In this episode I am joined by Mutiny Fund CIO Jason Buck and our close partner at RCM Alternatives, Jeff Malec.
In this quarterly review, we discuss what we saw in markets in Q1 and how various volatility strategies performed.
To give a bit of context, Q1 2021 saw The S&P up 6%, and the VIX down about -14.87% though it was fairly range bound. The inverse PutWrite index which is a rough proxy for at-the-money volatility on the S&P was down about -5.82%.
Accredited investors interested in learning more can contact us at info@mutinyfund.com for more information or submit an inquiry on our site, mutinyfund.com.
I hope you enjoy these conversations.
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Transcription
Taylor Pearson:
Hello and welcome. This is the Mutiny Investing podcast. This podcast features long form conversations on topics relating to investing markets, risk, volatility, and complex systems.
Disclaimer:
This podcast is provided for informational purposes only, and should not be relied upon as legal business investment or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of Mutiny Fund their affiliates or companies featured. Due to industry regulations participants of this podcast are instructed to not make specific trade recommendations, nor reference past or potential profits. Listeners are reminded that managed features, commodity trading, Forex trading and other alternative investments are complex and carry a risk of substantial losses. As such they’re not suitable for all investors and you should not rely on any of the information as a substitute for the exercise of your own skill and judgment in making a decision on the appropriateness of such investments. Visit mutinyfund.com/disclaimer for more information.
Taylor Pearson:
In this episode I am joined by Mutiny Fund CIO, Jason Buck, and our close partner at RCM Alternatives Jeff Malec. We discussed what we saw in markets in Q1 and how various volatility strategies performed and react to key events. Do give a bit of context Q1 2021 that we’ll be talking about saw the S&P up about 6%, the VIX was down about 14.8% that was fairly range-bound over that period and the put right index, which is a rough proxy for at the money volatility on S&P was at up about 5.82% so that’s people’s selling options at the money. The credit investors that want to learn more can contact us at info@mutinyfund.com. For more information, or you can submit an inquiry on our site at mutintyfund.com. So without any further ado I hope you enjoy this conversation.
Jeff Malec:
Jason what are your big takeaways from Q1?
Jason Buck:
So Q1 in general saw S&P stoke going rip and higher. We saw up 6% over Q1 vol still crushing back down. I think at one point we were up in the 30s, it came back down for the first time in the teens, this first time we’ve seen the teens since the pre COVID era. But inside of that there’s always a lot of noise inside of those numbers. So Jeff, what was your individual takeaways?
Jeff Malec:
Yeah, I think the big takeaway for me if I had to label Q1 would just be a return to normal to more normal. But I think inside of that normalness was still a lot of craziness that if we’d been in ’17 or ’18 it would have been big market moving altering events. You had a GameStop, Melvin Capital, a couple other hedge funds on the ropes in January. Then you had the I’m going to butcher the Greek name Archegos or whatever it was Bill Hwang’s family office, and him going from 200 million net worth to 10 billion to zero over the course of a few weeks. So those kinds of things even in ’07, ’08 you saw the first Bear Stearns hedge fund that went bust because of their mortgage back exposure.
Jeff Malec:
Those kinds of stories felt like that, they felt like canaries in the coal mine but at the same time vol was just getting crushed throughout that period and market was going on to new highs. So do I look at it as there’s this insane ability to handle those events or are those still canaries in the coal mine and there’s a lot of fragility under the surface.
Jason Buck:
We only see those things really in hindsight. There’s all these canaries in the coal mines on the way to a top, and we’re not necessarily calling a top that’s not what we do in general. But it’s interesting that the Archegos blow up and seeing a cascade of billions of dollars in losses across the investment banks, which is going to have them reducing leverage across all different kinds of strategies to have nothing to do with what the Archegos is doing. If that had happened pre 2020, we would have thought that would have the cascade effect that spiked volatility. But once again it’s like when we saw the storming of the Capitol and volatility stayed unchanged, these are kind of unusual times that we’ve been living in especially that echo of volatility that we constantly talk about since March 2020. But that’s generally the markets we’ve seen and whether GameStop was a nice blip in volatility as people got a little nervous around the GameStop, but then it subsequently came back down rather quickly. Taylor, what kind of jumped out at you over the Q1 period?
Taylor Pearson:
So I would say let’s drill in maybe kind of go month by month and look at it more detail. I think for the GameStop Wall Street Bets was the show that mostly played out and basically kicked off in January and it’s still kind of been ongoing. Basically a bunch of people on Reddit decided to pump the stock of GameStop, which went from $2 to $200 or something. And there were a bunch of hedge funds that were short it and so we saw this big… Part of the story, there was this expensive implied volatility that didn’t really show up in realized volatility. We talked about that some last year the sort of typically implied volatility, which is reflection and options prices.
