Welcome to part two of the special edition podcast, What Happens in Vegas, where RCM’s Jeff Malec @AttainCap2 and I discuss the EQ Derivatives conference that we recently attended at the Las Vegas Wynn Hotel. I highly recommend you go over to the Derivative podcast and check out part one of our discussion. I also recommend you check out EQ Derivatives. It’s a tremendous source for volatility options and all forms of derivatives trading. I hope you enjoy this conversation with Jeff as much as I did…
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Transcript for What happens in Vegas…:
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.
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Jason Buck:
Welcome to part two of the special edition podcast, What Happens in Vegas, where Jeff Malec and I discuss the EQ Derivatives conference that we recently attended at the Las Vegas Wynn Hotel. I highly recommend you go over to the Derivative podcast and check out part one of our discussion. You can find the Derivative on any podcast player. I also recommend you check out our show notes, where you can find a link to the EQ Derivatives. It’s a tremendous source for volatility options and all forms of derivatives trading. With that, let’s get on with the show
Jason Buck:
Leaders in volatility was the next-
Jeff Malec:
Another one after our hearts. Yeah. So Leaders in Volatility, Monetizing Dislocation Globally was the title. But we had Will Bartlett from Parallax, Benn Eifert from QVR, Michael Golding from Optiver, and Josh Heller from CIP in Australia.
Jason Buck:
And like literally the biggest swingers in derivative space out there, right?
Jeff Malec:
Exactly. That’s why they’re Leaders in Volatility is the title.
Jason Buck:
Exactly. So yeah, start off, what were your thoughts overall there? Or I’ll start off since I have the mic. And I apologize for earlier saying we’re not going to go through each panel, because that’s what we’re doing.
Jeff Malec:
We’re skipping a few here and there.
Jason Buck:
Yeah.
Jeff Malec:
So I think that’s better now.
Jason Buck:
Yeah, we skipped the Bank of America infomercial, disguised as a panel.
Jeff Malec:
We were talking later about the slides that they started off with the Sebo that we didn’t think were necessarily related to the panel. But one thing I’ll pull from the slides is they’ve seen average daily volume, ADV, go up dramatically in option volume that are less than 10 days old. So that was the interesting statistic over the last like five to 10 years, is that ADV is up dramatically on shorter dated tenor in the option space, so that was just one of the things I wanted to point out.
Jason Buck:
ADV, average daily volume.
Jeff Malec:
Yeah. It keeps rising, which is interesting. So you would think you saw that spike due to like retail trading options on Robin Hood, but it continues to spike. And that daily volume can also primarily come from real institutions, pensions, endowments that are starting to sell weekly options. They used to sell like more quarterlies than monthlys, and now they’re down to like really selling that short vol on the weekly options
Jason Buck:
Will was saying different than March of 2020. Back then he was getting calls, worried calls, “What is happening?”
Jeff Malec:
Yeah. Yeah.
Jason Buck:
And now kind of getting calls, thankful that they have defensive positioning on and that they’ve covered for this eventuality. And then Benn threw in there like over the last year, he’s gotten more and more calls. Which kind of countered everything you see on the news and Fintwi. Nobody can believe bonds are down at the same time in stocks. He’s like, “No, I’ve been getting those calls from institutional investors for the past year. That’s all everyone was concerned about, what do we do if bonds don’t buoy the portfolio?
Jeff Malec:
Yep.
Jason Buck:
And so a lot of those investors are feeling vindicated on using some of these types of strategies as bond replacement.
Jeff Malec:
And I think the first thing that Benn said that jumped out at me is that what happens to public markets and volatility when private markets actually finally take a write down, and how that reverberates back through the public who traded software companies or tech companies. And then because of the highest float on the S&P and NASDAQ, do we see a crash in index markets that then spikes equity volatility?
Jason Buck:
And then everyone’s tweeting about that Wall Street Journal article that private investors have flowed in recently into private equity too. High net worth has kind of dabbled into that and what does that look like for them as well?
Jeff Malec:
Right. But they marked a model. So until they’re willing to take markdowns, we won’t I say have it. But I thought that was an interesting way Benn was talking about that reverberation from private to public, and then from public into volatility. The other thing, to echo that thing that Benn has said, dispersion was great, especially factor rotation, and then averaging out at the index level and then crowding in long short names. And so just to recap, dispersion trading is when you go short the index fall and long the single names. And so if you have this factor rotation from like tech to energies or et cetera, you can see a lot of volatility on those single names, but then it’s averaging out at the index level.
Jeff Malec:
So that’s the idea of dispersion, your short index ball, long single name ball. And like he’s saying, if you see a lot of crowding of long short hedge funds that have relatively large size, you can see a lot of moves in those single names, which is leading to this great trade in dispersion. But once again, I just want to point out, and we’ll maybe get this later with Will Bartlett, is just because dispersion has been great recently doesn’t mean it’s going to be great moving into the future. But that was the interesting takeaway, I think, from Benn talking about dispersion.
Jason Buck:
I don’t even know the answer to this? Can I be short dispersion? It’s just conversion, right?
Jeff Malec:
Yeah.
Jason Buck:
But would a dispersion trader take the other side of that? It went out, and now I’m going to bet on it coming back in. I bet a dispersion trader can trade both sides that, it does just have to be the expansion in the deltas.
Jeff Malec:
There’s a lot of nuance there. Like, yeah, it’s almost like calling all CTAs trend followers. It’s just the vast majority of dispersions trades short index while long single names. But also, you can also be short straddles or strangles, and long straddles or strangles, or you can just be directionally short the index and long single names. And then you can choose. Once again, it’s your basket, because the whole point of a dispersion trade is you’re not buying the entire 500 names in the S&P, you’re choosing which names to buy. So you can choose to try to match that basket vol of S&P, or you can choose to discretionarily choose the actual single names that you want to go long vol on. And so that can affect your P&L quite dramatically, whether you’re just trying to play the index dispersion game, or you’re trying to take single name bets.
