SpotGamma on Excess Returns

Summary

Brent Kochuba, founder of SpotGamma, discusses the impact of the rise of 0DTE options, fixed strike volatility and the implications of options expirations.

Highlights

• 📈 Zero DTE options have seen a rapid increase in volume and are causing mean reversion in the market.
• 👥 The use case for zero DTE options appears to be more institutional than retail, with some substituting futures trading for zero DTE contracts.
• 📊 The impact of zero DTE options on underlying liquidity, volatility and market trends is still being studied.
• 💰 Wealth managers may use zero DTE call and put spreads as a way to generate income.
• 📅 Daily expirations are causing an increase in options volume, but the volume has since plateaued.

Below is the transcript from this conversation:

welcome to excess returns where we focus on what works over the long term in the markets join us as we talk about the strategies and tactics that can help you become a better long-term investor Justin carbonneau and Jack forhand are principals at the Lydia Capital Management the opinions expressed in

00:13

this podcast do not necessarily reflect the opinions of Olivia Capital no information on this podcast should be construed as investment advice Securities discussed in the podcast may be Holdings of clients of Olivia Capital hey guys this is Justin in this episode of excess returns Jack and I sit down

00:26

with brencochuba founder of Spock gamma we talked to Brett about a range of options related topics including the rise of zero DTE options and the implications of these Market volatility and options the importance of option expiration dates rebalancing from large funds using options and much more options in the corresponding dealer flow

00:42

has many implications on the supply and demand and the pricing in the markets Brent was generous enough to share many great visuals from a spot Cameron’s proprietary research and the charts help us visualize and better understand the important forces at play as always thank you for listening please enjoy this

00:57

discussion with spot gamma’s Brent kachuba Brett how are you thanks for coming back on with us man I’m doing great uh happy to be back talking to you guys I missed you sweet well we’re gonna have a good interesting discussion around uh zero DTE options Market volatility option positioning some of these

01:16

expiration dates coming up and just overall I think try to learn and build our knowledge and our listeners and viewers knowledge on and what’s you know an important part of the market in a large part of the market um and that’s all this discussion around options and one of the things for anyone that’s listening to us on audio we

01:36

highly encourage you if you can to pop over to our YouTube channel because Brent has been nice enough to bring a bunch of slides and visuals with us or with him so that I think it’s going to helps or visualize some of these these Concepts so really appreciate appreciate that Brent yeah of course uh the

01:55

anything that means not having to look at me I think is a Improvement there you go look at any of us probably um so yeah let’s start with this um zero DTE options you know this is they’ve become sort of a little bit of a front and center here in the market given their rise in popularity so you know out of the gate I just wanted to

02:14

sort of talk about what these things are and maybe you know pick your brain a little bit about about these types of options yeah uh it’s been a uh it’s been a remarkable rise of options volume you know you could look back even to 2019 and and um and see just this increase in options volume and and the general

02:32

sort of idea why this all matters is because every time an option trades in theory there needs to be a certain amount of hedging flow tied to you know those options trades and so as the opposite volume increases in in interview we need to have more hedging flow you know which is the underlying stock or or Futures trade which which in

02:51

theory moves the market and so on this slide here I plotted the the real long-term view of putting call volume so you can see call volume here in red and put volume in purple and what you’ll notice is that in March uh April excuse me of 2022 they launched Tuesday expiration options in the s p that in

03:11

may they launched Thursday options in S P 500 so that meant that at that point in May of 2022 there was an options expiration for the S P 500 Index every single day of the week uh before that there was Monday uh Wednesday Friday expirations and then in September of 2022 it became official that okay this

03:30

pilot program now you know the real deal and they launched officially these daily expirations and then the exchanges followed on with that in November of daily expirations in the spiders the Spy ETF and then the queues and so what you can see here is that on this chart is that there’s a remarkable increase in

03:48

options volume tied to those dates right and you can see that shift up and what we’ve seen is that really those whatever the flow was that adopted that volume adopted it very quickly and then that volume has since plateaued right so it’s like immediately everyone started trading these things and then it you

04:08

know that volume just has basically Stood Still uh over time if you look at a percentage of volume basis in terms of looking at zero DT versus non-zero DT whatever it is the volume has really stayed steady so you know there’s like some extra Alpha in there or you know some other kind of new use case it

04:24

really hasn’t shown itself in terms of an increase in in volume so the point is that whatever the use cases seems to have stabilized um we did an in-depth study on this and you know not to plug our YouTube channel but we go to our YouTube channel you can see what our uh Deep dive and all the little data points is and what we view

04:42

uh is that the zero DT flow causes mean reversion in the market and we say that because anytime there’s a dip in the market you see Zero DT call buyers come in uh or put sellers come in and that pressures the market to go higher and conversely if the market rallies we see call sellers or put buyers come in and

05:02

we believe that pressures the market lower and so you can see this mean reversion come in on a daily basis on our website spotgammon.com we have a zero DT monitor so you can see this flow come out in real time um and what we’ve talked to clients about and what we’ve heard is that there are these kind of

05:23

inexplicable sudden reverses in the market where you know you think a trend is setting up and also on the market will just switch yesterday I mean today’s June 13th yesterday we saw the market just kind of like for no reason just it was quiet all day right we had CPI today and and fomc tomorrow but yesterday for whatever reason the market

05:40

just rafting one percent at 2 30 and if you watch the zero DT flow you can see that zero DT flow comes in all of a sudden call buyers came in uh to the tune of like a billion dollars of Delta notional and and up the market goes um so these are the fingerprints that are being left on a daily basis and I

05:57

it’s hard to draw longer term conclusions from this at this point because number one we haven’t gone through that many Market Cycles I would argue since the launch of zero DTE uh second you know there’s been a lot of interest rate changes which I think has impacts on underlying liquidity um you know we’ve had uh you know a big

06:17

drawdowns there’s a lot of strange things happening in applied volatility you know throughout the year and so um I think it’s hard to kind of like pull out the factor of exactly you know what the impact is but there are signs here and I can I’m going to show some of these in a few minutes um there are signs here that there is an

06:33

impact on volatility in other words how much the market is moving based on this do you have any sense of like of the volume like how much is retail and how much is institutional just I don’t know if there’s anything any data out there you have like uh just a sixth sense I was reading this Bloomberg article that

06:48

was kind of talking about it was like highlighting all these retail traders that were kind of using it and you know them in different ways and it was a little bit like like speculative gambling but then I’ve heard I’ve talked to other people that know it’s like a lot of institutional sort of options buyers in here so what

07:03

what are your thoughts yeah there’s an important delineation to make here first is in the SPX spy and cues there’s an expiration every single day so we refer to that as zero DT but if you look at single stocks Apple Tesla you know etc those only have expirations every Friday so we kind of classify those as the zero

07:20

DT for single stocks and so if you break it down what you’ll generally see is about in the SPX big contracts five to ten percent is retail and that comes from various Bank research reports you can actually monitor the retail flow explicitly on our site as well and that basically syncs up and then when you

07:39

look at the spiders which obviously has a smaller notional value on a relative basis and some of this individual stocks that that flow will get you know anywhere from 10 to sometimes towards 50 depending on the stock that you’re looking at in the time of day you’re looking at um you know like in GameStop or

07:54

something the retail flow come in hot and heavy and then in Tesla there’ll be a flash in the pan in terms of retail and then it’ll cool off so you know that 10 number is one that seems to come up quite often uh particularly talking about the bigger s p you know 500 Index and and the use case is different there

08:10

are institutions out there that may substitute the use of Futures Trading uh for zero DTE contracts right so rather by Future I’m going to hedge Myself by buying a zero DT call and just kind of eating that cost or I can offset some of my hedging exposure you know uh the various Greeks through using these zero

08:30

DTE contracts uh I think there’s a lot of quantitative funds we’ve seen quotes from the likes of like aqr out there saying hey you know zero DT gives us more at bats right because the strategy that I’m running uh suddenly can run with this option options expiration that happens every day um and then you know there’s some people

08:47

that talk about this idea that there’s a lot of wealth managers that want to sell uh those zero DT call spreads and put spreads as a way to generate income so the use case is fairly widespread I’d say um but it tends to be more institutional meaning professional money managers albeit under that bracket of

09:05

Institutions there’s a lot of different flows right there’s dealers and quantitative funds and wealth managers and that and that kind of thing so is this coming out of like options that are further out in the in the future like since people are using these more are they using options less they’re further out in the future yeah you can

09:21

see the impact of that there’s definitely this shift in in percentage of open interest and things like that where you know you definitely cannibalize some of the longer dated Flow by having these zero DTE contracts and if you think about it like if you wanted to hedge like the FMC for tomorrow like let’s I don’t really know

09:38

what the fed’s gonna say tomorrow uh but I’m a little worried like I got a long portfolio let’s say so I’m just gonna buy zero GTE contract right to hedge out pal saying you know we’re raising rates by 50 and they don’t have to worry about it whereas before what I had to do is buy like a contract like a month out

09:53

worry about the Decay worry about my cost and all that now I can just say I’m going to take this cheap Hedge isolate that event risk and then and then I’m done I’ll have to worry about it right because because the power doesn’t do anything well on Thursday we’re off the races and all is good right so you definitely see that

10:07

canalization does this you talk about kind of a mean reversion thing with this does this also I’ve heard other people talking about it saying like there is the mean reversion but it also kind of opens up the taste so that like a four percent decline in the market could become eight percent if this went the

10:21

other way or something I mean is there is there any truth to that do you think but yeah I mean everything in in finance is about you know uh balance basically right so if you have a situation where everybody’s short zero DTE options you know that could be the situation that causes a lot of problems right because if everybody has

10:38

to cover their position uh then that could suddenly Force flow the other way or if everybody comes out right now and just buys zero DT puts then that could push the market down and that and that was the whole vulmageddon you know JP Morgan piece that came out and got a lot of attention um but the the the the number of kind of

10:54

like qualifiers that they had to put in place to get that volume again scenario just made it feel very unlikely so if I just first started this idea of mean aversion you could see situations and then kind of the most famous one a lot of people talk about was I think it was October 13th of 2022 there was a really

11:10

nasty CPI print and the s p uh traded down like five percent pre-market I think the s p opened at 3 500. and and just after the market open you saw these giant zero DT call positions come in and the market rallied all the way back intraday right I think the market was up four and a half percent intraday and

11:29

that’s the mean reversion flow that’s kind of like you know that that is like the situation of mean reversion where if I own put options or if I own let’s say yeah if I just own puts right like three months outputs and the market gaps down four percent I don’t have to close that put anymore I could just buy some zero

11:45

DD calls to hedge myself in case the market rallies back and so that kind of situation is where you see the mean reversion where things can get out of control is when a lot of people get caught off sides and this is the tail risk and you know like if you look at today and you look at what these the market was pricing the market was

12:04

pricing uh before the market opened the zero DT straddle is trading for something like uh 75 basis points meaning that the Marcos pricing in a 75 basis point move and so Traders will sell zero DT options against that price right it’s pretty cheap price and and prices can get even lower you get a 50 50 basis point zero

12:22

DT straddle we’ve seen some of that recently so if anything causes the market to move more than that straddle price or the the implied Vol for the day then in theory that’s going to force traders to cover and anytime you have just like in a margin call or anything like that anytime you have Force covering that’s where things can kind of

12:39

spiral uh and really move the caveat to all this with the zero DT is that they expire at the end of the day so any exposure that’s tied to any of this in theory is gone at the end of the day right the books are all cleaned up the positions are gone it all settles it’s all you know it’s all moot point at

12:55

closing so you don’t have this persistent pressure of you know someone’s buying or everyone’s buying you know one month outputs where every day there’s this exposure that acid gets hedged uh and so I think that really relieves you could get a flash crash scenario more so than a than a real persistent you know clubbing because of

13:13

the because of the offsides so does does it seem like it could it be that on that one day you could get a much more substantial move then because yeah I’m just using zero DTE versus it they were spreading it out over you know over time 100 100 and and that’s why I say it’s like a flash crash scenario where you

13:28

know you you can get these imbalances intraday but what generally happens is and what alleviates a lot is pressure is if I’m long some puts for today and let’s say the market just moves down you know real very sharply I I’m incentivized to close that position up because the game of that position is so

13:45

high the sensitivity of that option to what the market is doing so so high that in a lot of ways I I I’m better off monetizing or closing out my position when it’s advantageous right and and so what that happens is then the pressure’s relief so like if we’re all long zero DT puts and the market crashes two percent

14:02

well I’m gonna start selling my puts and taking my money right I’m gonna close that position out because if the market starts to Rally I’m I’m you know I’m bleeding very quickly and it becomes a reflexive feedback loop I mean if the three of us are all you know long puts right and and Justin starts clothing out

14:17

hundreds of thousands of zero DD positions that can start the market to Rally up right or recover and then Jack you’re gonna go oh man like this is going against me now I might as well take you know take my gains you close out your puts and the market keeps going and then I gotta chase finally to get

14:31

out as well so you get you know there’s this kind of like feedback loop in the flow that that comes along with this how do you think like a lot of our listeners will be like longer term investors who don’t use options how do you think they should think about this I mean some people seem to talk to this

14:45

about this as a really big deal for the market that people need to worry about other people kind of say you know yeah it’s something going on behind the scenes but it’s not in terms of like moving the overall Market dramatically over time it’s not that big of a deal like where do you fall kind of on that

14:55

continuum I think for the longer term investor there could be some potential opportunities as maybe there’s certain days right a couple days a year where zero DT really drives an imbalance and that’s either in the market as a whole or in some individual single stocks right and we’re going to talk about this

