with the, with the white line you know, what’s interesting [00:38:00] to me is there was this very rapid adoption of the zero DT in terms of like, it became almost immediately upon launch, you know, 40 to 50% of volume. And it’s basically stayed at that level, which tells me that, you know, whatever the use case for this, if there wasn’t the edge to how people are trading or use for how people are hedging or whatever it may be, right, that hasn’t expanded, right?
[00:38:21] So what do you think is the prime use case for zero DTE? Do you have anything to make of the fact that You know, it’s been very stable in terms of its utilization. Kind of, how do you look at this in
[00:38:33] Noel Smith: general? Yeah, I can answer all that. So I think that if zero DTE, the fact that it became a everyday thing when the market was coming off of a drawdown is very relevant because, you know, stick with the BMWs, if you have a BMW and it’s brand new and it’s nice, you apply an insurance policy on it.
[00:38:52] Cause you don’t want to lose all your money. If you crash it, if you have no BMW, you’re not going to pay. Premium for the insurance because you [00:39:00] have no BMW to insure. So if you have de risked coming out of COVID and then the the market drawdown in 2022, and then your puts aren’t also working. So your, your insurance policy isn’t paying you and your BMWs craft.
[00:39:14] Like, well, I don’t want to have anything. This all stinks for me. So then what happens is then somebody comes out with a, you know, one day option in your BMW insurance policy, right? Well, I got a new car. It’s not as good as my old one and it’s, you know, cause it’s cheaper, but I don’t want to commit to it.
[00:39:26] I’m going to rent this thing, but I got to rent insurance for a day too. So it’s kind of a, you know, stick your toe in the water way of having some exposure to the market. So if you are an institution and you are charged with a benchmark and you have to be a participant in. Nvidia or Q’s or spy and you see this thing going up every day, but you see the macro backdrop, which is probably bearish So now you have to make a decision.
[00:39:49] Do you want to take your you know Billion dollars of risk and put it all on spy or do you want to take a billion dollars of notional risk and break off? You know, [00:40:00] 2 million and get a similar notional exposure, but for a very small time slice. And it’s kind of like what I’m saying, you know, you’re getting a similar exposure, but with way less risk.
[00:40:09] So if your macro thesis does work, which is to say, you think the market will go down, then you don’t, you know, just get clipped and it’s not a, you know, a career ending decision for you. So the confluence of zero DTE coming into existence at the same time, we’re coming up with market drawdown took us to that.
[00:40:26] Ascension of volume. And why is it tapered off? Well, because when you’re coming from a higher VIX, you can go out and bang out a condor, an iron fly or something like that. You can sell this, you can sell the premium. There is a natural decision. And there is a mathematical justification for doing that. But now that vol has come in so much, it’s gone from being probably a profitable trade to really just a coin toss.
[00:40:45] So do you know if the market’s going to go up or down 1% today? I have no idea. So if the straddle is rich, you can say, well, the market might move 1%, but I’m going to collect 1. 2%. I’m going to get my edge. But now it’s kind of like, well, I don’t know. And then the shuttle’s priced accordingly. So [00:41:00] it’s much closer to fair now.
[00:41:01] So the economic incentive for you going out there and banging out a bunch of iron flies or the other way around is just kind of like, you know, it doesn’t really matter. So that’s why you don’t see more people, more participants coming into it because there’s really no economic justification for doing that.
[00:41:17] Yeah, the
[00:41:18] Brent Kochuba: margin for error now is kind of one of the things I try to talk about a lot. The margin for error now in the zero DTEs is very small if you’re trying to sell them. Right.
[00:41:25] Noel Smith: So if you look at like a, right, if you, if you look at a one standard deviation condor in the zero DTEs you know, a 1 wide wing, you used to be able to collect something like 50 cents.
[00:41:35] Now your 50 cents is something like 22 cents, 23 cents. So you’re talking, you know, half the premium for the same risk. So with that, why, how many more are you going to do at that same level? I would argue you’re not going to do any more.
[00:41:48] Brent Kochuba: Yeah that’s, it’s great to hear you kind of echo that. Cause there are, and to your point earlier too on the strategy selection, we talked to a lot of people, like this is, this is what I do.
[00:41:58] I sell zero DT [00:42:00] every day and it doesn’t, you know, that doesn’t change. And that just always felt like kind of a recipe for, for sort of disaster here. On the, on the topic of the zero DTEs, I mean, it seems like, and I’ve, I’ve been looking at this for… And running all sorts of different studies and ways I can look and there’s a lot of things that I can say, you know, I can put an X on the map and be like, look, you know, right here is where zero DTS were launched.
