Speaker 1: Hey, there are aud Loots listeners. It's Tracy Alloway.
Speaker 2: And Joe Wisenthal.
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Speaker 1: Hello and welcome to another episode of the Audlots podcast.
Speaker 1: I'm Tracy Alloway.
Speaker 2: And I'm Joe Wisenthal.
Speaker 1: Joe, as part of my preparation for this episode, I
Speaker 1: have spent the morning on TikTok and Twitter, slash x
Speaker 1: Instagram watching videos.
Speaker 2: Did you find any good techniques that you are going
Speaker 2: to employ for generating two hundred thousand dollars a year
Speaker 2: on two hundred and fifty thousand dollars in capital by
Speaker 2: selling short term options? You know what?
Speaker 1: First of all, there are so many accounts that are
Speaker 1: basically pitching trading with derivatives options. Some variation of those nowadays.
Speaker 1: I did, to your point, find a guy a video
Speaker 1: of a guy saying that one thousand dollars is only
Speaker 1: nine doubles away from becoming a million, and a million. True,
Speaker 1: a million is only ten doubles away from a billion.
Speaker 2: So that's true too. Now, I think that sounds roughly right. Yeah,
Speaker 2: so what's the catch? You know, someone's got to do it.
Speaker 1: No catch, Joe, It's it's all good. We can all
Speaker 1: be billionaires. No, I think. I think the thing about
Speaker 1: derivatives trading nowadays is when it's started, it was very
Speaker 1: much a retail phenomenon. It was, you know, the guys
Speaker 1: on Wall Street bets Yo, lowing into some crazy derivatives trade,
Speaker 1: basically buying a lottery ticket on the market. But what's
Speaker 1: happened since then is derivatives have really gone mainstream in
Speaker 1: various ways. So, for instance, if you look at options
Speaker 1: like across the S and P five hundred right now,
Speaker 1: something like sixty percent of the volume is shorter dated options.
Speaker 1: So yeah, zero DT or one DT, which is kind
Speaker 1: of crazy.
Speaker 2: It's totally crazy, you know. I remember first, do you
Speaker 2: remember Tracy early on when we started at Bloomberg, You
Speaker 2: brought in. There was someone I forget who it was,
Speaker 2: but there was someone from some sort of like actual
Speaker 2: like institutional options trading research firm that came in and
Speaker 2: did this little like mini seminar for some of the
Speaker 2: reporters on like how to analyze options data. Do you
Speaker 2: remember doing that you brought in anyway, But one of
Speaker 2: his points was is that the purpose of options are
Speaker 2: like they're largely hedging instruments. They're sort of tactically used
Speaker 2: by institutions for very specific purposes, you know, insurance essentially,
Speaker 2: that options sort of played this role as insurance for
Speaker 2: specific things. And then since then I get the impression
Speaker 2: that the world is just like totally changed. And I
Speaker 2: think the other thing that surprised me. I would have
Speaker 2: guessed that if we're sitting here in twenty twenty five,
Speaker 2: that that craziness of twenty twenty one would have been
Speaker 2: some sort of peak. Right, there is Robinhood here, Memestock,
Speaker 2: ere et cetera. I would not have guessed the durability
Speaker 2: of it, especially with the FED having hiked and everything
Speaker 2: that we've seen transpires.
Speaker 1: Since No, that's my point, right, Instead of like the
Speaker 1: Yolo crowd basically reducing their options trading. Instead, we had
Speaker 1: Wall Street yoloing into options trading to serve first. Okay,
Speaker 1: So options, derivatives, they're everywhere right now, and you have
Speaker 1: different groups of people, so institutional and retail using them.
Speaker 1: You have a bunch of different strategies, you have a
Speaker 1: bunch of different products that deploy them, that give again
Speaker 1: new types of traders access. So we should talk about it.
Speaker 2: Let's do it.
Speaker 1: And who do we call to talk about derivatives? The
Speaker 1: perfect guest, one man, the perfect guest. We have Ben
Speaker 1: i for managing partner at QVR. Back with us, Ben,
Speaker 1: thanks for coming back.
Speaker 4: On Tracy Joe. It's so good to see you, guys.
Speaker 4: I'm really excited about this. It's always so much fun
Speaker 4: talking to you.
Speaker 1: It's been a while. I have to say, maybe just
Speaker 1: to start out with videos' favorite.