15:12

I think in a minute where you know how you take advantage from this so I think there’s some distortions that can be created in the short term over the longer term There’s No Smoking Gun obvious signal here as to what the zero DT is doing like I have some evidence obviously that mean reversion is is increasing but we’re also coming off

15:28

this time where volatility was so extreme right um in the market that you know it’s hard to build out the factors that say okay you know the reason that the market is now you know vix is back at 13 is because of zero DTE um you can make you can make that case but it’s not you know conclusive at this

15:45

point so I think as time evolves a little bit we’ll understand a little bit better but again for the for the longer term investor there’s some short-term distortions that can occur because of this and and we can identify some of those so I want to next to volatility um it’s something I don’t know a ton about

15:59

but obviously a lot of us are watching it you know a lot of people monitor the vix now more than they used to in the past but like as I’ve studied it more I’ve kind of learned the vix is not the entire picture of volatility and one of the things we’ve seen a lot of people talking about is this idea of fixed

16:13

strike Vol which we’re going to ask about in a second but before we do that I wanted to ask about the Vixen general just for anybody who doesn’t know can you just talk about what the vix actually measures sure so the the vix measures the implied volatility of the S P 500 and the way that it does that is it measures S P 500

16:28

Index options that expire roughly 30 days out in times you know it changes a little bit 27 to 32 days basically but what it’s meant to tell you is what how much movement do Traders expect in the S P 500 and so it’s become known as the fear gauge because typically the Vixen will Spike right as the market crashes

16:47

but all it’s doing is expressing that Traders are expecting kind of higher volatility and so one of the things that’s come about now is with the impact of zero DT or the release of zero DT there’s the vix one day contracts now and the vix you know kind of excuse me not contracts but one vix one day index vix 90 index there’s

17:05

these shorter term indices and in options land sort of the argument is does the vix still have value right because all these options now trade zero DT I mean 45 roughly the S P 500 is zero DT you know trading so there there’s a lot of volume that’s concentrated in the very shortest term um expirations and so the question is is

17:27

the vix still valuable and what I would say is it is because the the the way that you can make that assessment is in March there was the bank crisis right and suddenly the zero DT volume subsided and people started to buy longer term options they started to hedge their tails because they were worried about

17:48

the systemic risk of all these Banks going down so you suddenly saw you know the vix spiked rather violently but you suddenly saw these longer dated S P 500 options trades come in so what I would say is that the utilization of the vix or the way that people watching the information you get from it is being

18:02

augmented or adjusted maybe uh as a result of the zero DD flow um and then the second part of your question is you know we’re in this situation now where there’s a a lot of demand for call options and the vix measures both puts and calls so if there’s a lot of demand for call options you can have a situation where the vix is going up as

18:25

the market goes up which is counterintuitive to what a lot of people think but in this environment here with heavy options demand et cetera you can get a lot of demand for calls and you can have the vix stabilizer actually increase slightly as the Market’s going up which is again a little bit counter-intuitive but but

18:41

ultimately the vix is just a volatility gauge not a not really a fear gauge so you talked about like the 30-day vix these the shorter term fixes coming in but is the 30-day vix I mean is it you know is it like we have to draw a line here and say post zero DTE it’s now distorted in some way or is it like if

18:56

we look at it relatively history does it not really impact that if you look at the correlation between the S P 500 Index and the vix the correlation has changed right since the launch of zero DTE and so there is enough evidence here to say yes there is a difference in the way that the uh the vix responds to Market crashes and its

19:16

ranges on the day and things like that and and a lot of this is because so much Action Now takes place in the zero DTE space especially when you consider out to five days right in the S P 500 that’s where 50 plus percent of the volume is taking place so there’s all this movement in five day contracts

19:34

uh in zero DTE contracts and the vix is just only looking at 30-day contracts so it’s not picking up any of that flow right they’re not picking up any of that reaction and so just to give you an idea of this I had this chart here of term structure and what term structure does is it monitors the implied volatility

19:52

called we call it the at the money implied volatility the s p so the at the money option is if the s p opens today at 30 4 300 what is the implied volatility of that contract right that’s the at the money and what you see is that the implied volatility is very elevated for the first few expirations in other words traders who are trading

20:10

with zero DT are looking for a lot of volatility today because there may be a lot of volatility around you know the CPI or fomc but if you look at the the price of that Contracting Fireball I’ll tell you that contract out 30 days the implied volatility is relatively low right nobody cares so 30 days on time no

20:26

one cares about volatility no one’s pricing volatility but for today people are pricing a relative uh higher amount of volatility because you know of the zero DT phenomenon or the or the reaction to whatever the Market’s doing today um and so this kind of epitomizes what the vix is missing right because if you

20:43

you know the term structure here across the x-axis is we see every single expiration date and then we’re looking at the at the money implied volatility for every expiration date so in this case what is the 43 the market closed around 43.50 today right what is the Vault implied volatility for the 4350

20:58

contract every day for every expiration on time and so again if you look 30 days on time which is roughly July you can see by this white line on the on the chart here that the the curve or the the the curve is very flat out there right out in time versus there’s some backwardation we call it in the near term because people

21:20

are pricing in short-term volatility like I.E volatility today due to CPI and fomc um so again all this elevated short-term volatility that the Traders are pricing in from today with the CPI tomorrow FMC none of that’s being picked up or or reflected in the vix because that looks at the 30-day contract okay and I think

21:38

this is us into this concept a fixed strike Vol um you know one of the things I’ve noticed like when you you know people like me you know nothing about volatility are sitting there watching the vix all day and people like you who know what they’re talking about or not as much at least and you know one of the

21:51

things I noticed in this in this recent increase in the market is a lot of the Vol guys were kind of saying you know on these updates you would see the vix still down a little bit although I think it has gone up a little bit on the most recent updates yeah it did but but a lot of them behind the scenes were saying

22:04

even before that happened they were saying actually volatility was up today because fixed strike is all it was up today um if you could talk about what that is and like we’re how people are measuring that sure so one of the things I would say to trip when the vix was up a little bit with the CPI on the fomc tomorrow

22:19

and so you know there there’s still some longer data hedging occur around some of these events um and if you you can use this thing called the rule of 16 and what that is is you divide implied volatility so whether the vix is 14 or 16 whatever if you divide that by the number 16 that tells you what Traders are expecting as

22:37

a one-day move for the S P 500 and so you can hit these what I call lower bounds in the vix where you know if you start to get a fix of like 10 you know which is kind of like a historic real low you know that’s like a market pricing in 65 70 basis points of movement in the in the s p so you could have a 50 point Rally or a 50 basis

22:56

point rally in the market right and that means the vix was under pricing volatility so you can have these situations where the vix has to go up because the market rallied 50 basis points right and in the same way that the market crashed one percent the vixo have to go up so what what has happened recently several times is that the vix

23:13

has gone down even though you know to your point Traders come out and say well no volatility went up and and the reason is because the vix has a weighting to what we call at the money contracts and so if you look at the way that volatility is priced there’s this skew or a smile in the way that implied

23:31

volatility is priced over various contracts so on your screen here on the x-axis are the strikes for the S P 500 so you can see here there’s 4305 you know 40 through 50 et cetera and this is from Bloomberg in red is on the y-axis is the implied volatility for each one of these strikes and this is on a one month basis so last week uh

23:53

excuse actually yesterday the 12th on this red line here you see the implied volatility for every single strike right so at the 43.55 the implied volatility was about 11 and a half right 11.5 and what happened day over day is that the implied volatility of these contracts all went up and you could tell

24:13

that because this white line the white curve here which was today’s implied volatility reading from around nine o’clock this morning so or eight o’clock this morning so before the CPI you can see that the implied volatility for each of these strikes is higher right so the 4355 contract for yesterday was 11 and a

24:29

half remember this is looking at the same one month contract 43.55 for yesterday and today excuse me 11 and a half for the 43.55 and today that insane level of implied ball was 12 and a half right so volatility actually went up when you look at it on a fixed strike basis and further what you can see is there’s

24:48

this again this Distortion or kind of curve right that happens here and we highlighted in this green box where at the time the s p opened around 4350 all these calls above had a relatively even higher implied volatility so what you take away from this is that there is a demand for call options that is pushing

25:07

the implied volatility on a fixed strike basis higher right so while the at the money had a implied volatility increase from 11.5 to 12 and a half the 43.95 contract went from an 11 implied Vol 2 12 or 12 and a half in ply ball so it had a relative higher gain at these higher strikes and so what this is

25:26

reflecting is some call demand is is the way that we would interpret this now if you look to the vix you would see maybe the vix went down or this was or a lot of where the discussion came around as the vix went down now why would the vix go down when you see these fixed strike implied Vol measurements occur this

25:43

comes back to this idea of at the money options right on Tuesday the at the money contract was the let’s say 43.25 just for sake of argument right and you can see here in red again that the at the money contract had roughly an applied volatility of 12. so let’s just say that meant that the vix is 12 because the vix has a

26:02

weighting to the at the money contract right so the vix is going to say great at the money for today which would be Monday morning is a 12. now what happens is the market rallies overnight uh or throughout the day right and such that on Tuesday Morning the new at the money contract is let’s say the 43.75. well the the at the money implied

26:21

Vol for the 43.75 is an 11 and a half so all the VIXX did was reflect the fact that we changed the at the money strike from 43.25 to 43.75 and implied volatility is lower at that strike so all that happened was the vix slid down this curve so to speak and that is why I implied volatility went lower so you know in general there’s

26:45

like this idea of puts you is like everyone is I think is aware of this idea even if you’re not in the options world like after the 1987 you know uh October crash right suddenly puts carry a higher implied volatility they care they carry a higher relative value to calls right so if you look at the the

27:01

put implied volatility or the put price of a five percent of the money put it generally is higher than a five percent out of the money call right and that’s because of this idea that in general people own puts because of this crash protection right generally people are long S P 500 or long stocks and they

27:19

they buy puts for protection so that’s why you have this SKU that you can see in the S P 500 here where you know puts have Empire higher implied volatant calls and this is this is almost always how it looks in the S P 500 you almost never see this curve kind of inverted where calls have a higher implied ball level

27:35

and so you know oftentimes what happens when you see the vix slide down or go up it’s just a function of the at the money strike changing right it’s not that the volatility of that individual strike necessarily change that much it’s just we’re shuffling around what the at the money strike is so if we go down

27:53

sometimes you’ll see the vix go up but all we did was shift from this 4375 strike which had 11 implied Vol to the 43 25 strike which had a 12 implied ball right and that’s all that happened is the vix slid up this curve and and volatility changed along with it I know volatility is an ambiguous concept so there’s probably like no not

28:12

one good way to measure it or not one complete way to measure it but so do you look at stuff like this when you want to see a volatility is going up or down will you look at this more and you look at the vix you know the what I tend to do is I thumb through a bunch of different charts so there’s there’s some

28:25

skew indexes that you can look at for example like uh well the skew index is one there’s another one s decks you know there’s there’s some of these bigger picture things that you can look at and see if there’s something kind of funky going on and then you can kind of drill in and look at things like fixed strike

28:38

ball or look at skew or term structure and start to put together a little bit you know more pieces of the puzzle right so what Traders are doing the general idea is that if you have higher implied volatility generally what that means is Demand right so if putting five balls going up people are buying puts if if

28:54

put by ball is going down they’re selling them right there’s that’s kind of like the the high level takeaway now under the hood you can say well the Traders are pricing in an event or this or that other thing but at the highest level that’s kind of what you’re looking at right is there demand for these options

29:09

higher prices means demand is increasing and that’s that’s starting to take so when you look at this call Applied Vault on the fixed strike base is going up on our especially on a relative basis here this little slight curve that’s telling us like oh before the C the CPI reading people are buying calls here people are

29:23

trying to get long in front of this event right um and then you know what you want to take away from that can also be deliberated uh as well but you know this is part of what we get you know paid to do is is to to look at all these different metrics and try to you know glean some Edge out of it yeah I assume

29:39

someone would need access to something like Bloomberg to do this is there’s not some index that’s like publicly available where you can look at this kind of thing now there’s not a fixed strike index uh we’re we’re developing a fixed strike dashboard and essentially looks like a big grid right in it it’s

29:51

like a heat map essentially that changes so you know this is becoming a hotter topic a a more nuanced thing to look at and you know as this options volume increases and more Traders come in you know these are some of the metrics that you start to hear and you and you start to talk about um and again on a daily basis it’s not

30:07

terribly interesting uh for most people out there right but sometimes there are these big shifts in this data that really kind of should wake up all investors you know regardless of your time horizon or whether or not you trade options at all right because this information is you know sometimes telling you things that are that are

30:25

rather important is there any validity to this idea that has fixed strike Vols going up along with the market that that’s some sort of red flag like that the Market’s more vulnerable to do a decline when they’re going up together yeah it’s a supply and demand thing number one so anytime you see Vol up

30:38

market up that is a sign that there’s some exuberance in the market that doesn’t necessarily mean the market has to crash it just means that whatever this move is it’s it’s overdone right it’s it’s time for a pause and this is one of the things I think longer longer term Traders or investors can use as an

30:56

interesting signal there’s a lot of people like to overwrite and I think when you look for these signals of Market of all up or stock up volup if you look at an individual stock those are times where you can make an argument that it’s effective to sell calls or overwrite my position right it’s great

31:12

that people are buying calls there’s a lot of bullishness in that but sometimes it just gets overheated right and and that implied volatility increases when a stock ramps up like all these AI stocks I have a chart we can or a slot I can on show on this um for example on here I have what we call the iwm we call this the 25 Delta