Jason Buck:
You’re essentially short correlation, right?
Jeff Malec:
Right.
Jason Buck:
So as this correlations return to a one, but that’d be a whole nother argument we can skip for now.
Jeff Malec:
Well, actually we’ll get into it later. But Michael Golding, so we were talking about once again there’s like four market makers in electronic option space. One of which being Optiver out of Chicago. And so you had Michael Golding from Optiver there. And he was saying that vol is supplied, like echoing what Gem’s sentiments were. And then he was talking that it’s all set up on market positioning. But what I thought was really interesting, he’s talked about rate vol and how rate vol pairs well with inflation. So as we’ve seen inflation pick up, then we’re seeing interest rate vol pick up.
Jeff Malec:
And so that was interesting. And so he’s saying, what happens if we come down the other side? If inflation is transitory, do we see a collapse and rate vol? So he was just kind of like, the best thing about like a market maker like Optiver, they don’t have any global macro takes. They have no positions and he kept avoiding all those. He was just talking about what he’s seeing on the flow side. And once again, he was kind of talking about that flows over pros. It’s like they just, as a market maker side, that the vol supply and the flows are what’s really overwhelming the markets.
Jason Buck:
Makes sense. Multiple times like ask me that question is to ask me where I think inflation’s going to be within a year, and I’m not the person to answer that, right?
Jeff Malec:
Right. Yeah. That correlation between inflation and rates vol is all he was talking about not saying where he thinks inflation’s going.. And then so it about that cross asset class again is that Will Bartlett brought up at Parallax, that the opportunity has been in commodity vol and he sees that continuance. So what’s interesting is Parallax trades, cross asset cross vol, but they also specialize in commodity vol and they even have specialist pods even in different forms of commodity vol from like nat gas vol to oil vol. They’ll have even different traders. And they’re trading like hundreds of thousands of contracts a day. And so as we saw people talking about trend following, Will is echoing that, but on more the commodity volatility option side. And that’s where they’ve had really target rich environments where they made a lot of their P&L. And he sees a continuance there. Like you said, he didn’t want to bet on the future either.
Jason Buck:
And perhaps bleeding over, you said, right? Yeah.
Jeff Malec:
Yeah, exactly.
Jason Buck:
And then back to Mike, he had some thing of like, which we all do on Twitter and elsewhere, like comparing the same magnitude selloff with different, but their vols different is quite naive in his opinion, right? Of like, oh, last time the market was down 18%, VIX did this” last time the market was down 15, VIX did this. And now why isn’t it doing that? It’s like totally dependent on market positioning. And as a market maker, you can see that. Like if people need to cover their asses, you’re going to get a much different reaction than you’re getting.
Jeff Malec:
It echoes, yeah, what we went back to like that Vix strike vol supply. How have we seen an orderly sell and not a pop VIX? So it goes with Russell Rhodes is saying, and everything is like, and what Gem says and is like market positioning, that’s what Michael kept hitting on, is like, this is where the market’s positioned so you’re not going to see that movement.
Jason Buck:
Yeah. And he had two examples, 18 Vom again, VIX again. The derivatives drove that cellar. It was the tail wagging the dog. At the end of 18 within the same year, you had this dynamic. The end of 18 because of the beginning, everything was hedge and it was slow grind even in just one month. And it was already hedged, there wasn’t any opportunity there. And then 20 was surprised out of nowhere. And even on the way down, there was still the opportunity to hedge. So more and more hedges were getting put on as it was going down.
Jeff Malec:
That’s a good point to reiterate. I hate historical analogs, but when we’re talking about options, that’s easier to do in this sense. It’s like you just said, people were hedged in December of 2018, and so what happened is the market grinded down less than expected variants. So if the markets were expecting 1% moves a day, and the market was going grinding down 50 bits a day, you’re not going to see a pop in volatility. And that’s exactly what we saw in December and that’s kind of what we’re seeing in the first five months of this year.
Jason Buck:
The Australian guy, Josh, he was bemoaning and counterdicting the other people like, “Hey, I have to trade in Australian hours.” There’s not a ton of liquidity there. Especially as we go into some of the outside of the Russell or the EFA and some of the other markets. And then he had the thing of like, he’s all for these diverging central bank policies, because you think that’s going to create opportunity and create volatility that they can either capture or trade against.
Jeff Malec:
Yeah. I think that was like the other big piece of this panel is liquidity. And that guy was like… Because earlier panels had talked about, especially the people that represent like CIBO or CMA, like there’s think there’s plenty of liquidity there. And that was Josh’s original position is like, “I’ve never seen liquidity in markets, but that’s because I’ve been trading in Australia most of my career, so it’s always been a lack of liquidity.” But before we get to liquidity, I want to talk about something else that Mike Golding from Optiver talked about with positioning. I was going to bring this back around, but I think this is a good time to bring it up. He’s saying that a good spot right now they see what positioning is like the long-dated ball, like 12 months out because of structured products.
Jeff Malec:
So the banks are structure products. And even, we’ll get to this later, Sidio talking about the U.S is even starting to outpace Asia and Europe for the issuance and structure products. But because those are typically longer dated, that if you want to buy vol 12 months out is seemingly a decent price compared to shorter tenors, less than 12 months. But he also said, because of positioning, we’re seeing this orderly selloff. But he thinks if we quickly slide down another 10 to 15%, we’re going to see an explosion in convexity just based on positioning. So I just want to reiterate that on the positioning side, before we get into the liquidity. Because then what was great is Will Bartlett from Parallax was talking about, he sees a lot of unseen liquidity traps. And so he was talking about he sees lack of liquidity.