Speaker 4: The one actually from a few days ago that I
Speaker 4: just absolutely loved. I'm gonna I'm gonna forget her name
Speaker 4: off the top of my head, but she's called the
Speaker 4: she Wolf of Indian options trading and she has a
Speaker 4: whole show. She was actually reacing me. She was recently
Speaker 4: banned by the Indian government from you know, doing what
Speaker 4: she's doing because she's sort of so controversial, but she's
Speaker 4: very intimidating it. Like I like to kind of take
Speaker 4: on these option influencers and sort of say, look, you know,
Speaker 4: come on, guys, this isn't right. I don't know, man,
Speaker 4: she's she's pound, you know, pounding the table about making
Speaker 4: one hundred percent in ten minutes, you know, like guaranteed profits,
Speaker 4: interdate options trading over and over again while like a
Speaker 4: band plays in the background and fireworks go off. It's
Speaker 4: like truly incredible stuff.
Speaker 2: I'm reading an article on livemint dot com SCBI, which
Speaker 2: I guess is the Indian regulator banning her from capital markets.
Speaker 2: But one hundred percent in ten minutes sounds pretty good.
Speaker 4: What's the kid, what's the cat? Well, it turns out
Speaker 4: it's a lot better money for her than it is.
Speaker 2: Usually Well what is Okay, that's a very extreme example,
Speaker 2: but we all, you know, we've all seen these videos.
Speaker 2: The modal TikTok options is influencer. What is the sort
Speaker 2: of the gist of what they're telling viewers that they
Speaker 2: can do.
Speaker 4: Yeah, absolutely, I mean the things that you that they say,
Speaker 4: you guys just kind of joked a little bit about
Speaker 4: this earlier, but you know, make twenty thousand dollars a
Speaker 4: month in passive income, you know, easily with only a
Speaker 4: two hundred and fifty thousand.
Speaker 2: What's the gist of that stor we all are very
Speaker 2: skeptical results, But what is the basic thing that they're
Speaker 2: saying that you.
Speaker 4: Can absolutely achieve. The typical thing these days is they
Speaker 4: want you to sell short data, short term options, right,
Speaker 4: And there's various formats that might take. The really popular
Speaker 4: stuff might be just selling puts, you know, one month
Speaker 4: puts on your favorite stocks or on the equity index,
Speaker 4: or maybe weekly puts or maybe zero DT puts, sort
Speaker 4: of daily puts over and over again. Could be selling
Speaker 4: covered calls or uncovered calls. Could be selling you know,
Speaker 4: straddles or strangles or whatever it is. But the common
Speaker 4: idea or the kind of they'll pack all of these
Speaker 4: different handwavy justifications into why this is free money or
Speaker 4: why this is really easy. You'll hear people say, oh,
Speaker 4: ninety percent of options expire out of the money, so
Speaker 4: it's just super easy. You just make money on all
Speaker 4: these trades, you know, and then and then anything that
Speaker 4: could go wrong they explain away as how it's not
Speaker 4: really a problem. You know, Oh, well, if you sell
Speaker 4: the put and the stock goes down, then you get
Speaker 4: to buy the stock really cheap and the stock is
Speaker 4: going to go back up and it's kind of fine.
Speaker 4: Or you know, oh, you reduce your cost basis on
Speaker 4: the stock over and over again, and then then you
Speaker 4: get the stock for free. For all of these things
Speaker 4: over and over again. Where at the end of the day, Look,
Speaker 4: if you say you can sell an option, that's fine.
Speaker 4: It's just a trade. It has a payoff profile. You
Speaker 4: get a little bit of premium and maybe you lose
Speaker 4: a bunch of money or maybe you don't, and you
Speaker 4: can kind of analyze that trade the same way you
Speaker 4: would analyze any trade. It's not free money, you know.
Speaker 4: But the justifications and explanations and persuasiveness that goes into
Speaker 4: this from these from these kind of influences is very powerful.
Speaker 1: Do we have any sense of what people are using
Speaker 1: these four And you know, one thing I hear in
Speaker 1: particular on shorter dated options from this mostly comes from
Speaker 1: institutional traders, but the idea that well, these allow you
Speaker 1: to be more precise when you're hedging. This is a
Speaker 1: tactical move versus a strategic move. But then of course
Speaker 1: you look at something on a subreddit or something like
Speaker 1: that and people are just basically buy lottery tickets.
Speaker 4: Yeah, I think that's exactly right. So, you know, derivatives
Speaker 4: have been around for a long time, and options have
Speaker 4: been around for a long time, and they certainly enable
Speaker 4: you to make very customized, precise bets or hedges in
Speaker 4: intelligent ways if that's what you're trying to do, and
Speaker 4: you know, that's super. But most of what you see
Speaker 4: being sold on YouTube or on Instagram is much more.