31:32

risk reversal all this is doing is looking at the relative price of a 25 Delta call so kind of a slightly out of the money call versus a slightly out of the money it right that’s all this is showing you and so anytime this line shoots higher that’s telling us that the value of the call is jumping relative to

31:48

the value of the put right so you know obviously if the Market’s crashing like it did back here in in November of 2000 and this is actually 21. that makes sense right people are buying puts they’re scared nobody wants to buy a call markets crashing put values are exploding you know vix goes to 40. that makes sense

32:06

that this line will go down because the put values are increasing what we’ve actually seen as you can see here over the last two weeks there’s this massive jump in call prices relative to puts that’s telling us that there is all this kind of excessive demand in iwm’s and iws have pretty good performance but

32:24

this is at a level now that you just don’t see when you look back historically and you can look at this on individual stocks as well and the point with this is that as call prices increase the odds or or opportunity for you to make money on calls goes down right because you’re paying more for calls you

32:42

need the market to move more or you need the stock to move more as the call prices go up for you to get a payoff and that’s what this implied volatility Is Telling You Higher option Price Right higher implied Vol High relative option price I need more movement more volatility to get this payoff so if I’m

32:57

overpaying for calls I can have a situation where I’m buying calls and can never get a payout those are great times to arguably sell calls against my long stock positions because the froth is in there right there there’s a lot of elements or or signals that hey you know this is overdone we’re due for a pause

33:15

or or some pullback and so again this is one of these shorter term signals or volatility signal that can be very effective for you know a longer term uh Trader or investor options expiration is this week right Friday so we have the FED tomorrow and then there’s a very you know a humongous uh options exploration on Friday that

33:34

flooded on your screen here so what I did is I plotted what we call Delta notional so if you want to consider what the stock equivalent was to what an option stock size equivalent was that’s what we do by looking at Delta and what you can see on our screen here in Blue uh or or purple I guess I will call it

33:51

uh is the call Delta so how big is the notional value of these call positions when you represented the stock so if all the options liquidated right now you know what’s the value of that um and you can see it’s about 600 billion dollars it’s very large and then the put side you know we’re quite a bit smaller

34:08

that’s what’s in teal so this is a very call heavy options expiration and these quarterly expirations tend to be extremely large you can see that the next largest expiration is June January right and what’s interesting about this is that the last time we had a call expiration that was this large it was January of

34:28

2020. in January 2020 was a pretty nasty market movement right from basically gen 1 to Jan Opex the market traded down I think 10 10 13 somewhere in that neighborhood in the bottom of that market uh drop at least short term bottom was the day after options expiration I think it was January 25th and what happens is

34:52

call positions as they go in the money they gain in value so if I bought a call a month ago or two months ago or three months ago whatever it is and the market rallies my call keeps gaining in value right so when Apple goes up 15 a month or Nvidia goes up 80 in a month or whatever it is those calls are all

35:10

gaining in value and the theory is that the Hedge is required from dealers and market makers to offset that risk is gaining in value right because if I’m short a bunch of calls as a deal or a market maker and these calls continue to go up I have to buy more and more and more stock to to maintain my hedges and

35:25

so you know the the I always talk about this is like the January Opex these are the leaps they always have a huge expiration this is like the Pelosi trade right she’s famous for like buying like massive numbers of Google and Amazon calls or whatever and then they run up in the money and then she trick she

35:41

closes those out in January and they expire so this is like a similar thing here in June because the markets rise so much the value of these calls has has risen immensely and by default the way that we look at this is that these calls have to be closed out they could be rolled higher or adjusted or whatever it is but on net we think

35:58

there’s a lot of hedging flow that should lead to some short-term selling in in some of these stocks that have been moving up a lot um and that’s as a function of of Hedges being Unwound and positions shifting and these positions are forced to shift because you know they’re they’re expiring so you know as a Trader if I

36:14

own these calls I have to make an adjustment and if I don’t I’m going to be assigned you know a whole lot of stock so when you look at like options expirations that end up being Major Market moving events versus ones that don’t I mean what are the common characteristics is it like this where the Market’s moving in One Direction

36:30

there’s a lot of open interest in that same direction is that where you have the tendency to maybe have a reversal yeah the the default way that we look at this is that mean reversion is what we generally look for in the big options expiration so number one what is the size of the expiration uh the court of the expirations are

36:47

almost always large December in particular the year-end expiration is always very very large the monthly expirations you know it’s like a stock by stock basis whether it is you know meaningful when I say meaningful it’s like how much underlying liquidity is tied to these expirations um and then the weeklies can even matter

37:04

now because of the increase of zero DTE so by default the way that we look at this is meaner version the markets had a big rally here uh huge call positions as those come off we would look for some short-term weakness or consolidation in the market as a result of uh all these calls expiring in a similar fashion if

37:22

you look at historic lows in the in the stock market I think we’ve talked about this before you know again March of 2020 or December of 2018 or June of last year um there’s huge put positions that expire and the market rallies the Monday after in June of 2000 just a year ago we had the complete opposite situation the

37:39

market was making it’s I think it was a zero to date low was in June uh it wasn’t the low of the year it was a major low and the market rallied immediately after options expiration so that turning point is something that you know a lot of people have caught on to aren’t aware of now and what I think is

37:54

interesting um I put this slide together if you faded the move which means that I just went back and I looked at all of the options expiration since 2020. and I said okay if the market was weak into this expiration let’s imagine we bought the market at the close on Friday of expiration and held it for one week right makes sense

38:16

so if the market sold off into Friday I buy the market on Friday and hold it for a week and that return was 23 if you did that from January 2020 to today right that’s a pretty good return just what what I say you know fading the move or playing mean or version after Optics um and it’s pretty well distributed it’s

38:34

not that there’s like one day that just made you 20 right and uh and the other times were kind of like you know noise right the the the data here seems pretty conclusive that that there is something here now what’s fascinating to me about this and like I actually you know I was like I knew I was going to talk to you

38:52

guys I sort of put this together as we have this June Optics something changed such that if you do that same trade from September of 2022 to today or you know obviously May Opex is the last one you actually lose eight percent doing that same trade so 73 of the time historically you make money doing the flip trade but after

39:14

September of 2022 it only works one out of three times is that because people are front running it I wish I had a beautiful answer to that um number one people are aware of this options flow the second one which I can’t help but kind of like point to is the fact that zero DT became an official uh you know listed ending whatever it is

39:35

on in September of 2022 so September 2022 was officially when zero DT launched now again May kind of picked up and and that’s when the contracts were available but you know this September date is when they’re like okay these are going to be listed in perpetuity and so for whatever reason the Opex flip trade

39:53

broke right at the same uh at the same time these are are listed it’s a it’s a it’s there’s a lot of these like coincidental factors that seem to come into play and again the tricky part is like well you know the markets had this incredible rally and again all the rate volatility and you know these different things that are

40:14

moving around it’s a little difficult to say this is the reason why but the you know it’s a thing like Walks Like A Duck talks like a duck it’s a duck I think um but you know it’s a fascinating thing to me the other thing that’s really interesting to me is that if you looked at rather than fading the move on a

40:30

week-to-week basis so if the week was weak coming into Opex and I held it for another week what happens if I just played a one day meaner version what’s what’s what blew my mind on this is that from January 2020 to the present the return of that strategy is a zero meaning you wouldn’t make any money

40:51

by by fading the Opex move I just played it on Mondays right but if you fade the move on Monday you actually lose three percent so that’s another you know this other time frame right of saying okay if everybody’s got to adjust their Hedges on Monday after Opex and that should clear everything out well you know

41:07

that’s why I wanted to look at what happens just one day kind of mean reversion play it it breaks in a whole different way the distribution which you see on here is incredibly normal like you know it’s amazing to me of how perfect this distribution is you know from January 2020 to now in a way you know you go well maybe this makes sense

41:26

right it’s market makers are unwinding positions and dealers are unwinding positions and they don’t want to Market impact and maybe we’re just perfectly offsetting the week’s move by adjusting positions on Monday right but again whatever happened in September 2020 the meaner version trade whether you look at

41:40

it on a week basis or on a daily basis has changed um and again the zero DT stuff is what is is really fascinating to me about this so does that like as you think about that going forward it’s funny because maybe think about value investing and this has nothing to do with value investing but like value

41:54

investing didn’t work for a very long period of time and then you’re stuck with this idea of like have things changed or do I do I rely on the long-term stuff so this is like a short-term version of that like does this have does this give you less confidence in the idea that these these options expirations are going to be

42:09

turning points yeah I mean look you by and large what you know it was like this this trade and again A lot of people are aware of this now um that hey look big puts are expiring buy the dip right or big calls are expiring so the rip and and not necessarily the market has to have this complete you know uh reversion and if

42:27

you go back and and we talk about our last last podcast and those were like you can look at historical moves in the market and see okay yeah Opex hits and there’s a little bit of weakness some consolidation which I think makes sense right now uh you have the buyback blackout starting on the 15th you know

42:43

uh a lot of these names are very rich losing a lot of call positions there’s like these factors you go this is like seems like a home run for me and reversion here right like sell this and then buy the dip next week that makes a lot of sense but that trade’s been completely broken uh over the last several months and so

43:01

to your point on value investing I you know uh how long do you wait to see you know what what the what the impact of this is the other thing that’s really interesting about it is is this idea of you know does the vix expiration fall before or after does the flmc fall before or after and and those factors

43:19

there’s a little bit of evidence there of to the weather that stuff matters uh incidentally the last several expirations Vic’s expiration has fallen before uh Opex and so maybe that’s some of this you know this time Vic’s expiration Falls after so there’s additional hedging flows tied to volatility that could maybe add to some

43:37

of this um but but whatever it is like you know it’s one of those zero DT signals where you go like stinks I think this is like a zero DT impact trade and you can make a case of that because if I have a whole bunch of exposure you know that I need to head for Opex I could just put on these zero DD contracts make a very

43:53

calculated hedge and then like I’m done I don’t have to adjust anything for Monday so you know it’s it’s it’s curious and it’s weird and it’s muddy the waters for me like if if this September it’s a present number was 100 then I I’d be much happier sitting here saying like this is the trade we all got to do because it works you know

44:11

funny like this is this is what brings the short-term options guys and the long-term value guys together which is this concept that investing is really hard um you know you think you’ve got the thing that works and then suddenly it doesn’t work anymore and so yeah no matter what you’re doing no matter what

44:25

part of investing you’re in I mean that that rule seems to hold yeah and you know we’ve injected leverage into the system with these options and and that’s you know so should it cause short-term distortions yes but at the same point if you have these zero DT chasing entities in Nvidia and AMD and apple and all this

44:42

sort of stuff that moves those stocks right and I I you know we’ve gone back and looked at this in detail in in so many different ways that you go okay well the zero DT and the s p maybe it doesn’t matter but if you own Nvidia as a as a long only investor you’ve owned it for a long time you can see that all these short-term

45:03

calls come in and implied volatility in the stock just goes through the roof as people are buying calls so you have this signal right this signal that is really reflecting emotions that there’s this Chase going on um and suddenly you know the price the sales of Nvidia is uh what like a 40 or something like that like it’s higher

45:21

than any stock ever in the history of the market and so you know if you’re a value investor you’re sitting there and you own this stock that just went up 100 you know in a month it must affect the way that you think about things because I don’t think you know you’re like oh we had a two-year Horizon on this stock but suddenly I got

45:38

two years worth of movement in a week because of the fact that all this call Flow just came in and you know it’s on Wall Street bets that we should all buy this thing and so like what I’ve what I’ve kind of like the way I like trying to phrase this is like you you need like an options adjusted beta so it’s almost like you

45:55

understand like oh there’s all this call flowing so if I think that you know I have some long tech stops here and and the beta the to the s p is 1.5 for a letter just for sake of argument well if all these people are buying calls with the beta of that stock the s p is now 2.5 or whatever as opposed to 1.5 like

46:11

how do you adjust to that like I think you have to adjust to that but you know I I leave that to the value Professionals in this case yeah you know Nvidia is really interesting for me like it’s a yeah I mean back to your point I’m like holding Nvidia like I would never hold it in the first place because you know as a value

46:30

investor I would have never liked it and you know I would never like at the beginning and then like one of my weaknesses is I certainly would have sold it on the way up like I would never like you know 40 time sales or something I would never be around for 40 time sales yeah are you seeing like the same

46:41

types of pressure on the like we talked about kind of the market reversing because of a lot of call buying you know coming into Opex is the same thing going on with these the nvidias of the world like there’s tons and tons of call buying here coming in topics yeah uh so the call buying really occurred over the

46:55

last like two three weeks kind you know there was that day where Steve Cullen came out and drucken Miller and like somehow all these guys on the same day said we’re all getting into AI right and and those stocks went bananas and then what happened is you know you had this volatility in amds and videos and

47:11

anything related those things went up 50 right in like a week you know what I mean and then if you look at over the last two weeks they just stuck like yeah there’s some intraday of all but like Nvidia hit 400 two weeks ago and it’s at 400 now and AMD hit 125 two weeks ago and it’s at 125 now and so through our

47:28

lens what happened is all these people bought calls and the value of those calls surges and the stock trades to where those big call positions are and then suddenly there’s like all this flow that’s just tied to this strike and it just like pins the stock at this level and now Friday all those call positions are going to go

47:49

away now whether that means the stock moves up a bunch or down a bunch you know we we can make a couple of different cases for that but the volatility is invoked in our a lot of ways by or exacerbated by these call options and then the call options at the same time shut the volatility off kind of pin the stock on

48:06

this chart here kind of explains this there’s a bunch of different ways you get each one of these stocks is an individual what we call gamma profile right this is for iwm and what you see here on the x-axis is kind of a proprietary measure we call a gamma ratio and that just basically looks at how much game