Taylor Pearson:
So effectively how much people are willing to pay to ensure their portfolios against volatility versus realized volatility, which is what the market is actually doing. Typically those tend to track each other fairly closely, but we saw again sort of in January something we’d seen kind of Q4 2020 which was realized volatility stayed pretty low and implied volatility spiked up. You said it maybe people looked at it and they saw this is something that would have been a weird, a big deal in 2017, 2018 but turned into a nothing burger.
Jeff Malec:
Yeah. Sorry I cut you right before you’re famous nothing burger line, but I think there’s a slight nuance there of in Q4 you had implied was kind of pegged. It was staying at the same level people had this worry around the election, around the storming of the Capitol all this stuff but it wasn’t really increasing. After that in Jan in the beginning of June, we saw all realized and implied started to come down. Then the GameStop, Melvin Capital implied kind of spiked a little. People, this canary in the coal mine factor they said, “Hey, here’s a hedge fund getting taken out some big rescues having to happen, that’s a signal and let’s bid up some option vols to protect ourselves later on.” But as you said Taylor, realized, didn’t really do it. So there was all this talk, there was all this worry but outside of GameStop going up 4000% down a 1000% round tripping all over the place there, there wasn’t really the realized vol inside of the S&P especially.
Jason Buck:
Yeah, it’s good to point out that you have that volatility in GameStop, but it’s such a tiny equity that we’re primarily focused on the S&P 500 and major sell-offs in the S&P 500. So you’re not going to see that really affect our portfolio much at all. We do have managers that trade dispersion strategies as part of their overall programs or dispersion, you can be short index vol and long single name stock fall but you would assume they’d have to be in the GameStop trade, but also it’s just going to be one of many trades. So at the end of the day even if they weren’t GameStop it’s really not going to affect the overall portfolio of the long volatility series. And like you said we’re primarily concerned with those major sell-offs in the S&P 500 Index.
Jeff Malec:
Yeah, just to further on that point. If we saw one of the managers had a big position or even a modest position in GameStop we’d be, “What the hell are you doing? That’s not what we signed up for.” It’s a dispersion trade it’s just to say, “Hey, there’s going to be more upside volatility in these single names than there is in the index. And to capture that as a whole, not betting on some single semi bankrupt stock going up thousands of percent.”
Taylor Pearson:
And then February was sort of a fairly ho-hum month. I think S&P was up around 2%, vol drifting kind of lower. That’s the kind of environment where sure the dynamic VIX strategies we would hope would perform well and they did do okay in that period from what we saw. They’re able to capture some of that volatility erosion, so that dynamic VIX strategy is a relevant value trade using… it could be VIX futures, typically VIX futures just looking at where along that curve they think there’s relative value. You can go long part of the curve, short part of the curve and so they can do well in trending up volatility or trending down volatility environments.
Taylor Pearson:
So February their strategy seemed to be okay. We also saw February 25th, for example, there were some pretty strong intraday trends. So when you have the market close on its lows, those short future strategies which we’re doing that sort of intraday trend following can do well. We saw some of that and then I think options add to the implied volatility spiked up a little bit in January, it came back down pretty hard in February which was challenging for the option strategies.
Jeff Malec:
Yeah. I guess I’d say this overall concept of a return to normalcy, really, if you dig into the month by month it really was more in February and March than the whole quarter. But as you said February and March was more, “Hey, the market’s rallying, consistent rallying higher volatility is falling at a normal measured pace.” And as you said those dynamic fixed managers they kind of liked that a steady relationship. So no matter if vol is falling or rising, as long as it’s not falling way faster in the front month in the back months or vice versa, or as long as implied is not falling way slower than realized or vice versa. When there’s volatility inside of those measures of volatility not to get too complex, but they want that nice relationship to stay rather stable day-to-day, week-to-week in order for their models to work in that dynamic fixed spin.
Jason Buck:
As I think about January and February in general is kind of the way we built the portfolio of prolonged volatility series is that we want a distribution of returns coming from the different buckets we invest in. So hopefully certain parts of the strategy will balance other parts while we’re just trying to maintain our exposure for the massive sell-off. So in January like we said we saw that the two parts to our options buckets were up, and VIX arbitrage and the short futures were down. And then we saw the exact opposite in February and I think that speaks volumes to the ensemble approach of trying to maintain a level of exposure while waiting for a massive selloff of to happen.