[00:42:27] Right? And that’s true. But there’s also a whole bunch of other things that occurred at the same time, right? From the macro landscape in particular. But there’s a lot of things that just seem like, look, we have this bizarre, some of these weird anomalies, right? Like, you know, that skew index coming down or correlation dropping, all those things.
[00:42:43] Do you think that 0DT has a lot of impact on that? I mean, I think one of the things is like, you know, the tenor’s been pulled forward, right? So you can hedge on 0DTs rather than one month or whatever. Do you think that there is that kind of reverberation, so to speak? Where zero D’s DTs [00:43:00] are affecting the way that, you know, volatility has worked,
[00:43:02] Noel Smith: so to speak.
[00:43:04] Yes, I do. I do. I don’t think that like there were, you know, 10 units of risk in the marketplace and then, you know, five of them have been pulled into zero DT or very short tenor options. I think that the overall pie has expanded so that because there’s less dollars involved. But I think that some of that has moved into the very near term and it has had an effect on all things that we just discussed like skew.
[00:43:29] correlation all these things. And I think that the new, the new baseline until a whole new cycle of suckers are introduced to the table is, will be lower until everything re tips. And I think that your assessment that there’s a cyclicality to volatility is true. And I think it’s true because of human behavior.
[00:43:47] Again, you know, a whole new crop of people need to get wiped out yet again, or a new crop of people to like, well, I got blown out selling volatility, so I can’t sell any volatility. So then the guys that understand it better. You sell a bunch of [00:44:00] volatility and they make money for two, three, four, five years.
[00:44:02] And then everyone else piles on if they see it working again And then a whole nother new crop of guys get wiped out yet again, right?
[00:44:10] Brent Kochuba: Right. That’s that it’s that behavioral factor I guess that i’ve always thought is is the most exploitable for for a retail trader you know, I don’t I think a very little edge attempting to pick direction necessarily better on a lot of times, or certainly valuation, you know, what’s apples valuation or whatever, but, you know, knowing when, knowing when people are freaking out is much more easy to identify.
[00:44:33] I
[00:44:33] Noel Smith: think. Yeah. Sticking with the pit analogy. I mean, if you know, the guy next to you has a million dollar account, he’s down 900 grand. Well, you know, the end is near. He might not blow out that day, but you know, he doesn’t have another million dollars behind him. Right. So using that information, you can then.
[00:44:48] Basically force him to blow up if you’re, if you’re that cold hearted, but I’m just saying like, you know, you, you have information now that really nobody else has. So when you have a, an [00:45:00] XIV and you know, they have to go out and buy 400 million of notional, but there’s not that much notional in the market.
[00:45:05] Right. So you’re like, okay, well, their nav is 80, it’s going to be 80 cents. So I’m going to just wail on these futures. Until, you know, these guys are just no more, that’s exactly what happened. Right,
[00:45:18] Brent Kochuba: right. That’s so that’s it’s fascinating and it’s worked that way for eons, I guess, push somebody’s position against them.
[00:45:26] Last kind of question on this zero DT topic. And, and again, thank you so much for just Fielding all of my rapid fire questions at you here. One of the other things on the zero DT space that I thought was interesting is that, you know, this is when the banks blew up, you know, the regionals, so to speak.
[00:45:42] Well, not so to speak, it was regionals. That zero DT flow seemed to really subside or pull back at that time. And it seemed like suddenly the shift was, okay, I need to hedge, you know, I need to own some hedges here, right? Like, Taylorisk is back in the market. Or maybe I just want to own, you [00:46:00] know, Vega in this case, because, because maybe, you know, things are about to really, you know, get a little bit weird.
[00:46:04] Do you think that that sort of, we, we hit this point where we go from, you know, shorter duration, you know, whether you want to call it gamma hedging or, or measuring my deltas to like, hey, I have volatility finally to worry about. Is that an imbalance that you think could really, you know, materially shift things in this, in this market?
[00:46:23] Is there an embedded risk in there, I guess, you know, from a, from a volatility cover, so to speak?
[00:46:29] Noel Smith: Again, I’ll go back to the concept of, you know, what are you hedging against? What do you have? What is your book? And if you have a long equity book and you have, you either want to lose less or make more you typically will expect to express that in some kind of a convex.
[00:46:44] You know, instrument like an option and the options they shift in time as a function of where they’re, you know, best used. So if you think that the contagion of a regional bank could potentially spread to, you know, federal banks, not federal banks, but you [00:47:00] know what I mean, large banks, money center banks and like they did in 2008, then that’s not that hard to, that’s not that much of a leap, especially for anybody who traded through that period in 2008.