Jeff Malec:
You always see people talk about top of the order book, or level two order book liquidity. And you and I have argued, yes, that’s part of the equation. But now with algorithmic execution, people are hiding orders, so you’re not necessarily certain. And I think Benn Eifert echoed this. And he was saying like, A if you want immediate liquidity and you want to hit buy and sell right now large size, there’s scarce liquidity. But if you can work an order, even on listed options, he believes it’s very liquid. So if you want to work an order over a day or a couple of days, and you don’t have to take that immediate liquidity, he’s saying there’s a liquidity mismatch there. Where immediate liquidity is incredibly scarce and that’s what you would see in that or on top of the order book. But he is like, if you can work orders over multiple days, even in single names, he thinks there’s a lot of liquidity there for people that have that ability.
Jason Buck:
Yeah. I think if you’re demanding price insensitive at the market right now, worst it’s ever been, he said, the liquidity. Worst it’s ever been for I got to get out of this right now, which makes no sense. But I think that’s just the gamification of it all. Which is to your point, Ben, speaking of Ben, he brought up the European dividends, which he’s always apt to do. But he said another piece of this here of talking about opportunity in rates vol and where can you find these, if vols all bid you can’t find this opportunity. There’s asymmetric payoffs. He said, and this tied back to the liquidity, he’s like, there’s constant weird liquidity unwinds.
Jason Buck:
And he gave an example in European dividends. Some European bank blew out, needed to get out of all this stuff right away and it was trading at a huge discount and they stepped in bought it up. So goes back to that other panel of the third thing there at event hedge, or just opportunistic ability to take some things that are dislocated and get involved with a long skew, with asymmetric type of option profile payoff. So I thought that was interesting. More and more opportunities like that surprises are popping up globally.
Jeff Malec:
Right. And to echo Mike Golding from Optiver, Benn was saying too, it’s like, even on the equity wealth stuff, like deep out of money, lows skew convexity still high on maybe those longer tenors as well. This is not investment advice for anybody, but we’re just relaying kind of what the panel said. And then I might be front running you on this, but one of my favorite hot takes of the day is all we heard is dispersion good, dispersion good, dispersion, great everybody. And then Will Bartlett said, “Dispersion’s a bad idea.” He’s like, “That’s where I see one of the biggest liquidity traps and a sharp sell off.” And then you are just circling your point where you had just written down an hour prior, like is the top end for dispersion.
Jason Buck:
Yeah. Yeah. Huge liquidity trap. If we go lower in 3,300 in the S&P, dispersion’s going to get blown out, is what he said.
Jeff Malec:
So like you said, short correlation. So those correlations go to one in a liquidity event, or any sort of bar selloff.
Jason Buck:
Yeah. Yeah. Yeah. I think that’s it for the day.
Jeff Malec:
That’s day one. That’s day one done.
Jason Buck:
Day one done.
Jeff Malec:
Luckily day two, I don’t think we have as many notes. So we’ll still get through day two.
Jason Buck:
Day two we were tired.
Jeff Malec:
A little tired.
Jason Buck:
Day two started out with Benn hunt, who I’m a fan of, been on the pod. I was a little actually upset, because it was all the stuff he writes about and tweets about and puts in his articles. I wanted some new stuff from him, but I understand it’s hard to just come up with new stuff for me. So loved his anecdote, which he says all the time of, “The old fish swims by the two younger fish says, ‘Hey, how’s the water?’ The two younger fish swim a little way. And then the one turns the other and like, ‘What’s water?’” So just his point of like we’re all in this bubble, we can’t even see everything that’s going around us for what it is, which is all a narrative trying to push us in one direction or the other. And then he had a Claude Shannon and shout out and picture, which I thought you’d enjoy. So I wrote that down, but that’s basically all I had for Ben. It was a good talk. Anything?
Jeff Malec:
I was waiting for you to ask. You know I took zero notes during Ben’s talk. And I think I was grabbing my coffee while he talked about Claude Shannon, because that would’ve been the highlight of my experience and I have a story.
Jason Buck:
And his whole Claude Shannon thing was basically just, he identified that the noise is an important part of this picture. He wasn’t just saying, ignore the noise to get the signal. He was saying, you have to account for the noise. And so that was his main point of like, this is all math, this isn’t something new he’s come up with. This is all out there. He’s just saying our human brains don’t, we want to just ignore the noise instead of accounting for the noise.
Jeff Malec:
And for those who don’t know, yeah, Claude Shannon is the founder of information theory. And Jim Oshack always talks about the Shannon limit. Like we can only all take in so much noise on a daily basis in our brain. So like we always reach like a Shannon limit. And I think that’s right when I walked in yeah, where Benn was talking about, yeah, you have to decipher, reduce the noise to see the signals. And then that’s what he thinks he does. And it’s not that I dislike Benn Hunt at all. I just think that he’s not my particular brand of fight club. And using narrative to talk about narratives and then narratives, it’s like it narrative turtles all the way down. And so to me it’s kind of ironic.
Jason Buck:
I’m going to start using that with my kids when I’m tired and they’re saying something to me and I’m just have the blank stare. I’m like, “Sorry, I’m at my Shannon limit.”
Jeff Malec:
Yeah, exactly.
Jason Buck:
See what they say.
Jeff Malec:
So I know you were more excited for Benn Hunt, and so then I didn’t take any notes. But then in the very next panel was from hedge fund to institutional investors opportunities than digital assets. So this was the crypto portion, so I would assume I took more notes than you did.
Jason Buck:
Yeah. I had the wrong pen because I was in the new morning and it was like cramping my hand writing with that little wind pen. So I had to go back to the good pen. First world problems, those damn nice wind pens are two small.