48:22

there is relative to the underlying and what you can see is that when you get more gamma the volatility on a five-day basis here declines right so more gamma and if you look at you can look at this across a whole bunch of individual stock it’s the same story a little bit of gamma means High volatility but a lot of

48:38

gamma means stuck right and you can see this that there’s this relationship here between low volatility and high gamma right and the idea here is that there’s all these people that are hedging their options positions dealers or vault Traders or whatever it may be and that’s causing price to just stick

48:58

you know and I think these names that that also Skyrocket that get like you know call implied ball of 100 which is humongous right and these call Skis you’ve never seen these options prices before that and that also brings in us another class of Trader right there’s volatility traders who don’t care about

49:16

the fundamental of the stock or what the stock price is doing they just see that the implied volatility is huge and they come in and they buy or sell those options and they’re hedging it all day long right so all of a sudden like there’s a whole nother class of flow in these names that arguably wasn’t there

49:31

before so you know it changes the kind of complexion I guess of of what’s taking place in the name right it trades in a different way which kind of brings me back to this beta idea I guess so the idea is we don’t know which direction is going to go obviously but there’s a decent chance it gets unstuck

49:47

here after Friday I mean I I would say like my money would be on some meaner version right and and the thing is is like well now what happens is like you get one day of weakness and then everyone goes hey uh everybody else on you know Wall Street bets like Nvidia actually went down one percent let’s all buy it and let’s buy a zero DD

50:04

called and you just see the thing probably so it’s like the first order effect is like more volatility right that that’s it and then you’re like well anytime you have lots of calls expiring there’s evidence that the stock mean reverts right and that that’s always felt like very clear and stable a stable

50:17

concept of me going in going in and in fact if you look at this right this chart here shows us the amount of gamma expiring and this is actually in the S P 500 amount of gamma expiring versus the one day return post Opex so if we know that calls are expiring and we do this we can measure this right if we think calls are

50:41

expiring which would mean we slide left on this axis the market return the following day is almost always negative right and if you go to the right if people are adding calls the day after Optics then the market return is almost always positive it’s a very clear relationship here and if you look at on

50:56

a single stock basis it’s the same thing you know it’s not nothing in finance is 100 but this is a very strong it might do linear relationship and what’s so weird about this is that you go oh what are like the last six months returns right what are these weird dots that’s actually not the last six months so it’s

51:14

like the zero DT thing may have changed this relationship around options expiration but what what it seems to be doing almost is it’s like the zero DTE flow is inviting like the way that the the options expiration is being hedged so in other words this idea of like game increasing or decreasing being tied to

51:31

you know higher or lower returns in the market after options expiration still exists even though that relationship you know the fade relationship I was talking about before has changed I think the zero DT flows is allowing a different hedging protocol around options expiration that’s that’s kind of changed

51:49

what the mechanics are but the bottom odd here is that go look uh it’s hard to believe that Nvidia AMD name the AI stock 50 of their gamma position is set to expire on Friday Tesla all of them right huge huge expiration as we show the social it’s hard to believe that that you know you’re not going to lose this these call

52:08

positions on net right on Friday now they’re probably going to reload next week slowly as people build new positions or roll to a new you know higher contract or whatever it is so like we think the default way to play this is weakness next week and then you can get this return you know and then we can resume the the swing higher so to

52:28

this point of value investing you know if you want to rotate positions right when do you want to time the rotation of your positions when you want to enter or exit a position rather than kind of maybe sticking your finger in the air and saying like this is the interesting time um these can be interesting moments

52:43

because you know what the flow is that’s moving the stock right it’s not necessarily news or anything else it’s just these hedging flows adjustments that can distort the stock price in in the short term as we close up I want to ask you about this JT Morgan trade because it’s something that’s in the news a lot and

52:58

it’s something like people like me don’t understand that well so it seems like there’s there’s a very large JPMorgan fund that’s executing some sort of hedging trade at the end of every quarter and that trade may or may not have a significant impact on the market um so as we step through it the first

53:13

thing I want to ask you about is the type of trade they’re doing the types of options trade they’re doing can you just talk about what that is and like what that trade is for yes the the funding question is the JPMorgan hedged Equity Fund it’s uh its symbol is j h e q X so you just Google that it’ll come up it’s got 15 billion

53:32

dollars in Long only assets so they just own stocks and performance is pretty good uh of those returns so the reason it’s called the hedged equity strategies because they put on this collar trade every quarter and and it’s in their perspectives that this is what they do and a color trade means that you

53:52

sell a call and you use that money to buy puts in this case they buy put spreads to kind of lower their cost and the idea is that I don’t want to spend the money to buy a put because that’s just a tax on my portfolio it’s just a drag on my portfolio so I’m going to fund that put by by selling a call

54:09

now of course the way that they do this is that at the end of every quarter which in this case will be June 30th they sell call generally two to three percent out of the money that expires on the next quarter so in this case it’ll be September and then they use the proceeds of that call to buy you know

54:26

some put spread that’s generally roughly five percent of the money right and the idea is that obviously if the market crashes they have this hedge on and this trade because the fun has grown in size you know 15 billion this size is this trade has grown in in size so it’s 45 000 ish contracts uh you know several

54:42

billion dollars notional are tied to this this options trade um aside from the fund’s assets and everybody now in the options universe and even if you’re not on the options Universe you you watch this trade because you know the day it’s going to expire you think you have an understanding of how it’s the new trade is supposed to be

55:04

rolled on and how it’s supposed to hedge and et cetera et cetera Etc and so this has become this like really heavily watched uh exercise in the market kind of like options expiration uh or call options or whatever it is when everyone’s doing it or everyone’s watching it like 10 things to Independence or break down

55:22

or or get distorted a little bit so if you looked at the way that the markets traded the last two quarters yeah in December I believe it was we pinned the JPMorgan strike so what happens is the market tends to move almost like a magnet to where the big JP Morgan position is set to expire on the day of expiration uh last month or

55:44

excuse me last quarter in March the strike was at 40 65. the market was about two percent below that uh a day or two prior and it rallied that day that Friday actually went through that strike and closed the market closed at 4100 and a lot of people were saying well this is hedging flows related to the JP Morgan

56:01

you know uh collar trade or collar roll right so the strike this month for that the call strike is at 43.20 today we closed I think about 30 or 40 points over that in the s p so the idea is that this is this this level is a magnet either if we’re around that call the Market will draw to it or if around that

56:21

put the market will draw to it and I think it there are hedging for those I think that are tied to it you can make that case uh I think there’s a lot of when everyone watches the same level the market kind of like moves to that it’s like that famous Gumball exercise where like if we all guess how many gumballs are in the

56:38

machine like in the machine like the mean of our guesses is like that that’s what the number of gumballs is it’s kind of the same thing like we’re all watching that you know that one strike and so somehow like all of our trades like push us to that level I don’t know um but the issue is that because

56:52

everyone knows that this trade is going on I think that the way they hedge it like JP Morgan has to end up with the same color strategy but the way that the dealers May implement the trade must change drastically now that everyone’s watching right like we were talking to uh a guy that used to run the city

57:09

derivative zest and a couple others and and he was set talking about these big trades he used to do and he’s like when everybody knows I have to hedge we would just go to lunch or go do something else because everyone’s expecting us to do this and you know there’s a negative expected return because of that right if everyone knows

57:27

I need to hedge I can’t just hedge the way they’re expecting because I’m just you know disadvantaging myself so this trade was heavily watched I was watching the strike and you know it’s a big amount of flow it may have a short-term impact in terms of like right around quarter end you know there’s a little bit of strange

57:47

movement particularly if we’re in and around that strike again this time it’s 43 20. um but it’s hard to say there’s a longer term impact or issue you know because of that strike in in the way that it exists today there’s some arguments to be made when the market is crashing and if the market trades down to around where the

58:06

put strike is there is some arguments to be made that that trade can suppress Market volatility because the idea is that you know dealers are you know hedging in some certain form or fashion that could you know support the market a little bit so that is something to be aware of so it’s helpful to be aware of

58:22

where these strikes will be and again um you know they’re set to roll on the 30th but I I would say most of the time it doesn’t matter if the market crashes a lot maybe you want to pay attention to it if we get around the quarter end you want to watch it but then the other issue that compounds this is that

58:37

there’s always big funds uh fun flows on quarter end anyways right so how do you actually like pull out what was just some Sovereign wealth fund you know reallocating versus you know oh that was all JP Morgan you know Roll Effect so um that’s for sure yeah I remember like last last quarter went above like people

59:01

were calling it pop the collar or something like what they’re trying to do like trying to get it like to breathe um I guess they did to some extent last quarter yeah but but this so my problem with that is sort of like well JP Morgan got screwed on this I was like I don’t know if they got screwed because those

59:16

are cash settled positions right because you’re trading the S P 500 Index position so it’s cash settled uh I think if the argument was that there’s going to be stock settlement like if you if you held spiders or Tesla over expiration and there’s stocks shifting around because of that but this is Cash

59:30

settled so maybe the broker’s like hey I’m gonna Jam this thing but I’m gonna hedge out JP Morgan at 9am and then whatever I do for the rest of the day doesn’t matter to JP Morgan because they got this hedge on right so what they used to do is they used to like put a trade on in the morning like they put like a starter structure

59:47

on let’s say 10 30 in the morning and then you know they’re hedging with Futures and they’re doing like efps and all this you know whatever is going on right throughout the day and then at the end of the day they would adjust the strikes based on how much the market moved right so the idea is like we put

1:00:03

on the structure the market moved this much and to compensate the broker or just the trade or whatever it is like we’re gonna print these strikes to basically cross them again at like 410 right before the market closes right so they would adjust that position I don’t why can’t they maybe they just did the

1:00:18

same thing you know they bought a zero DTE call or something like that right and and then when the market rallies a whole bunch well JP Morgan doesn’t care because you know they they have this long call that the broker put on for them so it’s not I think it’s very hard to say this is exactly you know the pop

1:00:33

the collar thing sounds great but maybe maybe didn’t necessarily work that way right I mean um who’s to say one way or the other I guess is what I’m getting at so do you think that the general conclusion for like longer term investors is this probably a lot of short-term people that are competing with each other to try to

1:00:49

make money off of this thing but for longer term investors it probably doesn’t matter that much I mean do you think that’s a fair way to look at it I I would say to the upside I don’t think it matters that much when the market is moving higher particularly if like you know that call strike is like weighing

1:01:01

the money it’s going to cause noise on the day and I think if you’re looking at the market you go like we just traded down for some reason and we hit the JP mortgage like then you can draw some Clues like okay I know why this distortion on the day was there because of this trade where it where you could

1:01:15

argue that there’s a longer term implication is if the market is very weak and selling off and we’re around the where the put spread is right the various legs of that puts red then volatility can change uh around that event right so I think that that’s where it becomes interesting so like one of the arguments was last year why was

1:01:34

there lower volatility made maybe in the market even though the market was crashing and lowers why didn’t the vix Spike so much and I think this was around September of last year or maybe it was June of last year for forgive me on the timing but if if the dealer is long this put strike so JP Morgan is

1:01:51

they want to put spread right there let’s say they’re long the 4 000 and they’re short to 3 000 strike right the market gets down to around three three thousand strike we know dealers own that strike so they may be hedging in a way that supports the market around that 3000 strike right around that very lower

1:02:07

uh lower bound to that JP Morgan spread and if it’s billions of dollars of daily hedging flow then maybe that stops the vix from spiking and holds the market up a little bit in that case so that could be a situation where there’s a longer term sort of like you know fingerprint or effect of that trade

1:02:23

um but you know if you look conclusively back like I looked over the last three or four years of of um foreign you know where the collar was positioned and how the market moved and and some days it you know it’s a magnet and and and half of them and the other ones particularly early on when no one was

1:02:41

really tracking that trade um it seemed kind of inconclusive like there wasn’t a strong signal like we pinned it last two two quarters ago it was certainly in play last quarter you know uh and so we’ll see it on on Friday you know uh excuse me two weeks from now um it’s possible but again as a longer

1:03:00

term value investor it’s like kind of a good to know in case there’s some distortions on the day but but yeah back to your original point it was a very long-winded way of me telling you probably doesn’t matter well thank you for spending so much time with this you know I’m one of these guys who likes to pretend I know a lot of my

1:03:16

options and then every time you come on I realize that I did not know a lot about options so it’s it’s like I love our episodes where we can learn a lot and these These are always ones where we learn a lot so we really appreciate you talking to us yeah well anytime I listen to you guys talk about uh value uh

1:03:26

investing and factorization on stuff uh you know it’s the same it’s the same feeling I I know nothing I’m totally lost I feel like a baby also you’re you’re getting up there in terms of our most frequent guests I think it’s your third time so I think our most frequent I guess I’ll leave it on four times so

1:03:42

uh we’ll have you back some time and you can break the record I I would like that anytime you want to talk about something if we get a zero DT flash crash we can do uh we can do a hot take outside that sounds good if people want to learn more about spot gamer about you where the best places to go uh spotgamer.com is

1:03:56

where we uh have our site you can sign up for our daily newsletter there’s a trial there if you want to try that out we write about the S P 500 every day both with the short-term View and a little bit of a longer term view you can look at these Opex positionings things like that and then I’m also at spot game

1:04:11

on Twitter where you can find me uh posting various musings and having a lot more followers than me well thank you again we really appreciate it thanks Jack appreciate it this is Justin again thanks so much for tuning in to this episode of excess returns you can follow Jack on Twitter at practicalquat and follow me on