[00:47:08] So the memory of that is, you know, pretty, pretty clear for a lot of us. And I. I, I did really well in that period of time, but not by buying volatility, but by selling volatility. So I think that a lot of people, then they had these short, keep me busy ideas like zero DTE versus like, this is actually my real book over here.
[00:47:26] And I need to figure this out right now. Cause I don’t know if this is going to, you know, become a problem writ large for the marketplace. And I don’t think anybody knew. And it became isolated to, you know, a handful of banks. And actually that speaks to the dispersion trade. Like we had puts in SVB. I had no idea that SVB was going to go out of business, but one of the reasons that dispersion trades work is because you, you screen for cheap options and you just have them in the book.
[00:47:48] They’re just on the shelf. And every now and then, and it does happen every year, you know, you get three, four, five, six, seven of these things where do you just get lucky? One of your names gets taken over. One of your names falls apart, whatever, you know, weather [00:48:00] happens, you know, there’s a natural disaster.
[00:48:01] Something goes outside of what the options market was pricing. And that’s another reason those books work.
[00:48:07] Brent Kochuba: , so the current dispersion trade is, is still kind of long equity volatility just to put a label on it, equities and short index, right? Can you break down a little bit, kind of what, what a sample book would look like?
[00:48:19] Noel Smith: Well, you know, it’s like saying apple pie, right? Well, what is apple pie? Well, it’s you know, flour, sugar, salt, apples, cinnamon. Whatever butter, but I think we can all agree that, you know, there is a widespread and apple pies, like grandma’s apple pie tastes different than, you know, the one you get at the mall and, but they have the same stuff, but they’re not the same.
[00:48:40] So you can have a dispersion book that is very different. I’ve talked to. I have four or five different dispersion guys in the last week, personally, just guys I know, and they’re down. And we’re not down this year in dispersion. We’re doing just fine in it. And I was really surprised that they were down because of other different reasons.
[00:48:57] So my point is, is that the book can be [00:49:00] generally constructed very, very similarly, but The execution of it and the way it is implemented can be actually quite different. And those details really do bear out in the P& L. Right. But to super duper answer your question, though, yes, is the answer to your question.
[00:49:14] Yeah, generally speaking, and the
[00:49:16] Brent Kochuba: like, I guess. And that’s going to leave me sort of my next question. You know, what, if anything, would cause a. There’s a sort of reversal in this. I mean, he just said a lot of guys aren’t doing that well, but, but let’s just use the, the CBOW index here. You know, we, we had one of my friends, Amiran, was talking about earnings is, you know, one of the reasons that correlation could be getting pressed lower and things like that.
[00:49:36] What are the. Is there a point here where you start to sort of flip that book around and say, okay, rather than sort of just as a blanket statement saying let’s be long equity vol versus short index vol, you know, is there a trigger point for turning that around? And do you think we’re kind of
[00:49:52] Noel Smith: near that?
[00:49:53] So, yeah, I think that earnings usually are a correlation suppressor because, you know, look at Google and [00:50:00] Microsoft, right? One goes this way, one goes the other way, right? What does the index do? Nothing. And that’s, that’s the dream, right? You’re long volatility into constituents. They both go crazy and the index goes nowhere and you make money thrice, right?
[00:50:12] Because you’re short law on the index or whatever else. So earnings do often have that effect on correlation. Now the core, the core 3M. That, or the core one M is a 50 is 50 stocks. We don’t really look at that. We look at the whole index and then we are portioned things in our own specific way. And what the SIBO does is a lot more just formulaic as it should be there.
[00:50:33] No, they’re an exchange. They’re not, right, exactly. So I’m not knocking on the SIBO at all. They’re just, that’s the product. They’re just trying to give you a quick and dirty way to see where these things are. But that doesn’t really mean that that’s your trade, right? So. But then to go to when do you get correlation the other way?
[00:50:52] It is a easy question with a very difficult answer. When is it good to own straddles? Well, it’s good to own straddles when they break the [00:51:00] straddle, who is going to sell you the straddle that breaks. Nobody, right? Nobody’s going to hand you free gamma. So if you buy a straddle for 10 and you can scalp, you know, long or short your stock so that you break even every day at the, at the straddle break even point, then you go home and you’ve lost nothing.
[00:51:16] You have free optionality. Nothing has happened. You’ve covered your theta. And somebody sold it to you for fair. So that’s a problem for the people that sold it to you. So what the best trade for you to have on as an options trader is for you to be along a bunch of gamma and it just goes crazy. Problem for the other trade is the other side of that trade is they’ve lost money on that.