Jeff Malec:
So I just have like a bunch of like kind of hot take or just quotes I kind of wrote down. And one of them was starting with Eric Peters from One River, whose claimed to fame, at least on the Bitcoin side was that he was like the first institution to put large size into Bitcoin for his clients. I think it was November 2020 they placed about 500 million into Bitcoin. So that’s what he got kind of known in the crypto spaces for that. But one of the things he said that was interesting right at the beginning was that he views future correlations will be dynamic. Meaning everybody’s now quoting that cryptocurrencies, especially Bitcoin are correlated with the broader markets.
Jeff Malec:
But like he’s saying, I always have a problem with correlations as well because you’re always using a time window analysis. So you’re arbitrarily picking your time window for correlations and correlations fluctuate and vary. And that’s why figuring out cross correlations or correlation matrices are so difficult. Then he was saying, even though we’ve seen it correlated, he expects in the future that the correlations will be very dynamic and sometimes it’ll be correlated, sometimes it’ll be negatively correlated.
Jason Buck:
That’s funny you thought that was interesting, because I wrote down talking his book.
Jeff Malec:
Well, of course. That’s every panel.
Jason Buck:
Yeah. But it’s that especially stood out to me there, like of course you’re going to say it’s not going to be correlated. Because to not would be like, this is a hugely speculative, complete risk asset that’s like to the right of NASDAQ, to the right of meme stocks almost even.
Jeff Malec:
Well, if we talk about too is like the entire two days, is everybody’s always talking their own book. Because everybody’s like, “This has been an organized sell off, really tough for long vol,” says every long vol manager. And like, “Dispersion’s been great,” says every dispersion manager. “Commodity trend’s been great,” says every trend manager. So like yeah, everybody’s talking their book. And the next one was Derek Devons from Neuberger Berman. His quote was, “You don’t know how good Bitcoin is until junk breaks.” And I know you and I have been having this argument. And what I was more pressing to me when we saw the Luna and terra selloff was like, Bitcoin’s down but it wasn’t as big as we expected. As all the all coins sold off 80, 90%. And we’ve seen this a million times in crypto and everything’s correlated, is that we saw like Bitcoin Ethereum only down 20 to 30%. So it was like, it was an organized selloff even though a $40 billion complex blew up, which is kind of impressive in a way. It’s weird to say like, cleanest dirty shirt kind of thing.
Jason Buck:
Well, but you’re still alive, Mrs Lincoln. Right?
Jeff Malec:
Yeah.
Jason Buck:
So the big thing that stuck out to me here, I’ll just go. This whole idea and they kept saying like, “This is terrific. Were experimenting with real money.” And that shocked me. Like, “That’s terrific”? Like it’s like 40 billion got blown up there, all this other trillion’s been evaporated. Like that’s terrific that we’re experimenting with real money? That’s like frightening to me that we’re experimenting. Like I feel like it discounts all the people who’ve lost real money on that side. And you can argue like they knew what they’re getting into, they’re investing in this. You can argue a lot of them were led to that place with unrealistic promises. But that just stuck out to me. If we tried to raise a fund, like, “Hey, we’re going to experiment with trading crude oil futures with your real money.” People would be like, “Are you crazy? Get out of here.”
Jeff Malec:
Yeah. But at the same time, I agree with what you’re saying, and people are talking their book. But I always think about it in like Teleb I think always talked about like, we should have like a restaurant restaurant owners’ day, or entrepreneur’s days. Like through 90% failure, we as a society benefit. We benefit for broad diversification of restaurants. We benefit from broad diversification of entrepreneurs creating products or different things to improve our lifestyle. So I think that’s more what they’re saying. Or even in the U.S, states rights versus federal rights is like, we would hope that each state actually goes off on their one off experiments and we see what works and what it doesn’t work. And so I think that’s what they’re trying to say is like the amount of ingenuity in space and where it is headed.
Jeff Malec:
And yes, we may be losing here or there, but do we stumble onto like a new financial system? It’s like, I can’t stand when the Austrians talk about mal-investment. Because like one man’s mal-investment is the future’s man infrastructure. like we got all those fiber optic cables during mal-investment. So like, you really don’t know over the long term what’s good or bad for us. But like you said, I was at Blockwork’s permissionless event just a few weeks ago as well. And I thought the vibe in that room would be fairly negative or depressed. But once again, we all have these psychological immune systems. And so everybody in that room was excited as like builders build and bear markets. So it remind me the analogy is like, everybody’s a trader until they have a losing position they don’t sell and now they’re a long term investor. And so that’s what I was think about crypto is like, now that they’re in another maybe crypto winter, they’re like builders build in bear markets and now I’m a builder. And like everybody changes their tune once again.
Jeff Malec:
But another little hot takes from that where John Laughlin, he’s the risk officer at GSR. He said, “Crypto learns from failure so you can see how smart it’s become.”
Jason Buck:
Yeah. So that was good.
Jeff Malec:
And then the other one for Derek Devons, and I can move on from this panel, is that he was talking about you know how good it is till junk breaks, but then he’s also reminding everybody that when high yield bond markets started, they’re very nascent markets, they collapsed and there’s a lot of carnage there. Same with MBS, when it started, there’s a lot of carnage and going to your favorite GFC, you just don’t know. Is like you have big risks when markets are nascent. And then the extreme hot take from Derek Devons was that Tether is the big winner from this. And I was like, “Excuse me?” What I think he was trying to say is-
Jason Buck:
It didn’t blow up as well. But, yeah.
Jeff Malec:
Yeah. The Tether didn’t depeg. So once again, cleanest dirty shirt is at least Tether didn’t depeg in this environment when Tara depegged. But Tether, what he was talking about is you’re going to use rap Tether to trade with because you don’t necessarily, that’s a way to re hypothecate and get some margin on leverage if you’re actually trading alt coins. And so at the same time, yeah, Tether gets stronger, but then, a lot of people would lose their shit and argue the structural weaknesses in tether, or that’s a nice way of saying fraud. So it was interesting to say like, Tether is a big winner because if you understand how the system works, you understand why tether was the winner. But in that crowd, it’s audible gas because they’re all of the boomer Bitcoin bearer that they think Tether is a complete fraud if they follow.