Speaker 4: You know, you should just do this all the time.
Speaker 4: This just makes sense. This is basically free money. It's
Speaker 4: really easy.
Speaker 1: There's no accompanying strategy.
Speaker 4: There's no accompanying strategy of when and why might something
Speaker 4: like this make sense? At what price? How do you
Speaker 4: know if it's a good trade. There's none of that.
Speaker 4: It's just justification that somehow this is a cheat code
Speaker 4: in markets that just lets you unlocked the infinite money,
Speaker 4: an infinite money cheat code that lets you unlock sort
Speaker 4: of spectacular returns.
Speaker 2: One day, Tracy, We're going to do an episode on
Speaker 2: the cheat code that I did find in markets, which
Speaker 2: I have I think i've hinted it.
Speaker 1: Wait, you found one and you're still here.
Speaker 2: Well, the short version is, I did find a cheat
Speaker 2: code in nineteen ninety nine. I didn't know that I
Speaker 2: had found a cheat code at the time, and so
Speaker 2: I was like, oh, at some point I'll pick this
Speaker 2: back up. But in retrospect, I should have gotten all
Speaker 2: my friends and family to go all into it for
Speaker 2: a month. I could talk about it some other time.
Speaker 2: I did briefly find it. Cheat coulde in the markets,
Speaker 2: and I thought, I was like, you know, and.
Speaker 4: He didn't tell any of.
Speaker 2: Us, Yeah, I didn't. I was like, oh, this is
Speaker 2: kind of cool. I made ten thousand dollars. You know,
Speaker 2: we talk about volatility, right, and so just a very
Speaker 2: crudely you know, they're you know, maybe higher vall opportunities
Speaker 2: present good times because you're getting large premium or whatever
Speaker 2: for some of the options trading, et cetera. What are
Speaker 2: like people who find who like walk into these extremely
Speaker 2: naive strategies, Oh, option ninety percent of the time options
Speaker 2: expire out of the money. What does the payoff look
Speaker 2: like for them? How many days do they how many
Speaker 2: pennies can they pick up before they get steamrollered?
Speaker 4: Yeah, totally. I mean, these kind of strategies again, if
Speaker 4: you're just doing them all the time without thinking about it,
Speaker 4: without thinking about the price, and you're just going out
Speaker 4: like on the S ANDT for example, and selling options,
Speaker 4: you know, most of the time these days, because that's
Speaker 4: a crowded one way trade where lots of people sell
Speaker 4: short dated options. You'll tend to make kind of a
Speaker 4: little bit of money at a time, sort of choppily
Speaker 4: for a while, and then once every you know, three
Speaker 4: years or five years, you'll kind of get wiped out
Speaker 4: and end up down.
Speaker 2: You just start getting into it the day after the
Speaker 2: wipeout exactly.
Speaker 4: And actually that's and actually there is something to that.
Speaker 4: Usually usually it's like a month or two after the
Speaker 4: wipeout because you don't know if there's going to be
Speaker 4: another big leg down or something. But there does tend
Speaker 4: to be some excess risk premium and options markets a
Speaker 4: little while after a big market crash that blows out
Speaker 4: a lot of these guys and kind of causes people
Speaker 4: to panic, that's totally true. And then that tends to
Speaker 4: go away after another you know whatever it is year
Speaker 4: or two years or something like that.
Speaker 1: So just in terms of the expansion of all different
Speaker 1: types of derivatives. I don't want to focus too much
Speaker 1: on shorter dated options because there are some other things
Speaker 1: out there that look really interesting. One of them is
Speaker 1: I saw a headline float by about the University of
Speaker 1: Connecticut's endowment dropping some of its hedge fund exposure in
Speaker 1: favor of buffer ETFs. What are buffer ETFs?
Speaker 4: Yep, So this is a a big new manifestation of
Speaker 4: a relatively old popular idea. So buffer ETFs are usually
Speaker 4: pitched as sort of defined outcomes in some sense over
Speaker 4: some time period where they say, well, what you're trying,
Speaker 4: what we're trying to do is give you equity exposure,
Speaker 4: but you have protection. You have a buffer down to
Speaker 4: say ten or fifteen percent, where you're not going to
Speaker 4: lose money as the market goes down, and then beyond
Speaker 4: that point you're exposed. And in order to do that,
Speaker 4: you're going to sell an upside call. You're going to
Speaker 4: give up some of your upside And so what this
Speaker 4: is it's basically just a put spread caller, which is
Speaker 4: a very standard kind of option structure. You sell a
Speaker 4: call to buy a put spread. That is for many
Speaker 4: many years and decades, by far the most popular thing
Speaker 4: that a Wall Street derivative salesperson will run around trying
Speaker 4: to pitch to their clients. It's a very easy thing
Speaker 4: to conceptualize, I'm giving up some upside, I'm getting some protection.