[00:51:35] So nobody is ever going to give you a straddle that performs. Nobody’s ever going to sell you gamma for less than they think they can collect for it. Same thing happens in dispersion and correlation trading. No one’s ever going to sell you a bunch of volatility in anticipation for an event where correlations go up.
[00:51:51] Right. They will sell you at best. What is fair now?
[00:51:57] Brent Kochuba: Yeah, that, it makes intuitive [00:52:00] sense. And I, that’s kind of the, that’s the way that it works even for, you know, single stock, right? Fair value is what some…
[00:52:06] Noel Smith: You have to, you have to be able to project forward volatility so that the current hedging regime is different.
[00:52:13] So if you’re hedging on a 12 vol now, and you’ve projected forward volatility to be 16, and then you are hedging on the future vol of 16, that is a… Correct way to do it. It’s hard. It’s hard to trade in real life though. Yeah,
[00:52:28] Brent Kochuba: so so that that I guess is Is what the true question is is what what is sort of or do you anticipate that there’s something here?
[00:52:35] That’s that that Makes that index vol kind of reprice You know slightly
[00:52:40] Noel Smith: higher so you the the question really is what is the future? And the future is, you know, it sounds like a smart ass answer, but that’s really what it is. Like what’s the future of all going to be? Well, the known knowns are kind of all known right now.
[00:52:52] You know, we, we got our FOMC, we got our GDP, we know nothing’s going to happen. And so for a few more data points until September, that’s already been kind of like wishy [00:53:00] washy telegraphed and, you know, absent war in China, whatever else, and that everyone throws it out, but it’s true, you know, absent some new news, right.
[00:53:09] Stuff’s pretty
[00:53:10] Brent Kochuba: fair. Right. Right. That, that It’s very pragmatic view there. So thank you for that. We are already at the top of an hour. So I want to be very respectful of your time. If anyone does have a question, I know people have not put in questions yet. You can put in questions if you want now.
[00:53:26] Do you have sort of as we, we, as we pivot away here and, and close things off. Do you have any trades that you think about saying like, Hey, as a, retail trader , these are the types of trades that I think are, are where you should sort of focus anything, any kind of insights or advice you can offer to, to people.
[00:53:43] I mean, we have a lot of what we call pro tail traders here, professional retail, a lot of people. Making their own living obviously trading here, but but don’t have you know They’re not on a desk where they’re getting a lot of the information flow and things like that So are there certain pockets of the market that you like now that you say?
[00:53:56] Hey, this is really interesting for [00:54:00]
[00:54:00] Noel Smith: Well, if you look at cross asset vol, you look at gold vol, you look at oil vol, you look at FX vol, you look at really rates vol, which is so important. A lot of it is still tradable. So there is plenty to do. I have tend to like range bound. built in neutral trades this year, something in the ilk of a strangle or a condor.
[00:54:18] But with vol low, you probably have to go into a little bit more nichey trades. So instead of banging out strangles or condors and spy or SPX you know, maybe you look at something with a higher relative and absolute vol, like a Russell or something like that. I think that there’s some action to be had there because if you look at the spread between what has performed and what hasn’t performed, something’s going to give, right?
[00:54:40] You know, these, these things that are, you know, or these traditionally fairly tight spread trades that have now widened out. Well, either the top is going to come down or the bottom is going to come up, or they’re both going to meet in the middle. Who knows? But I think that there is still some volatility in risk defined structured ideas.
[00:54:57] And is there edge there? No, I never think a trade is edge. [00:55:00] You know, that’s just a trade structure. But I think that you can make money in that because of the function of time.
[00:55:07] Brent Kochuba: That’s a great answer. Thank you very much for that. And it makes certainly a lot of sense. Alright. We buzzed through an hour.
[00:55:17] I appreciate you very much taking the time to handle all my rapid fire questions. If people want to get in touch with you as we kind of wrap things up here, you’re at Noel Convex, right, on Twitter. I recommend everybody kind of check out your… Your Twitter page, I’ll try to bring it up so you can see it.
[00:55:35] Anything else, you know, any other ways people can get in touch with you? We do have a lot of people here who do allocate money to funds and things like that. So you know, what’s the best way to get in touch?
[00:55:45] Noel Smith: Website or Twitter. You know, I only have like 3000 Twitter followers or something like that.
[00:55:50] So you know, it’s not like everyone gets buried in the, in the noise, cause I don’t even have that much noise, but if you want to get in touch with me a little more seriously, the website is a fine place to do it.
[00:55:58] Brent Kochuba: , no, can’t thank you [00:56:00] enough again for, for taking your time here a lot of amazing comments here. So people really appreciate it. And I look forward to talking to you again soon. Thanks for having me.