Jason Buck:
Like, I run a $4 billion hedge fund that has to have its financial statements audited by a big five firm. This is the big winner who has no audited proof that they have the backing.
Jeff Malec:
Well, like PEs or VCs don’t we wish we could have self station for even our PNLs or our volatility. And don’t get me wrong, I am just as skeptical as everybody else. And I’m very concerned that the only people that can really pull out money on tether and size is Alameda and Cumberland. So we really don’t know what’s legit and what’s not in Tether. So I’m not saying I’m pro or con tether. My bias more con, but like, it was interesting that was the hot take that Tether’s a big winner from the Terra collapse.
Jason Buck:
So I had a few other things here. Everyones saying, it’s too early to tell if crypto covers inflation. I can sort of get. But again, talking your book. Like, of course it’s too short of a period. Yield farming’s just covered call writing, which I’d like is an easy way to explain that. And then Luna is a $40 billion crater into the lake, which I wanted to say. I think that crater is what happens when something falls, not the thing that falls. But he is live on stage, so I’ll give him a pass on that. But saying he was alluding to, we might not have seen the ripples on the far side of the lake yet. And like calling back to March of 08′ when that first JP Morgan credit fund went bust.
Jason Buck:
And we didn’t see the down the lows of the GFC until much later. So he’s like maybe this Luna thing hit now, everyone was surprised didn’t cause more ripples. Maybe those ripples are 3, 6, 9, 10 months down the road. And then I got to say, later that night we were all debating crypto and I brought up my favorite thing of all right, we’re going to go in the wind pool. And it’s pointed out to you that there’s 10 turds in the corner of the pool. You still want to swim in that pool? To which you say…
Jeff Malec:
Yeah. What is there gold bars in that pool though? What risk are we taking? And you use that for crypto a lot. I think that’s the risk in any market. Yeah. All markets have risk, right? Like if you’re long S&P index, like you have an air pocket to the left side, you have a tremendous left skew. So it’s just about knowing where your risks are. And then position side is quarterly. Because as you know, I like to bang the drum on it’s like your only ability for due diligence or managing risks at the end of the day is position sizing, because you never know what you markets are slippage, you can get in and out. So the real, only risk metric we have is position sizing. So if you know what your risks are, then you can position size accordingly.
Jason Buck:
So you’re only going to put a foot in the pool, not your whole body, just a foot? Or maybe a hand, so you could grab the gold bar.
Jeff Malec:
If I was you I’d figuring out a device to skim across the water and grab the gold bar. You always trying to find option C.
Jason Buck:
And then the last piece on this panel, I can’t remember who was the One River guy. I think he was getting into social aspects, which I thought were interesting of like in the ’70s, young people were rebellious and they had all this loud voice, but not a lot of power. It’s like young people today because of crypto, and even because of social media, whatever, like have a ton of power. He was talking like these crypto bros, which is used derogatorily, but they have money and they have innovation and they’re smart, really smart. And he was kind of saying, they’re going to change the world whether we like it or not. Like they’re pushing fast and hard.
Jeff Malec:
Yeah. It was actually interesting when I was at the Real Vision Crypto event in Vegas last year. That was what I thought was interesting. A lot of the people in the space that are like more gen X, millennial, thirties, and forties, is they were using their crypto wealth to influence local politicians. So that’s what Eric’s referring to is like, yeah, if you’ve gained all that wealth and then you figure out I can move the market by co-opting my local politician to my side of the equation, we could see a lot of influence there. And what I always wonder is, what would being fantastic in my opinion, is like we have this enormous wealth transfer that’s got to happen from boomers to millennials or gen Z. And it could be very violent.
Jeff Malec:
Or what would be interesting if we could transfer it via crypto. And by the time crypto markets get institutionally adopted, where them pensions are investing and everything, hopefully their young retails now selling out. And that was like, and institutions are doing that when stocks and bonds are sold off. And so maybe that’s a non-violent transition of wealth that we could potentially see. But I’m hoping for a Goldilocks scenario there.
Jason Buck:
Which segues nicely into the insurance panel, where at the very end, actually the one youngest guy on the stage there said like, “Hey, I think… Basically everyone else is like no bid for crypto at these huge insurance firms that are like too new, too risky to everything. And they’re doing big structured products, annuities, fixed index annuities, whatnot. And this younger guy you’re good at the names, I’m not.
Jeff Malec:
It’s Faun from Beta Investments.
Jason Buck:
Yeah. He was like, “I think there’s a huge market here of like basically a fixed index annuity, which says it’s insurance with a rapper tied to some index. Young people are probably going to want that index to some crypto and/or their insurance is held in crypto or blockchain.” So there were a lot of interesting, but we’ll get off crypto.
Jeff Malec:
This is almost like the most exciting panel for us when our ears perk up is like, what are insurance companies doing? Because they are controlling trillions of dollars of assets. And where they flow into markets is what’s most important to us. And Benn Eifert has always been great about this is like, especially whether it’s pensions or insurance companies, they’re like these enormously large cargo ships. So for them to turn, it takes a very long time. So their flows can affect markets for three to five years before they move in and out. They’re not hot money by any sense, and so they don’t have that nimbleness. So you really need to pay attention to, because they have enormous amounts of flows and those flows can trend and continue for years on end.
Jason Buck:
And just to give a picture, if I’m a big insurance company and I’ve got tons of premium, I need to earn a yield on that to make the business profitable, but also to have the money down the line, it’s tied to some index. So it not only has to grow, it has to grow alongside the S&P or some other index. So what they were doing 2018-ish, massive sellers of all. I have a long enough timeframe. I don’t care if there’s one little spike or not. So I can sell all the vol I want, collect that premium, and basically be able to endure a spike. I can meet the margin calls. It’s like we were talking about in Vegas again, they came up with table limits because someone with enough money would just double their bet every time until they were back to even.