1:04:31

Twitter at jjcarbonneau if you found this discussion interesting and valuable Please Subscribe in either iTunes or on YouTube or leave a review or a comment we appreciate it Justin carbonneau and Jack forhand are principals at the Lydia Capital Management the opinions expressed in this podcast do not

1:04:48

necessarily reflect the opinions of Olivia Capital no information on this podcast should be construed as investment advice Securities discussed in the podcast may be Holdings of clients of living

00:00

welcome to excess returns where we focus on what works over the long term in the markets join us as we talk about the strategies and tactics that can help you become a better long-term investor Justin carbonneau and Jack forhand are principals at the Lydia Capital Management the opinions expressed in

00:13

this podcast do not necessarily reflect the opinions of Olivia Capital no information on this podcast should be construed as investment advice Securities discussed in the podcast may be Holdings of clients of Olivia Capital hey guys this is Justin in this episode of excess returns Jack and I sit down

00:26

with brencochuba founder of Spock gamma we talked to Brett about a range of options related topics including the rise of zero DTE options and the implications of these Market volatility and options the importance of option expiration dates rebalancing from large funds using options and much more options in the corresponding dealer flow

00:42

has many implications on the supply and demand and the pricing in the markets Brent was generous enough to share many great visuals from a spot Cameron’s proprietary research and the charts help us visualize and better understand the important forces at play as always thank you for listening please enjoy this

00:57

discussion with spot gamma’s Brent kachuba Brett how are you thanks for coming back on with us man I’m doing great uh happy to be back talking to you guys I missed you sweet well we’re gonna have a good interesting discussion around uh zero DTE options Market volatility option positioning some of these

01:16

expiration dates coming up and just overall I think try to learn and build our knowledge and our listeners and viewers knowledge on and what’s you know an important part of the market in a large part of the market um and that’s all this discussion around options and one of the things for anyone that’s listening to us on audio we

01:36

highly encourage you if you can to pop over to our YouTube channel because Brent has been nice enough to bring a bunch of slides and visuals with us or with him so that I think it’s going to helps or visualize some of these these Concepts so really appreciate appreciate that Brent yeah of course uh the

01:55

anything that means not having to look at me I think is a Improvement there you go look at any of us probably um so yeah let’s start with this um zero DTE options you know this is they’ve become sort of a little bit of a front and center here in the market given their rise in popularity so you know out of the gate I just wanted to

02:14

sort of talk about what these things are and maybe you know pick your brain a little bit about about these types of options yeah uh it’s been a uh it’s been a remarkable rise of options volume you know you could look back even to 2019 and and um and see just this increase in options volume and and the general

02:32

sort of idea why this all matters is because every time an option trades in theory there needs to be a certain amount of hedging flow tied to you know those options trades and so as the opposite volume increases in in interview we need to have more hedging flow you know which is the underlying stock or or Futures trade which which in

02:51

theory moves the market and so on this slide here I plotted the the real long-term view of putting call volume so you can see call volume here in red and put volume in purple and what you’ll notice is that in March uh April excuse me of 2022 they launched Tuesday expiration options in the s p that in

03:11

may they launched Thursday options in S P 500 so that meant that at that point in May of 2022 there was an options expiration for the S P 500 Index every single day of the week uh before that there was Monday uh Wednesday Friday expirations and then in September of 2022 it became official that okay this

03:30

pilot program now you know the real deal and they launched officially these daily expirations and then the exchanges followed on with that in November of daily expirations in the spiders the Spy ETF and then the queues and so what you can see here is that on this chart is that there’s a remarkable increase in

03:48

options volume tied to those dates right and you can see that shift up and what we’ve seen is that really those whatever the flow was that adopted that volume adopted it very quickly and then that volume has since plateaued right so it’s like immediately everyone started trading these things and then it you

04:08

know that volume just has basically Stood Still uh over time if you look at a percentage of volume basis in terms of looking at zero DT versus non-zero DT whatever it is the volume has really stayed steady so you know there’s like some extra Alpha in there or you know some other kind of new use case it

04:24

really hasn’t shown itself in terms of an increase in in volume so the point is that whatever the use cases seems to have stabilized um we did an in-depth study on this and you know not to plug our YouTube channel but we go to our YouTube channel you can see what our uh Deep dive and all the little data points is and what we view

04:42

uh is that the zero DT flow causes mean reversion in the market and we say that because anytime there’s a dip in the market you see Zero DT call buyers come in uh or put sellers come in and that pressures the market to go higher and conversely if the market rallies we see call sellers or put buyers come in and

05:02

we believe that pressures the market lower and so you can see this mean reversion come in on a daily basis on our website spotgammon.com we have a zero DT monitor so you can see this flow come out in real time um and what we’ve talked to clients about and what we’ve heard is that there are these kind of

05:23

inexplicable sudden reverses in the market where you know you think a trend is setting up and also on the market will just switch yesterday I mean today’s June 13th yesterday we saw the market just kind of like for no reason just it was quiet all day right we had CPI today and and fomc tomorrow but yesterday for whatever reason the market

05:40

just rafting one percent at 2 30 and if you watch the zero DT flow you can see that zero DT flow comes in all of a sudden call buyers came in uh to the tune of like a billion dollars of Delta notional and and up the market goes um so these are the fingerprints that are being left on a daily basis and I

05:57

it’s hard to draw longer term conclusions from this at this point because number one we haven’t gone through that many Market Cycles I would argue since the launch of zero DTE uh second you know there’s been a lot of interest rate changes which I think has impacts on underlying liquidity um you know we’ve had uh you know a big

06:17

drawdowns there’s a lot of strange things happening in applied volatility you know throughout the year and so um I think it’s hard to kind of like pull out the factor of exactly you know what the impact is but there are signs here and I can I’m going to show some of these in a few minutes um there are signs here that there is an

06:33

impact on volatility in other words how much the market is moving based on this do you have any sense of like of the volume like how much is retail and how much is institutional just I don’t know if there’s anything any data out there you have like uh just a sixth sense I was reading this Bloomberg article that

06:48

was kind of talking about it was like highlighting all these retail traders that were kind of using it and you know them in different ways and it was a little bit like like speculative gambling but then I’ve heard I’ve talked to other people that know it’s like a lot of institutional sort of options buyers in here so what

07:03

what are your thoughts yeah there’s an important delineation to make here first is in the SPX spy and cues there’s an expiration every single day so we refer to that as zero DT but if you look at single stocks Apple Tesla you know etc those only have expirations every Friday so we kind of classify those as the zero

07:20

DT for single stocks and so if you break it down what you’ll generally see is about in the SPX big contracts five to ten percent is retail and that comes from various Bank research reports you can actually monitor the retail flow explicitly on our site as well and that basically syncs up and then when you

07:39

look at the spiders which obviously has a smaller notional value on a relative basis and some of this individual stocks that that flow will get you know anywhere from 10 to sometimes towards 50 depending on the stock that you’re looking at in the time of day you’re looking at um you know like in GameStop or

07:54

something the retail flow come in hot and heavy and then in Tesla there’ll be a flash in the pan in terms of retail and then it’ll cool off so you know that 10 number is one that seems to come up quite often uh particularly talking about the bigger s p you know 500 Index and and the use case is different there

08:10

are institutions out there that may substitute the use of Futures Trading uh for zero DTE contracts right so rather by Future I’m going to hedge Myself by buying a zero DT call and just kind of eating that cost or I can offset some of my hedging exposure you know uh the various Greeks through using these zero

08:30

DTE contracts uh I think there’s a lot of quantitative funds we’ve seen quotes from the likes of like aqr out there saying hey you know zero DT gives us more at bats right because the strategy that I’m running uh suddenly can run with this option options expiration that happens every day um and then you know there’s some people

08:47

that talk about this idea that there’s a lot of wealth managers that want to sell uh those zero DT call spreads and put spreads as a way to generate income so the use case is fairly widespread I’d say um but it tends to be more institutional meaning professional money managers albeit under that bracket of

09:05

Institutions there’s a lot of different flows right there’s dealers and quantitative funds and wealth managers and that and that kind of thing so is this coming out of like options that are further out in the in the future like since people are using these more are they using options less they’re further out in the future yeah you can

09:21

see the impact of that there’s definitely this shift in in percentage of open interest and things like that where you know you definitely cannibalize some of the longer dated Flow by having these zero DTE contracts and if you think about it like if you wanted to hedge like the FMC for tomorrow like let’s I don’t really know

09:38

what the fed’s gonna say tomorrow uh but I’m a little worried like I got a long portfolio let’s say so I’m just gonna buy zero GTE contract right to hedge out pal saying you know we’re raising rates by 50 and they don’t have to worry about it whereas before what I had to do is buy like a contract like a month out

09:53

worry about the Decay worry about my cost and all that now I can just say I’m going to take this cheap Hedge isolate that event risk and then and then I’m done I’ll have to worry about it right because because the power doesn’t do anything well on Thursday we’re off the races and all is good right so you definitely see that

10:07

canalization does this you talk about kind of a mean reversion thing with this does this also I’ve heard other people talking about it saying like there is the mean reversion but it also kind of opens up the taste so that like a four percent decline in the market could become eight percent if this went the

10:21

other way or something I mean is there is there any truth to that do you think but yeah I mean everything in in finance is about you know uh balance basically right so if you have a situation where everybody’s short zero DTE options you know that could be the situation that causes a lot of problems right because if everybody has

10:38

to cover their position uh then that could suddenly Force flow the other way or if everybody comes out right now and just buys zero DT puts then that could push the market down and that and that was the whole vulmageddon you know JP Morgan piece that came out and got a lot of attention um but the the the the number of kind of

10:54

like qualifiers that they had to put in place to get that volume again scenario just made it feel very unlikely so if I just first started this idea of mean aversion you could see situations and then kind of the most famous one a lot of people talk about was I think it was October 13th of 2022 there was a really

11:10

nasty CPI print and the s p uh traded down like five percent pre-market I think the s p opened at 3 500. and and just after the market open you saw these giant zero DT call positions come in and the market rallied all the way back intraday right I think the market was up four and a half percent intraday and

11:29

that’s the mean reversion flow that’s kind of like you know that that is like the situation of mean reversion where if I own put options or if I own let’s say yeah if I just own puts right like three months outputs and the market gaps down four percent I don’t have to close that put anymore I could just buy some zero

11:45

DD calls to hedge myself in case the market rallies back and so that kind of situation is where you see the mean reversion where things can get out of control is when a lot of people get caught off sides and this is the tail risk and you know like if you look at today and you look at what these the market was pricing the market was

12:04

pricing uh before the market opened the zero DT straddle is trading for something like uh 75 basis points meaning that the Marcos pricing in a 75 basis point move and so Traders will sell zero DT options against that price right it’s pretty cheap price and and prices can get even lower you get a 50 50 basis point zero

12:22

DT straddle we’ve seen some of that recently so if anything causes the market to move more than that straddle price or the the implied Vol for the day then in theory that’s going to force traders to cover and anytime you have just like in a margin call or anything like that anytime you have Force covering that’s where things can kind of

12:39

spiral uh and really move the caveat to all this with the zero DT is that they expire at the end of the day so any exposure that’s tied to any of this in theory is gone at the end of the day right the books are all cleaned up the positions are gone it all settles it’s all you know it’s all moot point at

12:55

closing so you don’t have this persistent pressure of you know someone’s buying or everyone’s buying you know one month outputs where every day there’s this exposure that acid gets hedged uh and so I think that really relieves you could get a flash crash scenario more so than a than a real persistent you know clubbing because of

13:13

the because of the offsides so does does it seem like it could it be that on that one day you could get a much more substantial move then because yeah I’m just using zero DTE versus it they were spreading it out over you know over time 100 100 and and that’s why I say it’s like a flash crash scenario where you

13:28

know you you can get these imbalances intraday but what generally happens is and what alleviates a lot is pressure is if I’m long some puts for today and let’s say the market just moves down you know real very sharply I I’m incentivized to close that position up because the game of that position is so

13:45

high the sensitivity of that option to what the market is doing so so high that in a lot of ways I I I’m better off monetizing or closing out my position when it’s advantageous right and and so what that happens is then the pressure’s relief so like if we’re all long zero DT puts and the market crashes two percent

14:02

well I’m gonna start selling my puts and taking my money right I’m gonna close that position out because if the market starts to Rally I’m I’m you know I’m bleeding very quickly and it becomes a reflexive feedback loop I mean if the three of us are all you know long puts right and and Justin starts clothing out

14:17

hundreds of thousands of zero DD positions that can start the market to Rally up right or recover and then Jack you’re gonna go oh man like this is going against me now I might as well take you know take my gains you close out your puts and the market keeps going and then I gotta chase finally to get

14:31

out as well so you get you know there’s this kind of like feedback loop in the flow that that comes along with this how do you think like a lot of our listeners will be like longer term investors who don’t use options how do you think they should think about this I mean some people seem to talk to this

14:45

about this as a really big deal for the market that people need to worry about other people kind of say you know yeah it’s something going on behind the scenes but it’s not in terms of like moving the overall Market dramatically over time it’s not that big of a deal like where do you fall kind of on that

14:55

continuum I think for the longer term investor there could be some potential opportunities as maybe there’s certain days right a couple days a year where zero DT really drives an imbalance and that’s either in the market as a whole or in some individual single stocks right and we’re going to talk about this

15:12

I think in a minute where you know how you take advantage from this so I think there’s some distortions that can be created in the short term over the longer term There’s No Smoking Gun obvious signal here as to what the zero DT is doing like I have some evidence obviously that mean reversion is is increasing but we’re also coming off

15:28

this time where volatility was so extreme right um in the market that you know it’s hard to build out the factors that say okay you know the reason that the market is now you know vix is back at 13 is because of zero DTE um you can make you can make that case but it’s not you know conclusive at this