Jeff Malec:
Got it. And I think net net the idea is to outperform just a simple put buying strategy or something like that, where you can’t necessarily capture those different path dependencies week-to-week, month-to-month. And then Taylor you did mention something else and I think that was a pattern hopefully we’ll see more of February and March that intraday moves seem to hold a little bit better. We see them close a little closer to their lows or to their highs. I think that’s a result of volatility coming down or probably more technically the VIX coming down below 20 is more of a result of not flip-flopping throughout the day. So throughout last year with vol high we saw the market’s down, I’ll just talk in S&P or Dow terms if it’s down three, 4% and closes the day only down 1% or closes the day higher, those are the kind of days that really hurt those day trading models. So the more we see in the future of a down day finishes the day down will be helpful.
Taylor Pearson:
Yeah. I don’t think there’s not a lot more to talk about March specifically unless you want to chip in, but kind of as you said just a continuation of February in a lot of ways Shell volatility continue to decline. But I guess we’re like maybe it crushed down a little bit more in March than it did in February, and then the stocks rallied a little bit more aggressive I think the S&P was up four-ish percent for the month.
Jeff Malec:
Yeah. The big surprise to me there again was this Archegos stuff. Jason, how do I say it?
Jason Buck:
I liked when somebody else pronounced it as Archegos, So it’s really Bill’s just ego. So instead of Archegos you could just say Archegos.
Jeff Malec:
Archegos.
Jason Buck:
Archegos. [crosstalk 00:13:52].
Jeff Malec:
… coming out, I was seeing credit squeezed like billions five and a half billion or something, 7 billion. So there’s billions of dollars here, and it was just sort of a blip on the radar as markets crunched higher. So to me that was the March story of how was that such a nothing burger as you said.
Jason Buck:
That’s Taylor’s favorite nothing burger, but I think it’s one of those things you don’t know in hindsight of how did we not see the cracks in the pavement if hedge funds are blowing up and investment banks are losing billions across a wide swath of investment banks. So we won’t know except for in hindsight. I also think about in general as we’re seeing VIX or volatility get back in the teens like you’re saying this return to normalcy or Normalistan, that bodes well hopefully for our long volatility series in the future as we get to these pre pandemic levels. It allows our managers I think Taylor wrote very well about this over the Q1 period, that it allows us to rebalance and also reboot and reload on a lot of our convexity and the different strategies. And then that also bodes well for the 100-100 the long volatility series plus stocks, because now as S&P is still tending to rip higher from here where the long volatility series is maintaining at a lower volatility point, that helps that correlation between those two and that rebalancing effect moving forward.
Jeff Malec:
For sure. And that to me you saw that again in Q1 that’s just the power of that long volatility and stocks is the ability even… And I’m talking with clients and they’re like, “Oh, I’m starting to get scared of equities here.” And it just brings in that emotion and that fear and, “Okay, I’m going to reduce my exposure to only 60% or some arbitrary number.” Like how do you actually make those decisions is very tough. And so to me that’s the beauty of that series of just basically you don’t have to make those decisions, you can keep that exposure with the protection.
Taylor Pearson:
I think that’s a good… One of the things we talk about internally is covering different path dependencies. We’re moving into an uncertain future and there’s many paths that can be realized. So last summer I think there was all this… It was interesting word, the word path dependency wasn’t used but people referred to it rather we talked about a V-shaped recovery, or a W-shaped recovery, or an L-shaped recovery, or I think inverted co-sign recovery was one of them I’ve heard of square root recovery.
Jeff Malec:
A Nike swoosh recovery.
Taylor Pearson:
Nike swoosh recovery. It is kind of a intuitive thing because basically what those letters, those shapes, those letters you’re talking about is various different types of a path dependency. W-shaped recovery that was people saying, “Well, this is a bear market rally, and we’re going to have another big sell off.” And people like to make the Great Depression analogy like 1932 there’s another big sell off, and things are going to go back down or it’s going to be an L-shaped recovery and the S&P is going to recover, but very, very slowly or V-shaped recovery things are going to recover more quickly. So I think we got something closer to a V-shaped recovery the S&P recovered pretty aggressively over the past 12 months making new highs. But in terms of how we think about the portfolio construction is we wanted the portfolio to do well across all those different paths. We couldn’t predict which of those shapes or some other shapes the recovery was going to take. And so part of that is you don’t understand which piece of the portfolio is going to do well.