Jason Buck:
So the smart people, I think it was in France, actually, not Vegas, but whatever. They came up with table limits to say, “We’re not going to allow that. We need to be able to lock in our gains.” All that, to say the insurance historically big vol sellers, either outright, because they have long equity portfolios that are going to be susceptible to spikes in vol, or outright selling of vol to generate yield. So having said that, one of the first comments there from Brog, I think, Brog Arwell of… Got it there?
Jeff Malec:
Columbia Thread Needle.
Jason Buck:
Thank you. Was saying insurance are way down, way lower on their short VEGA exposure, VEGE being vol. So he was saying, he was guessing it’s between 800 million to a billion, which there was some charts flowing around back in ’18. I think it was four to 8 billion. I’m going to just throw out off the top of my head. Could be off by a factor or four there.
Jeff Malec:
And to clarify on Vega, for every one point move in volatility, that means you’d have a 800 billion to a… It was 800 million to a billions, right?
Jason Buck:
Yeah.
Jeff Malec:
That was what his quote was. And that’s what you’re saying. It used to be a lot more. So that’s what he’s saying. And that was an aggregate, I believe of him and two other insurance. So he’s like, “The three of us make up 80% of the market.
Jason Buck:
Just think about that being short a billion Vega. That’s even though that’s small piece right now.
Jeff Malec:
Everyone one point move.
Jason Buck:
Yeah. Right. So VIX goes from 10 to 20, that’s 10 billion off the table.
Jeff Malec:
Right. And give that context. It was because somebody else was throwing out numbers that like the insurance companies represent so many hundreds of trillions. And he was like, let’s just put it in very specific Vega numbers. And this is like for every one point move in Vega yeah, we’re moving probably about a billion dollars. So like that gives you more accurate picture than saying their notional value is like 10 trillion. Like those notional values are irrelevant. So that, yeah, what was interesting and like, that’s what you’re saying is like, so they’re participating less on the Vega side and they’re talking about the client’s portfolios they’re shifting. And I think this is like LT Grant saying more they’re like LT Grant from Protective Life talking about their they’re shifting more of just a portfolio construction.
Jeff Malec:
From being short or long Vega to even just switching to bonds and being more bond heavy. And we’ll see what happens in this bond selloff. So we look for those institutional flows from insurance companies in into Vega space. And that’s what they’re saying. They’ve been less interested in the last few years than they have previously. But we’ll see how long that takes before if markets stay calm, they become big, short Vega sellers again in the next three to five years.
Jason Buck:
Which you mentioned before, right? That’s kind of a premise of some long ago guys. Like there’s all this structured product. They’re massively short Vega. What happens when they have to cover that? All of this is what can cascade and spike vol to crazy levels. But to their point, and they also mentioned a few times, they’ve gone more into vol controlled products, which is essentially risk parody, more vol target products. Yeah. So they’ve kind of dampen just that outright short vol exposure was the big takeaway.
Jeff Malec:
The side note I noticed as well is like in this industry is like the fucking nomenclature changes like every day. And so it’s like, yeah, vol targeting now vol control. Like all this stuff is just like you just got to stay on top of it. And there’s a lot of acronyms thrown out these things, but the acronyms can be-
Jason Buck:
This panel is the worst. Yeah.
Jeff Malec:
Yeah. Like difference in insurance space versus regular space. So it’s just crazy. But the one hot take from Brog that we were like, “What?” Was he said, “Your hedging and your model portfolios like contingent on which accounting you’re using.” So you can model your accounting, like mark to market on like shorter dated tenors and Vega, or you could use non-gap or FIS counting and you can mark to model on a 10 year vol metric. So it was like, you can adjust your book depending on which accounting convention you want to use. And we’re like, “Excuse me?”
Jason Buck:
Excuse me. Right. Yeah. Which is like, “Hey, PE, hold my beer.”
Jeff Malec:
Exactly. Exactly.
Jason Buck:
I’ll show you how to mark this.
Jeff Malec:
This doesn’t look good in real time. Let me create a tenor vol model that then I can use in my accounting for. Another side note was I think it was LT Grant was talking about that clients are calling them up asking for rate hedges more than he is ever seen in his career. So he is like, is this a top once again for rate hedging? And that’s what they were asking. But then the one like you were referencing earlier about whether you’re a casino at Vegas with table limits, I think Emmanuel from AIG was kept talking about like, he just has a 30 year time horizon. And so he thinks about it very differently. And he’s saying Q1 or Q2 of a market selloff is not a long enough timeframe for insurance company to change their hedging structure at all.
Jeff Malec:
That’s going back to this analogy of a cargo ship. And that’s what he kept saying is like two quarters. Like we’re thinking in 30 year time horizon. So this really doesn’t matter to us at all. And like I said, they’re not shifting, they’re not nimble and part of that. But speaking of the 10 year time horizon, that was another thing that they brought up is like, historically, they used to trade a lot of like 10 year bar swaps, like pre GFC. And now we’re seeing like, they’re all coming all the way down to like two years out and trading more like listed exchanges. And part of it is like the new reg… They talked a lot about, and maybe this is a part that was maybe deep water for us is all the regulatory changes in collateral requirements for insurance companies.
Jeff Malec:
So that was like a lot of the panel. And that’s why they’re talking about, like now you’re seeing people move from OTC, over the counter, counterpart rest with banks and execute a 10 year bar swap. Is now they’re moving like to two year options within listed exchanges. So that’s why we’re seeing there’s a general push from the exchanges and obviously people speaking their book on exchanges at the event, is like the regulations are pushing people into listed exchanges. And this has actually Benn Eifert’s contention is like, this is why he wants to participate on listed side where previously he used to be on more the OTC bar swap side. Is because that’s where he thinks the opportunity is and the money is flowing more into liquid-listed exchanges than it is on just being this OTC market.