Speaker 4: They can be structured so that there's sort of zero
Speaker 4: premium outlay where you sell a call and use that
Speaker 4: same amount of money to buy a put. So if
Speaker 4: you're an aggressive salesman, you call that like a free
Speaker 4: hedge or a zero cost hedge. Of course you're giving
Speaker 4: up upside, so you can it can be very cool
Speaker 4: to pay.
Speaker 2: For it, but only implicitly by some notional change that
Speaker 2: you're not thinking about.
Speaker 4: That's exactly right. And there's three legs to the trade,
Speaker 4: so there's lots of bit offer spread and lots of commissions.
Speaker 4: So salespeople and traders really like that, and they're very,
Speaker 4: very very popular now. Buffer ETFs these days enable a
Speaker 4: retail investor or a high net worth individual to go
Speaker 4: and get that just by buying an ETF, you know,
Speaker 4: with a seventy basis points management fee or whatever it is,
Speaker 4: instead of having to, you know, be involved with Wall
Speaker 4: Street banks or doing trading themselves. People love that. There
Speaker 4: are very famous mutual funds like the JP Morgan one
Speaker 4: that everybody talks about, and it's twenty two billion dollars
Speaker 4: of assets or something like that. And now there's I
Speaker 4: think something like ninety billion dollars of bufferytf's doing the
Speaker 4: same kind of thing. And they're all doing something very
Speaker 4: very similar, which is again they're selling call it an
Speaker 4: eight percent or ten percent out of the money call
Speaker 4: or seven percent of the money call. They're buying an
Speaker 4: apt the money or slightly downside put and then selling
Speaker 4: out another like a ten percent down or fifteen percent
Speaker 4: down put to kind of give yourself this bus on
Speaker 4: the way down. You're giving up upside on the way up.
Speaker 1: One thing I don't get is like, why would you
Speaker 1: prefer doing that versus just buying a bunch of equities
Speaker 1: and maybe hedging in a more traditional way like buying
Speaker 1: some bonds.
Speaker 4: So this is exactly the right question. So the first
Speaker 4: thing that you know, a derivatives person looks at when
Speaker 4: you look at a trade like this is Okay, what
Speaker 4: does this do to the delta the equity exposure of
Speaker 4: your position? Right? So if you buy some equities that
Speaker 4: is a one delta, A derivatives guys would say, it's
Speaker 4: just a delta one position. Market goes up a percent,
Speaker 4: you make a percent. If you trade a typical put
Speaker 4: spread caller against that, you buy a put spread, you
Speaker 4: sell a call, you're probably going to take that one.
Speaker 2: Sorry. What's a put spread?
Speaker 4: Is a posh to put? A put spread would be
Speaker 4: you buy say the out the money put, but then
Speaker 4: you sell a ten percent out of the money put. Okay,
Speaker 4: So that's going to give you protection only for ten percent. Okay.
Speaker 4: So if you do that kind of a trade, you
Speaker 4: might take your one delta option down to like a
Speaker 4: point six down to a sixty delta, So now you're
Speaker 4: only participating kind of sixty percent in the movements of
Speaker 4: the market. And if you look at how these kind
Speaker 4: of trades perform over long periods of time, they actually
Speaker 4: act a whole lot just like having sort of sixty
Speaker 4: percent as much stock, right, because ultimately they're rolling these
Speaker 4: it's not really like a buy and hold to maturity thing.
Speaker 4: It's like they're rolling these options to kind of maintain
Speaker 4: this kind of exposure. And if you were just to
Speaker 4: take the counterfactual, which is why don't I just own
Speaker 4: sixty percent as much stock? And put forty percent of
Speaker 4: the rest in T bills. Turns out your fees are
Speaker 4: way less and your performance is probably better. Right, So
Speaker 4: you're doing this creative, smart sounding options thing, but actually
Speaker 4: you're underperformed.
Speaker 2: Are there institutions, you know, trace you mentioned the University
Speaker 2: of Connecticut. You know, institutions have sometimes very specific needs
Speaker 2: they need to have, like a guarantee return very long term.