15:45

point so I think as time evolves a little bit we’ll understand a little bit better but again for the for the longer term investor there’s some short-term distortions that can occur because of this and and we can identify some of those so I want to next to volatility um it’s something I don’t know a ton about

15:59

but obviously a lot of us are watching it you know a lot of people monitor the vix now more than they used to in the past but like as I’ve studied it more I’ve kind of learned the vix is not the entire picture of volatility and one of the things we’ve seen a lot of people talking about is this idea of fixed

16:13

strike Vol which we’re going to ask about in a second but before we do that I wanted to ask about the Vixen general just for anybody who doesn’t know can you just talk about what the vix actually measures sure so the the vix measures the implied volatility of the S P 500 and the way that it does that is it measures S P 500

16:28

Index options that expire roughly 30 days out in times you know it changes a little bit 27 to 32 days basically but what it’s meant to tell you is what how much movement do Traders expect in the S P 500 and so it’s become known as the fear gauge because typically the Vixen will Spike right as the market crashes

16:47

but all it’s doing is expressing that Traders are expecting kind of higher volatility and so one of the things that’s come about now is with the impact of zero DT or the release of zero DT there’s the vix one day contracts now and the vix you know kind of excuse me not contracts but one vix one day index vix 90 index there’s

17:05

these shorter term indices and in options land sort of the argument is does the vix still have value right because all these options now trade zero DT I mean 45 roughly the S P 500 is zero DT you know trading so there there’s a lot of volume that’s concentrated in the very shortest term um expirations and so the question is is

17:27

the vix still valuable and what I would say is it is because the the the way that you can make that assessment is in March there was the bank crisis right and suddenly the zero DT volume subsided and people started to buy longer term options they started to hedge their tails because they were worried about

17:48

the systemic risk of all these Banks going down so you suddenly saw you know the vix spiked rather violently but you suddenly saw these longer dated S P 500 options trades come in so what I would say is that the utilization of the vix or the way that people watching the information you get from it is being

18:02

augmented or adjusted maybe uh as a result of the zero DD flow um and then the second part of your question is you know we’re in this situation now where there’s a a lot of demand for call options and the vix measures both puts and calls so if there’s a lot of demand for call options you can have a situation where the vix is going up as

18:25

the market goes up which is counterintuitive to what a lot of people think but in this environment here with heavy options demand et cetera you can get a lot of demand for calls and you can have the vix stabilizer actually increase slightly as the Market’s going up which is again a little bit counter-intuitive but but

18:41

ultimately the vix is just a volatility gauge not a not really a fear gauge so you talked about like the 30-day vix these the shorter term fixes coming in but is the 30-day vix I mean is it you know is it like we have to draw a line here and say post zero DTE it’s now distorted in some way or is it like if

18:56

we look at it relatively history does it not really impact that if you look at the correlation between the S P 500 Index and the vix the correlation has changed right since the launch of zero DTE and so there is enough evidence here to say yes there is a difference in the way that the uh the vix responds to Market crashes and its

19:16

ranges on the day and things like that and and a lot of this is because so much Action Now takes place in the zero DTE space especially when you consider out to five days right in the S P 500 that’s where 50 plus percent of the volume is taking place so there’s all this movement in five day contracts

19:34

uh in zero DTE contracts and the vix is just only looking at 30-day contracts so it’s not picking up any of that flow right they’re not picking up any of that reaction and so just to give you an idea of this I had this chart here of term structure and what term structure does is it monitors the implied volatility

19:52

called we call it the at the money implied volatility the s p so the at the money option is if the s p opens today at 30 4 300 what is the implied volatility of that contract right that’s the at the money and what you see is that the implied volatility is very elevated for the first few expirations in other words traders who are trading

20:10

with zero DT are looking for a lot of volatility today because there may be a lot of volatility around you know the CPI or fomc but if you look at the the price of that Contracting Fireball I’ll tell you that contract out 30 days the implied volatility is relatively low right nobody cares so 30 days on time no

20:26

one cares about volatility no one’s pricing volatility but for today people are pricing a relative uh higher amount of volatility because you know of the zero DT phenomenon or the or the reaction to whatever the Market’s doing today um and so this kind of epitomizes what the vix is missing right because if you

20:43

you know the term structure here across the x-axis is we see every single expiration date and then we’re looking at the at the money implied volatility for every expiration date so in this case what is the 43 the market closed around 43.50 today right what is the Vault implied volatility for the 4350

20:58

contract every day for every expiration on time and so again if you look 30 days on time which is roughly July you can see by this white line on the on the chart here that the the curve or the the the curve is very flat out there right out in time versus there’s some backwardation we call it in the near term because people

21:20

are pricing in short-term volatility like I.E volatility today due to CPI and fomc um so again all this elevated short-term volatility that the Traders are pricing in from today with the CPI tomorrow FMC none of that’s being picked up or or reflected in the vix because that looks at the 30-day contract okay and I think

21:38

this is us into this concept a fixed strike Vol um you know one of the things I’ve noticed like when you you know people like me you know nothing about volatility are sitting there watching the vix all day and people like you who know what they’re talking about or not as much at least and you know one of the

21:51

things I noticed in this in this recent increase in the market is a lot of the Vol guys were kind of saying you know on these updates you would see the vix still down a little bit although I think it has gone up a little bit on the most recent updates yeah it did but but a lot of them behind the scenes were saying

22:04

even before that happened they were saying actually volatility was up today because fixed strike is all it was up today um if you could talk about what that is and like we’re how people are measuring that sure so one of the things I would say to trip when the vix was up a little bit with the CPI on the fomc tomorrow

22:19

and so you know there there’s still some longer data hedging occur around some of these events um and if you you can use this thing called the rule of 16 and what that is is you divide implied volatility so whether the vix is 14 or 16 whatever if you divide that by the number 16 that tells you what Traders are expecting as

22:37

a one-day move for the S P 500 and so you can hit these what I call lower bounds in the vix where you know if you start to get a fix of like 10 you know which is kind of like a historic real low you know that’s like a market pricing in 65 70 basis points of movement in the in the s p so you could have a 50 point Rally or a 50 basis

22:56

point rally in the market right and that means the vix was under pricing volatility so you can have these situations where the vix has to go up because the market rallied 50 basis points right and in the same way that the market crashed one percent the vixo have to go up so what what has happened recently several times is that the vix

23:13

has gone down even though you know to your point Traders come out and say well no volatility went up and and the reason is because the vix has a weighting to what we call at the money contracts and so if you look at the way that volatility is priced there’s this skew or a smile in the way that implied

23:31

volatility is priced over various contracts so on your screen here on the x-axis are the strikes for the S P 500 so you can see here there’s 4305 you know 40 through 50 et cetera and this is from Bloomberg in red is on the y-axis is the implied volatility for each one of these strikes and this is on a one month basis so last week uh

23:53

excuse actually yesterday the 12th on this red line here you see the implied volatility for every single strike right so at the 43.55 the implied volatility was about 11 and a half right 11.5 and what happened day over day is that the implied volatility of these contracts all went up and you could tell

24:13

that because this white line the white curve here which was today’s implied volatility reading from around nine o’clock this morning so or eight o’clock this morning so before the CPI you can see that the implied volatility for each of these strikes is higher right so the 4355 contract for yesterday was 11 and a

24:29

half remember this is looking at the same one month contract 43.55 for yesterday and today excuse me 11 and a half for the 43.55 and today that insane level of implied ball was 12 and a half right so volatility actually went up when you look at it on a fixed strike basis and further what you can see is there’s

24:48

this again this Distortion or kind of curve right that happens here and we highlighted in this green box where at the time the s p opened around 4350 all these calls above had a relatively even higher implied volatility so what you take away from this is that there is a demand for call options that is pushing

25:07

the implied volatility on a fixed strike basis higher right so while the at the money had a implied volatility increase from 11.5 to 12 and a half the 43.95 contract went from an 11 implied Vol 2 12 or 12 and a half in ply ball so it had a relative higher gain at these higher strikes and so what this is

25:26

reflecting is some call demand is is the way that we would interpret this now if you look to the vix you would see maybe the vix went down or this was or a lot of where the discussion came around as the vix went down now why would the vix go down when you see these fixed strike implied Vol measurements occur this

25:43

comes back to this idea of at the money options right on Tuesday the at the money contract was the let’s say 43.25 just for sake of argument right and you can see here in red again that the at the money contract had roughly an applied volatility of 12. so let’s just say that meant that the vix is 12 because the vix has a

26:02

weighting to the at the money contract right so the vix is going to say great at the money for today which would be Monday morning is a 12. now what happens is the market rallies overnight uh or throughout the day right and such that on Tuesday Morning the new at the money contract is let’s say the 43.75. well the the at the money implied

26:21

Vol for the 43.75 is an 11 and a half so all the VIXX did was reflect the fact that we changed the at the money strike from 43.25 to 43.75 and implied volatility is lower at that strike so all that happened was the vix slid down this curve so to speak and that is why I implied volatility went lower so you know in general there’s

26:45

like this idea of puts you is like everyone is I think is aware of this idea even if you’re not in the options world like after the 1987 you know uh October crash right suddenly puts carry a higher implied volatility they care they carry a higher relative value to calls right so if you look at the the

27:01

put implied volatility or the put price of a five percent of the money put it generally is higher than a five percent out of the money call right and that’s because of this idea that in general people own puts because of this crash protection right generally people are long S P 500 or long stocks and they

27:19

they buy puts for protection so that’s why you have this SKU that you can see in the S P 500 here where you know puts have Empire higher implied volatant calls and this is this is almost always how it looks in the S P 500 you almost never see this curve kind of inverted where calls have a higher implied ball level

27:35

and so you know oftentimes what happens when you see the vix slide down or go up it’s just a function of the at the money strike changing right it’s not that the volatility of that individual strike necessarily change that much it’s just we’re shuffling around what the at the money strike is so if we go down

27:53

sometimes you’ll see the vix go up but all we did was shift from this 4375 strike which had 11 implied Vol to the 43 25 strike which had a 12 implied ball right and that’s all that happened is the vix slid up this curve and and volatility changed along with it I know volatility is an ambiguous concept so there’s probably like no not

28:12

one good way to measure it or not one complete way to measure it but so do you look at stuff like this when you want to see a volatility is going up or down will you look at this more and you look at the vix you know the what I tend to do is I thumb through a bunch of different charts so there’s there’s some

28:25

skew indexes that you can look at for example like uh well the skew index is one there’s another one s decks you know there’s there’s some of these bigger picture things that you can look at and see if there’s something kind of funky going on and then you can kind of drill in and look at things like fixed strike

28:38

ball or look at skew or term structure and start to put together a little bit you know more pieces of the puzzle right so what Traders are doing the general idea is that if you have higher implied volatility generally what that means is Demand right so if putting five balls going up people are buying puts if if

28:54

put by ball is going down they’re selling them right there’s that’s kind of like the the high level takeaway now under the hood you can say well the Traders are pricing in an event or this or that other thing but at the highest level that’s kind of what you’re looking at right is there demand for these options

29:09

higher prices means demand is increasing and that’s that’s starting to take so when you look at this call Applied Vault on the fixed strike base is going up on our especially on a relative basis here this little slight curve that’s telling us like oh before the C the CPI reading people are buying calls here people are

29:23

trying to get long in front of this event right um and then you know what you want to take away from that can also be deliberated uh as well but you know this is part of what we get you know paid to do is is to to look at all these different metrics and try to you know glean some Edge out of it yeah I assume

29:39

someone would need access to something like Bloomberg to do this is there’s not some index that’s like publicly available where you can look at this kind of thing now there’s not a fixed strike index uh we’re we’re developing a fixed strike dashboard and essentially looks like a big grid right in it it’s

29:51

like a heat map essentially that changes so you know this is becoming a hotter topic a a more nuanced thing to look at and you know as this options volume increases and more Traders come in you know these are some of the metrics that you start to hear and you and you start to talk about um and again on a daily basis it’s not

30:07

terribly interesting uh for most people out there right but sometimes there are these big shifts in this data that really kind of should wake up all investors you know regardless of your time horizon or whether or not you trade options at all right because this information is you know sometimes telling you things that are that are

30:25

rather important is there any validity to this idea that has fixed strike Vols going up along with the market that that’s some sort of red flag like that the Market’s more vulnerable to do a decline when they’re going up together yeah it’s a supply and demand thing number one so anytime you see Vol up

30:38

market up that is a sign that there’s some exuberance in the market that doesn’t necessarily mean the market has to crash it just means that whatever this move is it’s it’s overdone right it’s it’s time for a pause and this is one of the things I think longer longer term Traders or investors can use as an

30:56

interesting signal there’s a lot of people like to overwrite and I think when you look for these signals of Market of all up or stock up volup if you look at an individual stock those are times where you can make an argument that it’s effective to sell calls or overwrite my position right it’s great

31:12

that people are buying calls there’s a lot of bullishness in that but sometimes it just gets overheated right and and that implied volatility increases when a stock ramps up like all these AI stocks I have a chart we can or a slot I can on show on this um for example on here I have what we call the iwm we call this the 25 Delta

31:32

risk reversal all this is doing is looking at the relative price of a 25 Delta call so kind of a slightly out of the money call versus a slightly out of the money it right that’s all this is showing you and so anytime this line shoots higher that’s telling us that the value of the call is jumping relative to

31:48

the value of the put right so you know obviously if the Market’s crashing like it did back here in in November of 2000 and this is actually 21. that makes sense right people are buying puts they’re scared nobody wants to buy a call markets crashing put values are exploding you know vix goes to 40. that makes sense