Jason Buck:
And the one guy on there was AIG, right? So poster child.
Jeff Malec:
Yeah. Emmanuel.
Jason Buck:
Yeah. This should all be on exchanges. Right? Like we shouldn’t have a bunch of OTC stuff that nobody knows what’s going on. But to me, that’s also like risk can’t be transmuted. So where is it going in the system? If you’re like, no, all this risk got we waved the magic wand. It all came on exchange. Now it’s all gone. So maybe it’s in that accounting convention. Like, yeah, there’s no risk here. We just market the 10 years.
Jeff Malec:
That’s an interesting argument that actually every like short vol blowup is also an accounting blowup. So always an accounting convection of like where are you able to hide the risk on an Excel sheet or something?
Jason Buck:
And I just don’t know. Like in a way, they changed the mark to market rules for all the banks. I don’t know if that’s been rolled back. Someone put it in the comments, whether that’s been fixed. Another thing you basically saying, even though they’re long term, very interest rate sensitive. And he said, they’ve become with rates so low they’ve become like Japanese auto callables, which I didn’t quite understand. Maybe you have more color on that, but… Maybe not.
Jeff Malec:
Oh no. Because you’re, you’re selling the call and buying or putting it back to the bank on-
Jason Buck:
Because rates were so low, you had to generate yield.
Jeff Malec:
Yes.
Jason Buck:
Is what you’re saying. Yeah. Yeah. Yeah. So he’s saying there’s some issues there. Just checking my notes, sorry.
Jeff Malec:
Or selling a call by input, sorry. I said that in reverse. As my brain’s still trying to wake up today. While you’re looking at your notes too, I thought the interesting one too. And obviously people speaking their book, the moderator Damien was from URAX. But they were talking about, like we’re saying the list of exchanges is they’re moving from total return swaps to total return futures
Jason Buck:
On CME. I know I got that too. I’m like, “Guys, your panel host is UREX. Stop talking CME.”
Jeff Malec:
Yeah.
Jason Buck:
He was very, definitely brought it back. He’s like, “And yes. On the CMEs.”
Jeff Malec:
Yeah. Yeah. So they’re obviously trying to do it as well in UREX. But like that is interesting that once again, moving from this opaque OTC market in total return swaps to total return futures. And so once again, we’re building out another market on the CME, so we’ll see what’s the liquidity and size and volume moving forward.
Jason Buck:
And then I just wrote down, I don’t know exactly what it means of the Vega Pac-Man product. So I think that just means massively short vol, and just eating up any vol bids Like Pac-Man.
Jeff Malec:
Yeah. And he’s referencing that it’s more on that 10 year term. So that’s what he’s saying, like recently, in the last five, 10 years, they moved from 10 years down to two years. And that’s what the question was like, when do they move back to those 10 year VAR swaps? They called the Pac-Man trade. Yeah. We need to get some more color on that. And I think that was the big takeaway for you is like, you need to get Brog on the podcast because he was fantastic on the panel. Maybe he can explain the PAC man trade in detail.
Jason Buck:
If anyone wants to offer me 10 year vol at whatever, because no one knows what it’s going to be. And my duration’s way longer new, I’m going to eat it up. Like Pac-Man all day long.
Jeff Malec:
Our buddy Chris Sidio gave a talk that was maybe only like 10 to 15 minutes. So he ripped through it pretty quickly. But it’s all stuff we know too. But he was saying, he was trying to talk about, you can fund a tail risk with capacity constrained edges. So what he is trying to show in his talk is like there’s a lot of opportunities in low capacity strategies that larger institutions that are running tens or hundreds of billions of dollars can’t touch. And so he’s saying you have an uncorrelated way, instead of using like dispersion or highly correlated basis trades, there’s a way of using capacity constrained edges to get a little bit of income, to help cover the cost of funding tail risk. Now, of course, he gives that presentation, but he is not going to go into detail of what those actually capacity constrained strategies are.
Jeff Malec:
Yeah. But he was giving people some insights. And one of the biggest charts he was showing was about the idea of just daily volatility, and showing how that’s kind of changed over time too. Once again, we were talking about a lot of the panels I think the overall hype was around volatility changing tenors, right? It used to be like when insurance side from 10 years are coming down to two years, we start talking about pensions funds. They were selling quarterly options, then monthly options. Now they’re selling weekly and probably they’ll start branching into daily options. And so Chris was talking about opportunities on intra day vol. And so maybe if you can figure out different capacity constraint strategies there, that’s a way to provide income while to fund your tail risk options.
Jeff Malec:
And then the last one before I had to leave for the airport, it was kind of interesting. It was like it was a round table kind of discussion with. Basically it was called fireside chat with systematic overlays as an asset owner’s perspective. So it was interesting. You get Jerome from Credit Suites interviewing Powess from UPS Group Trust. And Powess, he works with Rockton McNeil. And so obviously like UPS to me is like the most sophisticated pension in America. And they even below the Canadian pensions out of the water. Like what Rockton and Powess are doing there is truly incredible. And I just love always hearing or talking to them about what they’re doing. But basically like Jerome’s trying to pick his brain for the audience to know how they can pitch products to like a UPS pension. So they’re kind of going through that.
Jason Buck:
They mainly do it all themselves. So that’s a little weird.
Jeff Malec:
Yeah. And this was more like an internal takeaway because we always have these discussions internally. So it was interesting if you and Taylor have been around for this, because it was a lot more of our internal discussions of how UPS builds their book. Especially Powess is in charge of alternative hedge fund investments. But one of the things you talked about that we’ve discussed a lot internally, is let’s say they’re going to give a manager, like they’ve gone through all the due diligence process, right. They start with a quant side, like show us your numbers.