Taylor Pearson:
So in the case of a long volatility in stock strategy, the stocks obviously were the component that did really well. But as Jeff was saying that long volatility component was there in the case that maybe it was a W-shaped recovery, maybe there was a big second leg down maybe there still is another second leg down to come, I don’t think we have any idea. I think the presidential election last year for sure I think was a lot of there’s a lot of concern around that. And that turned into another nothing burger as it was.
Jeff Malec:
I think the issue is you forget the recovery, who cares what shape the recovery is, but what if it’s the Zorro non recovery. Like if there’s a huge sharp Z down to another what were we down 30%, if we went down another 30% and we were back at kind of ’08 down 75% on the NASDAQ kind of levels, that’s like generationally wealth killing stuff there. So that’s what we’re Mutiny’s dedicated to protecting that kind of a loss. And as you said the gravy is helping to manage that whatever shape of that upside recovery looks like.
Jason Buck:
Part of that what you’re alluding to is that’s what the long volatility series is there for. And obviously nobody likes draw downs, we don’t like drawdowns, we have our own money, our family money and our in-law’s money in the fund. So we don’t like draw downs but proper portfolio diversification is having some structurally negatively correlated assets. So sometime you might have something losing and others gaining, but it’s about what does that look like holistically? So they were talking about the different shapes of potential draw-downs or second or third leg downs.
Jason Buck:
The other flip side of that is Taylor’s reference to 1930s, in ’32 and ’33 you had markets rip up 70% in ’32 plus and above 80% in ’33 after massive drawdown. So once again it’s a holistic construction. If you can hold both that equity beta and that long volatility and tail risk and rebalance frequently, that allows you to ride any of those market environments not just the ones on the way down but as we’ve seen this S&P ripping up higher. And granted the drag doesn’t feel good, but that’s general portfolio construction. That’s how you build a holistic portfolio that can maintain through any macro economic environment.
Jeff Malec:
And I just jarred my memory actually little off topic from what we were just talking about, but my final comment on the Q1 was the gold and bonds really got smoked. So some of our managers look to use those as proxies if index volatility is overpriced or a little too expensive to hold, which was the case in January less the case in February less the case in March. But in general that was a drag on the overall portfolio of those two markets seeing some of their worst quarterly performance in over 50 years. Wayne Himelsein in his March newsletter pointed those stats out.
Jason Buck:
Yeah. Part of that was this idea in Q1 we had this new part of our nomenclature so everybody’s got to be aware of the reflation trade now. But the question then is it transitory or is this a new inflation environment we’re about to be in, and nobody knows that for certain especially coming out of post lockdown pandemic at least in the United States, while other parts of the world are still on lockdown so we’ll see what the future looks like. I think a lot of people keep referencing the roaring ’20s, but they forget the post Spanish flu there was a two to three-year recession before we had the roaring ’20s. Now we’re not that keen on historical precedence as we don’t think it maps perfectly, but I just do think it’s interesting to point out that people forget that dip before the roaring ’20s. And then coming out of a an unprecedented pandemic, global pandemic environment like this in a modern digital age, none of us know quite what it’s going to look like, which once again behooves us to have much more holistic portfolio construction that can handle multiple environments.
Jeff Malec:
And it’s interesting you say that because people are holding these two separate thoughts in their head of like of, “Oh, it’s reflation and we’re going into the new roaring ’20s.” But then you also hear all this stuff, the pandemic condensed 10 years of growth into one year, but they never equate that to the market. What if it condensed 10 years of the roaring ’20s into one year, and that was the year we just came through. So I feel like they’re trying to say here’s all this growth it’s been condensed, it’s been accelerated into the now. But I could argue, “Well, haven’t we seen that in the market.” That’s why the market’s gone where it’s gone.
Jason Buck:
I think that’s an excellent point people have said that there’s been dislocation between the market and the real economy, but as a lot of people would say the markets a forward projecting market. So that’s a great point, what if we just condense the next 10 years into the last year and a half?
Taylor Pearson:
Great. Well, any other thoughts on Q1 or I think that sums it up.
Jason Buck:
Yeah. I just want to point out some things on the operation side, we had both Headwaters volatility and Pearl both ended up closing down shop, run by Matt Rowe and Tim Jacobson. And we wish both of them and everybody that worked those terms all the best in all their future endeavors. And at the same time we’ve added Ambrus Group with primarily at the forefront is Kris Sidial there and William Wise, and then we’ve also added the guys at Breakout Funds as well. And so we look at Ambrus as part of our volatility arbitrage bucket, where they’re using much more opportunistic trades, a lot of dispersion trades to try to capture some of those volatility moves. But also they combined both yield and convexity, so we think it fits nicely into our volatility arbitrage, so we’re happy to have Kris and Ambrus on board.