32:06

that this line will go down because the put values are increasing what we’ve actually seen as you can see here over the last two weeks there’s this massive jump in call prices relative to puts that’s telling us that there is all this kind of excessive demand in iwm’s and iws have pretty good performance but

32:24

this is at a level now that you just don’t see when you look back historically and you can look at this on individual stocks as well and the point with this is that as call prices increase the odds or or opportunity for you to make money on calls goes down right because you’re paying more for calls you

32:42

need the market to move more or you need the stock to move more as the call prices go up for you to get a payoff and that’s what this implied volatility Is Telling You Higher option Price Right higher implied Vol High relative option price I need more movement more volatility to get this payoff so if I’m

32:57

overpaying for calls I can have a situation where I’m buying calls and can never get a payout those are great times to arguably sell calls against my long stock positions because the froth is in there right there there’s a lot of elements or or signals that hey you know this is overdone we’re due for a pause

33:15

or or some pullback and so again this is one of these shorter term signals or volatility signal that can be very effective for you know a longer term uh Trader or investor options expiration is this week right Friday so we have the FED tomorrow and then there’s a very you know a humongous uh options exploration on Friday that

33:34

flooded on your screen here so what I did is I plotted what we call Delta notional so if you want to consider what the stock equivalent was to what an option stock size equivalent was that’s what we do by looking at Delta and what you can see on our screen here in Blue uh or or purple I guess I will call it

33:51

uh is the call Delta so how big is the notional value of these call positions when you represented the stock so if all the options liquidated right now you know what’s the value of that um and you can see it’s about 600 billion dollars it’s very large and then the put side you know we’re quite a bit smaller

34:08

that’s what’s in teal so this is a very call heavy options expiration and these quarterly expirations tend to be extremely large you can see that the next largest expiration is June January right and what’s interesting about this is that the last time we had a call expiration that was this large it was January of

34:28

2020. in January 2020 was a pretty nasty market movement right from basically gen 1 to Jan Opex the market traded down I think 10 10 13 somewhere in that neighborhood in the bottom of that market uh drop at least short term bottom was the day after options expiration I think it was January 25th and what happens is

34:52

call positions as they go in the money they gain in value so if I bought a call a month ago or two months ago or three months ago whatever it is and the market rallies my call keeps gaining in value right so when Apple goes up 15 a month or Nvidia goes up 80 in a month or whatever it is those calls are all

35:10

gaining in value and the theory is that the Hedge is required from dealers and market makers to offset that risk is gaining in value right because if I’m short a bunch of calls as a deal or a market maker and these calls continue to go up I have to buy more and more and more stock to to maintain my hedges and

35:25

so you know the the I always talk about this is like the January Opex these are the leaps they always have a huge expiration this is like the Pelosi trade right she’s famous for like buying like massive numbers of Google and Amazon calls or whatever and then they run up in the money and then she trick she

35:41

closes those out in January and they expire so this is like a similar thing here in June because the markets rise so much the value of these calls has has risen immensely and by default the way that we look at this is that these calls have to be closed out they could be rolled higher or adjusted or whatever it is but on net we think

35:58

there’s a lot of hedging flow that should lead to some short-term selling in in some of these stocks that have been moving up a lot um and that’s as a function of of Hedges being Unwound and positions shifting and these positions are forced to shift because you know they’re they’re expiring so you know as a Trader if I

36:14

own these calls I have to make an adjustment and if I don’t I’m going to be assigned you know a whole lot of stock so when you look at like options expirations that end up being Major Market moving events versus ones that don’t I mean what are the common characteristics is it like this where the Market’s moving in One Direction

36:30

there’s a lot of open interest in that same direction is that where you have the tendency to maybe have a reversal yeah the the default way that we look at this is that mean reversion is what we generally look for in the big options expiration so number one what is the size of the expiration uh the court of the expirations are

36:47

almost always large December in particular the year-end expiration is always very very large the monthly expirations you know it’s like a stock by stock basis whether it is you know meaningful when I say meaningful it’s like how much underlying liquidity is tied to these expirations um and then the weeklies can even matter

37:04

now because of the increase of zero DTE so by default the way that we look at this is meaner version the markets had a big rally here uh huge call positions as those come off we would look for some short-term weakness or consolidation in the market as a result of uh all these calls expiring in a similar fashion if

37:22

you look at historic lows in the in the stock market I think we’ve talked about this before you know again March of 2020 or December of 2018 or June of last year um there’s huge put positions that expire and the market rallies the Monday after in June of 2000 just a year ago we had the complete opposite situation the

37:39

market was making it’s I think it was a zero to date low was in June uh it wasn’t the low of the year it was a major low and the market rallied immediately after options expiration so that turning point is something that you know a lot of people have caught on to aren’t aware of now and what I think is

37:54

interesting um I put this slide together if you faded the move which means that I just went back and I looked at all of the options expiration since 2020. and I said okay if the market was weak into this expiration let’s imagine we bought the market at the close on Friday of expiration and held it for one week right makes sense

38:16

so if the market sold off into Friday I buy the market on Friday and hold it for a week and that return was 23 if you did that from January 2020 to today right that’s a pretty good return just what what I say you know fading the move or playing mean or version after Optics um and it’s pretty well distributed it’s

38:34

not that there’s like one day that just made you 20 right and uh and the other times were kind of like you know noise right the the the data here seems pretty conclusive that that there is something here now what’s fascinating to me about this and like I actually you know I was like I knew I was going to talk to you

38:52

guys I sort of put this together as we have this June Optics something changed such that if you do that same trade from September of 2022 to today or you know obviously May Opex is the last one you actually lose eight percent doing that same trade so 73 of the time historically you make money doing the flip trade but after

39:14

September of 2022 it only works one out of three times is that because people are front running it I wish I had a beautiful answer to that um number one people are aware of this options flow the second one which I can’t help but kind of like point to is the fact that zero DT became an official uh you know listed ending whatever it is

39:35

on in September of 2022 so September 2022 was officially when zero DT launched now again May kind of picked up and and that’s when the contracts were available but you know this September date is when they’re like okay these are going to be listed in perpetuity and so for whatever reason the Opex flip trade

39:53

broke right at the same uh at the same time these are are listed it’s a it’s a it’s there’s a lot of these like coincidental factors that seem to come into play and again the tricky part is like well you know the markets had this incredible rally and again all the rate volatility and you know these different things that are

40:14

moving around it’s a little difficult to say this is the reason why but the you know it’s a thing like Walks Like A Duck talks like a duck it’s a duck I think um but you know it’s a fascinating thing to me the other thing that’s really interesting to me is that if you looked at rather than fading the move on a

40:30

week-to-week basis so if the week was weak coming into Opex and I held it for another week what happens if I just played a one day meaner version what’s what’s what blew my mind on this is that from January 2020 to the present the return of that strategy is a zero meaning you wouldn’t make any money

40:51

by by fading the Opex move I just played it on Mondays right but if you fade the move on Monday you actually lose three percent so that’s another you know this other time frame right of saying okay if everybody’s got to adjust their Hedges on Monday after Opex and that should clear everything out well you know

41:07

that’s why I wanted to look at what happens just one day kind of mean reversion play it it breaks in a whole different way the distribution which you see on here is incredibly normal like you know it’s amazing to me of how perfect this distribution is you know from January 2020 to now in a way you know you go well maybe this makes sense

41:26

right it’s market makers are unwinding positions and dealers are unwinding positions and they don’t want to Market impact and maybe we’re just perfectly offsetting the week’s move by adjusting positions on Monday right but again whatever happened in September 2020 the meaner version trade whether you look at

41:40

it on a week basis or on a daily basis has changed um and again the zero DT stuff is what is is really fascinating to me about this so does that like as you think about that going forward it’s funny because maybe think about value investing and this has nothing to do with value investing but like value

41:54

investing didn’t work for a very long period of time and then you’re stuck with this idea of like have things changed or do I do I rely on the long-term stuff so this is like a short-term version of that like does this have does this give you less confidence in the idea that these these options expirations are going to be

42:09

turning points yeah I mean look you by and large what you know it was like this this trade and again A lot of people are aware of this now um that hey look big puts are expiring buy the dip right or big calls are expiring so the rip and and not necessarily the market has to have this complete you know uh reversion and if

42:27

you go back and and we talk about our last last podcast and those were like you can look at historical moves in the market and see okay yeah Opex hits and there’s a little bit of weakness some consolidation which I think makes sense right now uh you have the buyback blackout starting on the 15th you know

42:43

uh a lot of these names are very rich losing a lot of call positions there’s like these factors you go this is like seems like a home run for me and reversion here right like sell this and then buy the dip next week that makes a lot of sense but that trade’s been completely broken uh over the last several months and so

43:01

to your point on value investing I you know uh how long do you wait to see you know what what the what the impact of this is the other thing that’s really interesting about it is is this idea of you know does the vix expiration fall before or after does the flmc fall before or after and and those factors

43:19

there’s a little bit of evidence there of to the weather that stuff matters uh incidentally the last several expirations Vic’s expiration has fallen before uh Opex and so maybe that’s some of this you know this time Vic’s expiration Falls after so there’s additional hedging flows tied to volatility that could maybe add to some

43:37

of this um but but whatever it is like you know it’s one of those zero DT signals where you go like stinks I think this is like a zero DT impact trade and you can make a case of that because if I have a whole bunch of exposure you know that I need to head for Opex I could just put on these zero DD contracts make a very

43:53

calculated hedge and then like I’m done I don’t have to adjust anything for Monday so you know it’s it’s it’s curious and it’s weird and it’s muddy the waters for me like if if this September it’s a present number was 100 then I I’d be much happier sitting here saying like this is the trade we all got to do because it works you know

44:11

funny like this is this is what brings the short-term options guys and the long-term value guys together which is this concept that investing is really hard um you know you think you’ve got the thing that works and then suddenly it doesn’t work anymore and so yeah no matter what you’re doing no matter what

44:25

part of investing you’re in I mean that that rule seems to hold yeah and you know we’ve injected leverage into the system with these options and and that’s you know so should it cause short-term distortions yes but at the same point if you have these zero DT chasing entities in Nvidia and AMD and apple and all this

44:42

sort of stuff that moves those stocks right and I I you know we’ve gone back and looked at this in detail in in so many different ways that you go okay well the zero DT and the s p maybe it doesn’t matter but if you own Nvidia as a as a long only investor you’ve owned it for a long time you can see that all these short-term

45:03

calls come in and implied volatility in the stock just goes through the roof as people are buying calls so you have this signal right this signal that is really reflecting emotions that there’s this Chase going on um and suddenly you know the price the sales of Nvidia is uh what like a 40 or something like that like it’s higher

45:21

than any stock ever in the history of the market and so you know if you’re a value investor you’re sitting there and you own this stock that just went up 100 you know in a month it must affect the way that you think about things because I don’t think you know you’re like oh we had a two-year Horizon on this stock but suddenly I got

45:38

two years worth of movement in a week because of the fact that all this call Flow just came in and you know it’s on Wall Street bets that we should all buy this thing and so like what I’ve what I’ve kind of like the way I like trying to phrase this is like you you need like an options adjusted beta so it’s almost like you

45:55

understand like oh there’s all this call flowing so if I think that you know I have some long tech stops here and and the beta the to the s p is 1.5 for a letter just for sake of argument well if all these people are buying calls with the beta of that stock the s p is now 2.5 or whatever as opposed to 1.5 like

46:11

how do you adjust to that like I think you have to adjust to that but you know I I leave that to the value Professionals in this case yeah you know Nvidia is really interesting for me like it’s a yeah I mean back to your point I’m like holding Nvidia like I would never hold it in the first place because you know as a value

46:30

investor I would have never liked it and you know I would never like at the beginning and then like one of my weaknesses is I certainly would have sold it on the way up like I would never like you know 40 time sales or something I would never be around for 40 time sales yeah are you seeing like the same

46:41

types of pressure on the like we talked about kind of the market reversing because of a lot of call buying you know coming into Opex is the same thing going on with these the nvidias of the world like there’s tons and tons of call buying here coming in topics yeah uh so the call buying really occurred over the

46:55

last like two three weeks kind you know there was that day where Steve Cullen came out and drucken Miller and like somehow all these guys on the same day said we’re all getting into AI right and and those stocks went bananas and then what happened is you know you had this volatility in amds and videos and

47:11

anything related those things went up 50 right in like a week you know what I mean and then if you look at over the last two weeks they just stuck like yeah there’s some intraday of all but like Nvidia hit 400 two weeks ago and it’s at 400 now and AMD hit 125 two weeks ago and it’s at 125 now and so through our

47:28

lens what happened is all these people bought calls and the value of those calls surges and the stock trades to where those big call positions are and then suddenly there’s like all this flow that’s just tied to this strike and it just like pins the stock at this level and now Friday all those call positions are going to go

47:49

away now whether that means the stock moves up a bunch or down a bunch you know we we can make a couple of different cases for that but the volatility is invoked in our a lot of ways by or exacerbated by these call options and then the call options at the same time shut the volatility off kind of pin the stock on

48:06

this chart here kind of explains this there’s a bunch of different ways you get each one of these stocks is an individual what we call gamma profile right this is for iwm and what you see here on the x-axis is kind of a proprietary measure we call a gamma ratio and that just basically looks at how much game

48:22

there is relative to the underlying and what you can see is that when you get more gamma the volatility on a five-day basis here declines right so more gamma and if you look at you can look at this across a whole bunch of individual stock it’s the same story a little bit of gamma means High volatility but a lot of