Jeff Malec:
They dig in the numbers, they start changing parameters, shock testing, see if that’ll work. Then they dive into like the due diligence on the discretionary side and kind of walk through that. But at the end of the day, Powess is a man after my own heart. He said, “At the end of the day, due diligence doesn’t matter, it’s position sizing.” So if they’re going to give 100 million clip to this manager, they’re likely just to put in 25 million for the first three years, see how it goes. See if they can actually generate alpha, see if they’re all on the same page, before they re-up that allocation to the 100 million.
Jason Buck:
Did you have a little like that emoji touchdown hands like… When he said.
Jeff Malec:
Like, everything you said was exactly what we talked about internally. So it gave me a confidence. That was the overarching thing is like based on that event, it was like, it gave all of us a lot of maybe confidence isn’t the right word. But it was like speaking, like you’re saying everyone likes to talk their own book. And it felt like they were talking the book for cockroach for us. Like it was all broad diversification, diversified diversifiers, all those sorts of things and like unknown unknowns and commodity vol, rates vol, like you need to branch out, take some basis risk, like all that stuff. And you know exactly what we do. So it was one big love fest, at least from my per perspective.
Jason Buck:
Yeah. And there’s an unlimited supply for derivatives products, or unlimited demand for them and supply. Like these exchanges, these groups are just going to keep coming out with new. And I think are definitely going to hourly at some point in the next 10 year, hourly options. And even down to like what you’re saying, going on to exchange, the blockchain to facilitate some stuff. So like we’re just going to see more and more, and really what the conference were to help people understand these different newer products and how the existing products were being used. It’s funny to think of options as a product, right?
Jeff Malec:
Yeah.
Jason Buck:
Just seems like something we’re all born with, but somewhere, someone came up with it at the wherever, CME ages ago. I’m reverting to my futures base roots, but we don’t even know this. Where were they first traded?
Jeff Malec:
So options, you can say the Japanese grain exchange in the 12 hundreds, I believe is what they saw. Or like daily zamaledis allegedly traded options on olive oil presses. And that’s where he made his fortune. So depending do you want to talk about actual modern markets is a different story.
Jason Buck:
When were they first created for profit? Yeah. Like for an exchange.
Jeff Malec:
But one of the things is, as we wrap up here. Is I hope we gave, as all these events, the interesting conversations are in the hallways of the in-between times, grabbing a coffee with somebody or whatever. And so I hope we gave some color to that. I wish we gave more, but a lot of these are private conversations that people don’t want to air publicly. But I’m just wondering outside of the actual talks, was there any other like takeaways or hot takes or any experiences that you thought would be interesting to the audience?
Jason Buck:
I think the wind waterfall that turns into a singing frog was super cool. I hadn’t seen that before. So go check that out. I can’t remember what it’s called. They got a little mini lake. It’s like a mini Bellagio show, but more interactive.
Jeff Malec:
Yeah. We’re down at like the AFT cocktail, like pier over that lake. And it is this crazy, like the imagination that goes into that, like a crazy Disney show pops off every 15 minutes or whatever that’s different. And then just to me, the juxtaposition of watching all these sophisticated vol managers we were hanging out with all like. Be shutting up to watch the show. Yeah.
Jason Buck:
And then as traders will do, we’re sitting there looking at there’s this fountain, all this stuff and tons of trees. Like they’ve basically created a backdrop with all these trees. So everyone starts saying like, make a market. What do you think all that vegetation costs? I think I was at 20 million. Someone else was like at 2 million. Those aren’t all real, so right. That’s it. I think Vegas is back. Seemed pretty busy, right?
Jeff Malec:
Oh, it’s crazy busy. I mean, Vegas is amazing how you can’t tell time and how it all it is about keeping you awake.
Jason Buck:
And then we talk about, like I’m always amazed just with the innovation, right? Like that’s American capitalism on steroids. Like you think you have a good thing win? No, you have to come up with something new every six months to keep the traffic moving.
Jeff Malec:
Yeah. I’m always fascinated by the logistics. You got hotels up to thousands of rooms and their entire city onto itself. And I try to watch all the logistics in the early morning as I walk around, like, how does this system work? And then it’s multiple hotels in an entire city with just the most amazing logistics system I think in the world. And that was Will Wise and I from Ambers, were talking about it’s built in the desert. And so actually people come from all over the world to see how they’re able to conserve water at these hotels because their technology in the water conservation has to be the best in the world for them to be able to just run these properties. But just watching the amount of groups going in and out on a daily basis, it is truly fascinating.
Jason Buck:
I had the opposite take on that. I’m like, these guys are like causing water issues. There’s no low flow shower there. You’re getting doused in the shower. And I’m sure people have the shower on for a hundred hours in their rooms.
Jeff Malec:
But they’re recycling so insistent. But you would think like, but on that per capita water use is basis, they’re the best in the world. So yes, you are still draining Lake Mead, like Powell in the Colorado River and there’s issues going on right now with that. But like it’s amazing.
Jason Buck:
Sorry, everyone downstream.
Jeff Malec:
Yeah. But their ability to use the least amount, you’d think, like you said, with high flow shower heads and millions of people. Yeah. You would think it would be the worst, but like the way they’re able to conserve is pretty impressive.
Jason Buck:
Awesome.
Jeff Malec:
Thank you, Jason. Good luck on Pirates today. Hopefully you don’t have anyone walking through your background and we will talk to you soon.
Jason Buck:
Thanks, Jeff.
Jeff Malec:
All right.
Taylor Pearson:
Thanks for listening. If you enjoyed today’s show, we’d appreciate it. 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@mutinyfund.com. And Jason is jason@mutinyfund.com. Or you can reach us on Twitter. I’m @TaylorPearsonMe, and Jason is @JasonMutiny. To hear about new episodes or get our monthly newsletter with reading recommendations, sign up at mutinyfund.com/newsletter.