Jason Buck:
And then the breakout funds we look at them more as a global macro way to trade futures, which goes into our futures bucket. And the idea being that some of these global macro trades are basically long options trades, as you put on trades and all the different global macro instruments and you’re waiting for those to play out over weeks, months or quarters. It’s a form of long optionality even though they’re using the futures markets and using a different way of algorithmically looking at those futures trades. But we highly recommend that people check them out on our podcast, so you can learn more about both Ambrus and Breakout and now we added them in Q1 and how we look at them fitting into our overall portfolio.
Jeff Malec:
And I think it’s worth noting we mentioned back in Jan and March, what previously might’ve been market blow up events or kind of the catalyst that caused a sell off. Nothing happened. I think people like Kris Sidial and Jim Carson would say, “Well that’s because Gary or the market makers had pegged the market at a certain level because that’s where all their exposure was and they weren’t going to let the market go below that.” So just to say those pieces are covering yet another path dependency of, “Okay, what if all this other stuff happens?” But if the market dynamics and market structure and flow of options and delta hedging doesn’t allow the market to go below certain levels, that’s what those guys are now in there for and they’re playing in that game so to speak.
Taylor Pearson:
Briefly, Gary used a term that Jim Carson coined I’ve seen him use it the most but it’s a personification of option market makers as some individual named Gary. So the kind of thesis there that some people think about is you have these option market makers and they’re selling options and they’re having to hedge their positions and that is having a bigger impact on the markets. If you have certain market micro structure things with the option market makers that they can basically act either as very strong support for the market, that they’re buying depths and selling rallies that’s giving relatively low or things can tip the other way and they can end up driving the market further out that they’re selling declines and buying increases. There’s some effect there, that’s some part of the dynamic but how much is it, how big of an impact is it having still an open question so we’ll see.
Jeff Malec:
Yeah. And I always find it helpful. Market makers seems nebulous and mysterious a lot of times, but really we’re talking about Citadel and groups like Citadel who are selling all the options to all the Robin Hood traders that are buying them essentially. And then they have to hedge that exposure if that market rallies through and they have to pay out on those options, they need to be making money on the way up so they buy those stocks on the way up.
Jason Buck:
Let’s just name some others though like PEAK6, Wolverine, Jane Street, et cetera so those kinds of market makers. And to Taylor’s point what we like about what these guys are doing is being very cognizant of building their algorithms around trading volatility, watching the volatility surface but then more importantly looking at the different players in the space and how you can create sometimes pinning effects around certain inflection points. So being cognizant of those pinning effects might keep vol suppressed, but then if we move beyond there it can accelerate into a long volatility environment. So they’re very cognizant on the shortfall side of pinning effects of market makers while maintaining a long volatility position because in case we break through Two Sigma then you could see a massive acceleration as well.
Taylor Pearson:
I was very interested that there’s a Twitter account I believe it’s SqueezeMetrics, the guy’s avatar is a lemon but he put out a white paper I think sometime last year. He came up with sort of a way of measuring this he called the GEX, but basically looking at doing an estimate of what’s the net overall positioning of options, market makers, and again imperfect proxy that may or may not be useful. But I think he talks through the dynamic in a pretty well explained way so we can link to that or you can find him on Twitter and see the paper.
Jason Buck:
Yeah. Yeah. You have the GEX with SqueezeMetrics, you have Lily’s NOPE Index but then also all of our managers create their own models of this. And then they’re also getting all of that institutional dialogue from the traders that are trading against to get some ideas of where all that is. So everybody has to create their own and it gives them a bit of insight, but it’s never a perfect simulacrum of how the market’s going to move into the future otherwise these guys would own islands.
Jeff Malec:
Yeah, exactly.
Taylor Pearson:
Great. Well, that’ll wrap up Q1 and thank you all very much. Thanks for listening. If you enjoyed today’s show we’d appreciate if you would share this show with friends, and leave us a review on iTunes as it helps more listeners find the show and join our amazing community. To those of you who already shared or left a review thank you very sincerely it does mean a lot to us. If you’d like more information about Mutiny Fund, you can go to mutinyfund.com for any thoughts on how we can improve this show or questions about anything we’ve talked about here on the podcast today. Drop us a message via email on taylor@mutiny.com and Jason is jason@mutinyfund.com, or you can reach us on Twitter I’m @taylorpearson.me and Jason is @JasonMutiny. To hear about new episodes or get our monthly newsletter with reading recommendations, sign up at mutinyfund.com/newsletter.