48:38

gamma means stuck right and you can see this that there’s this relationship here between low volatility and high gamma right and the idea here is that there’s all these people that are hedging their options positions dealers or vault Traders or whatever it may be and that’s causing price to just stick

48:58

you know and I think these names that that also Skyrocket that get like you know call implied ball of 100 which is humongous right and these call Skis you’ve never seen these options prices before that and that also brings in us another class of Trader right there’s volatility traders who don’t care about

49:16

the fundamental of the stock or what the stock price is doing they just see that the implied volatility is huge and they come in and they buy or sell those options and they’re hedging it all day long right so all of a sudden like there’s a whole nother class of flow in these names that arguably wasn’t there

49:31

before so you know it changes the kind of complexion I guess of of what’s taking place in the name right it trades in a different way which kind of brings me back to this beta idea I guess so the idea is we don’t know which direction is going to go obviously but there’s a decent chance it gets unstuck

49:47

here after Friday I mean I I would say like my money would be on some meaner version right and and the thing is is like well now what happens is like you get one day of weakness and then everyone goes hey uh everybody else on you know Wall Street bets like Nvidia actually went down one percent let’s all buy it and let’s buy a zero DD

50:04

called and you just see the thing probably so it’s like the first order effect is like more volatility right that that’s it and then you’re like well anytime you have lots of calls expiring there’s evidence that the stock mean reverts right and that that’s always felt like very clear and stable a stable

50:17

concept of me going in going in and in fact if you look at this right this chart here shows us the amount of gamma expiring and this is actually in the S P 500 amount of gamma expiring versus the one day return post Opex so if we know that calls are expiring and we do this we can measure this right if we think calls are

50:41

expiring which would mean we slide left on this axis the market return the following day is almost always negative right and if you go to the right if people are adding calls the day after Optics then the market return is almost always positive it’s a very clear relationship here and if you look at on

50:56

a single stock basis it’s the same thing you know it’s not nothing in finance is 100 but this is a very strong it might do linear relationship and what’s so weird about this is that you go oh what are like the last six months returns right what are these weird dots that’s actually not the last six months so it’s

51:14

like the zero DT thing may have changed this relationship around options expiration but what what it seems to be doing almost is it’s like the zero DTE flow is inviting like the way that the the options expiration is being hedged so in other words this idea of like game increasing or decreasing being tied to

51:31

you know higher or lower returns in the market after options expiration still exists even though that relationship you know the fade relationship I was talking about before has changed I think the zero DT flows is allowing a different hedging protocol around options expiration that’s that’s kind of changed

51:49

what the mechanics are but the bottom odd here is that go look uh it’s hard to believe that Nvidia AMD name the AI stock 50 of their gamma position is set to expire on Friday Tesla all of them right huge huge expiration as we show the social it’s hard to believe that that you know you’re not going to lose this these call

52:08

positions on net right on Friday now they’re probably going to reload next week slowly as people build new positions or roll to a new you know higher contract or whatever it is so like we think the default way to play this is weakness next week and then you can get this return you know and then we can resume the the swing higher so to

52:28

this point of value investing you know if you want to rotate positions right when do you want to time the rotation of your positions when you want to enter or exit a position rather than kind of maybe sticking your finger in the air and saying like this is the interesting time um these can be interesting moments

52:43

because you know what the flow is that’s moving the stock right it’s not necessarily news or anything else it’s just these hedging flows adjustments that can distort the stock price in in the short term as we close up I want to ask you about this JT Morgan trade because it’s something that’s in the news a lot and

52:58

it’s something like people like me don’t understand that well so it seems like there’s there’s a very large JPMorgan fund that’s executing some sort of hedging trade at the end of every quarter and that trade may or may not have a significant impact on the market um so as we step through it the first

53:13

thing I want to ask you about is the type of trade they’re doing the types of options trade they’re doing can you just talk about what that is and like what that trade is for yes the the funding question is the JPMorgan hedged Equity Fund it’s uh its symbol is j h e q X so you just Google that it’ll come up it’s got 15 billion

53:32

dollars in Long only assets so they just own stocks and performance is pretty good uh of those returns so the reason it’s called the hedged equity strategies because they put on this collar trade every quarter and and it’s in their perspectives that this is what they do and a color trade means that you

53:52

sell a call and you use that money to buy puts in this case they buy put spreads to kind of lower their cost and the idea is that I don’t want to spend the money to buy a put because that’s just a tax on my portfolio it’s just a drag on my portfolio so I’m going to fund that put by by selling a call

54:09

now of course the way that they do this is that at the end of every quarter which in this case will be June 30th they sell call generally two to three percent out of the money that expires on the next quarter so in this case it’ll be September and then they use the proceeds of that call to buy you know

54:26

some put spread that’s generally roughly five percent of the money right and the idea is that obviously if the market crashes they have this hedge on and this trade because the fun has grown in size you know 15 billion this size is this trade has grown in in size so it’s 45 000 ish contracts uh you know several

54:42

billion dollars notional are tied to this this options trade um aside from the fund’s assets and everybody now in the options universe and even if you’re not on the options Universe you you watch this trade because you know the day it’s going to expire you think you have an understanding of how it’s the new trade is supposed to be

55:04

rolled on and how it’s supposed to hedge and et cetera et cetera Etc and so this has become this like really heavily watched uh exercise in the market kind of like options expiration uh or call options or whatever it is when everyone’s doing it or everyone’s watching it like 10 things to Independence or break down

55:22

or or get distorted a little bit so if you looked at the way that the markets traded the last two quarters yeah in December I believe it was we pinned the JPMorgan strike so what happens is the market tends to move almost like a magnet to where the big JP Morgan position is set to expire on the day of expiration uh last month or

55:44

excuse me last quarter in March the strike was at 40 65. the market was about two percent below that uh a day or two prior and it rallied that day that Friday actually went through that strike and closed the market closed at 4100 and a lot of people were saying well this is hedging flows related to the JP Morgan

56:01

you know uh collar trade or collar roll right so the strike this month for that the call strike is at 43.20 today we closed I think about 30 or 40 points over that in the s p so the idea is that this is this this level is a magnet either if we’re around that call the Market will draw to it or if around that

56:21

put the market will draw to it and I think it there are hedging for those I think that are tied to it you can make that case uh I think there’s a lot of when everyone watches the same level the market kind of like moves to that it’s like that famous Gumball exercise where like if we all guess how many gumballs are in the

56:38

machine like in the machine like the mean of our guesses is like that that’s what the number of gumballs is it’s kind of the same thing like we’re all watching that you know that one strike and so somehow like all of our trades like push us to that level I don’t know um but the issue is that because

56:52

everyone knows that this trade is going on I think that the way they hedge it like JP Morgan has to end up with the same color strategy but the way that the dealers May implement the trade must change drastically now that everyone’s watching right like we were talking to uh a guy that used to run the city

57:09

derivative zest and a couple others and and he was set talking about these big trades he used to do and he’s like when everybody knows I have to hedge we would just go to lunch or go do something else because everyone’s expecting us to do this and you know there’s a negative expected return because of that right if everyone knows

57:27

I need to hedge I can’t just hedge the way they’re expecting because I’m just you know disadvantaging myself so this trade was heavily watched I was watching the strike and you know it’s a big amount of flow it may have a short-term impact in terms of like right around quarter end you know there’s a little bit of strange

57:47

movement particularly if we’re in and around that strike again this time it’s 43 20. um but it’s hard to say there’s a longer term impact or issue you know because of that strike in in the way that it exists today there’s some arguments to be made when the market is crashing and if the market trades down to around where the

58:06

put strike is there is some arguments to be made that that trade can suppress Market volatility because the idea is that you know dealers are you know hedging in some certain form or fashion that could you know support the market a little bit so that is something to be aware of so it’s helpful to be aware of

58:22

where these strikes will be and again um you know they’re set to roll on the 30th but I I would say most of the time it doesn’t matter if the market crashes a lot maybe you want to pay attention to it if we get around the quarter end you want to watch it but then the other issue that compounds this is that

58:37

there’s always big funds uh fun flows on quarter end anyways right so how do you actually like pull out what was just some Sovereign wealth fund you know reallocating versus you know oh that was all JP Morgan you know Roll Effect so um that’s for sure yeah I remember like last last quarter went above like people

59:01

were calling it pop the collar or something like what they’re trying to do like trying to get it like to breathe um I guess they did to some extent last quarter yeah but but this so my problem with that is sort of like well JP Morgan got screwed on this I was like I don’t know if they got screwed because those

59:16

are cash settled positions right because you’re trading the S P 500 Index position so it’s cash settled uh I think if the argument was that there’s going to be stock settlement like if you if you held spiders or Tesla over expiration and there’s stocks shifting around because of that but this is Cash

59:30

settled so maybe the broker’s like hey I’m gonna Jam this thing but I’m gonna hedge out JP Morgan at 9am and then whatever I do for the rest of the day doesn’t matter to JP Morgan because they got this hedge on right so what they used to do is they used to like put a trade on in the morning like they put like a starter structure

59:47

on let’s say 10 30 in the morning and then you know they’re hedging with Futures and they’re doing like efps and all this you know whatever is going on right throughout the day and then at the end of the day they would adjust the strikes based on how much the market moved right so the idea is like we put

1:00:03

on the structure the market moved this much and to compensate the broker or just the trade or whatever it is like we’re gonna print these strikes to basically cross them again at like 410 right before the market closes right so they would adjust that position I don’t why can’t they maybe they just did the

1:00:18

same thing you know they bought a zero DTE call or something like that right and and then when the market rallies a whole bunch well JP Morgan doesn’t care because you know they they have this long call that the broker put on for them so it’s not I think it’s very hard to say this is exactly you know the pop

1:00:33

the collar thing sounds great but maybe maybe didn’t necessarily work that way right I mean um who’s to say one way or the other I guess is what I’m getting at so do you think that the general conclusion for like longer term investors is this probably a lot of short-term people that are competing with each other to try to

1:00:49

make money off of this thing but for longer term investors it probably doesn’t matter that much I mean do you think that’s a fair way to look at it I I would say to the upside I don’t think it matters that much when the market is moving higher particularly if like you know that call strike is like weighing

1:01:01

the money it’s going to cause noise on the day and I think if you’re looking at the market you go like we just traded down for some reason and we hit the JP mortgage like then you can draw some Clues like okay I know why this distortion on the day was there because of this trade where it where you could

1:01:15

argue that there’s a longer term implication is if the market is very weak and selling off and we’re around the where the put spread is right the various legs of that puts red then volatility can change uh around that event right so I think that that’s where it becomes interesting so like one of the arguments was last year why was

1:01:34

there lower volatility made maybe in the market even though the market was crashing and lowers why didn’t the vix Spike so much and I think this was around September of last year or maybe it was June of last year for forgive me on the timing but if if the dealer is long this put strike so JP Morgan is

1:01:51

they want to put spread right there let’s say they’re long the 4 000 and they’re short to 3 000 strike right the market gets down to around three three thousand strike we know dealers own that strike so they may be hedging in a way that supports the market around that 3000 strike right around that very lower

1:02:07

uh lower bound to that JP Morgan spread and if it’s billions of dollars of daily hedging flow then maybe that stops the vix from spiking and holds the market up a little bit in that case so that could be a situation where there’s a longer term sort of like you know fingerprint or effect of that trade

1:02:23

um but you know if you look conclusively back like I looked over the last three or four years of of um foreign you know where the collar was positioned and how the market moved and and some days it you know it’s a magnet and and and half of them and the other ones particularly early on when no one was

1:02:41

really tracking that trade um it seemed kind of inconclusive like there wasn’t a strong signal like we pinned it last two two quarters ago it was certainly in play last quarter you know uh and so we’ll see it on on Friday you know uh excuse me two weeks from now um it’s possible but again as a longer

1:03:00

term value investor it’s like kind of a good to know in case there’s some distortions on the day but but yeah back to your original point it was a very long-winded way of me telling you probably doesn’t matter well thank you for spending so much time with this you know I’m one of these guys who likes to pretend I know a lot of my

1:03:16

options and then every time you come on I realize that I did not know a lot about options so it’s it’s like I love our episodes where we can learn a lot and these These are always ones where we learn a lot so we really appreciate you talking to us yeah well anytime I listen to you guys talk about uh value uh

1:03:26

investing and factorization on stuff uh you know it’s the same it’s the same feeling I I know nothing I’m totally lost I feel like a baby also you’re you’re getting up there in terms of our most frequent guests I think it’s your third time so I think our most frequent I guess I’ll leave it on four times so

1:03:42

uh we’ll have you back some time and you can break the record I I would like that anytime you want to talk about something if we get a zero DT flash crash we can do uh we can do a hot take outside that sounds good if people want to learn more about spot gamer about you where the best places to go uh spotgamer.com is

1:03:56

where we uh have our site you can sign up for our daily newsletter there’s a trial there if you want to try that out we write about the S P 500 every day both with the short-term View and a little bit of a longer term view you can look at these Opex positionings things like that and then I’m also at spot game

1:04:11

on Twitter where you can find me uh posting various musings and having a lot more followers than me well thank you again we really appreciate it thanks Jack appreciate it this is Justin again thanks so much for tuning in to this episode of excess returns you can follow Jack on Twitter at practicalquat and follow me on

1:04:31

Twitter at jjcarbonneau if you found this discussion interesting and valuable Please Subscribe in either iTunes or on YouTube or leave a review or a comment we appreciate it Justin carbonneau and Jack forhand are principals at the Lydia Capital Management the opinions expressed in this podcast do not

1:04:48

necessarily reflect the opinions of Olivia Capital no information on this podcast should be construed as investment advice Securities discussed in the podcast may be Holdings of clients of living