Speaker 2: They may not be optimizing for maximum returns. They have
Speaker 2: to dole out a certain amount for student aid, whatever
Speaker 2: it is. Are there certain types of institutions where, whether
Speaker 2: we're talking about the buffer ETFs specifically or analogus to
Speaker 2: that strategy, that this is, in your view, in alignment
Speaker 2: with the institutional mandate.
Speaker 4: So that there are cases when that's to some extent true,
Speaker 4: at least with some kinds of derivative structures. So you
Speaker 4: will have cases where there's like a big dispersement that
Speaker 4: has to be made at some future date and they
Speaker 4: want to lock in for sure the fact that they
Speaker 4: can make that dispersement. But usually something more like an
Speaker 4: outright put is going to be a better match for that, right,
Speaker 4: Because the thing about the put spread or the put
Speaker 4: spread collor is you've only got like this, say, ten
Speaker 4: percent buffer of protection, and what if the market crash, So.
Speaker 2: If the stock falls, or if the market falls twenty
Speaker 2: five percent, which does happen, you're actually not protected against
Speaker 2: all of that.
Speaker 4: Yeah, exactly right. So this stuff really doesn't like lock
Speaker 4: in defined outcomes to the downside. It just gives you
Speaker 4: of some buffer of protection in exchange for some upside
Speaker 4: that you're losing.
Speaker 1: You touched on this earlier, but talk to us a
Speaker 1: little bit more about the commissions and the execution and
Speaker 1: whether or not you're getting a good deal on those,
Speaker 1: because my sense is these all seem to be algorithmic, right,
Speaker 1: very mechanical, So I'm not entirely sure what you're paying for.
Speaker 4: He yeah, no, So this is a really important point.
Speaker 4: So generally these are not always, but typically these kind
Speaker 4: of structures exist in fairly popular, fairly liquid underlyings. Right.
Speaker 4: This isn't like microcapstocks. This is S and P or something.
Speaker 4: So the you know, the bid offer spreads don't look
Speaker 4: that wide when you look at it. But you have
Speaker 4: to keep in mind if you have a twenty two
Speaker 4: billion dollar fund that once a quarter is rolling this
Speaker 4: giant collar and everybody knows about it and knows exactly
Speaker 4: what you're going to do and knows exactly when you're
Speaker 4: going to do it, then obviously the market just moves
Speaker 4: right ahead of you, right and everybody positions first trade.
Speaker 1: What happened during Vollmageddon as well, very much so.
Speaker 4: When when you have a big tray that everybody knows
Speaker 4: what you're going to do and when you're going to
Speaker 4: do it, they're going to position ahead of that. In
Speaker 4: this specially in a poor liquidity environment, you know that's
Speaker 4: going to really hurt you. Like markets can you know,
Speaker 4: the markets can move very significantly as market makers and
Speaker 4: arbitrazurers and volatility people sort of position for this big
Speaker 4: trade that's coming. And so the execution you end up
Speaker 4: getting in these trades is really poor. And usually they're
Speaker 4: not again they're doing something very simple, very mechanical. They're
Speaker 4: not randomizing their trades in small batches to work into
Speaker 4: position really efficiently. They're just outsourcing execution to some agency
Speaker 4: only broker who doesn't care at all about how they
Speaker 4: just have to get a filled and they put it
Speaker 4: up way over the offer side of where the market
Speaker 4: really should be.
Speaker 2: Are there funds that claim to do something more sophisticating,
Speaker 2: because it does sound obvious, like all the rules are
Speaker 2: out there, the prospectus, the mechanics, the timing, et cetera.
Speaker 2: It does seem very I guess front runnable. Do they
Speaker 2: have tactics or approaches to avoid what sounds like the
Speaker 2: most obvious risk in the world.
Speaker 4: Yeah, I mean certainly there are you know, volatility arbitrage
Speaker 4: type of funds like ours and like others out there.
Speaker 4: We will work with institutional clients that are trying to
Speaker 4: do some similar kinds of things, but in an intelligent way.
Speaker 4: And yeah, the way we execute in the marketplace is
Speaker 4: very different, right, So we take the same objective of
Speaker 4: the exposure we want to get, but we're going to
Speaker 4: work into it sort of passively and secretly and quietly
Speaker 4: in very smart ways and try to kind of get
Speaker 4: mid market execution and have nobody know what we're doing.
Speaker 1: And so the competitive advantage is really on the execution
Speaker 1: side rather than the actual design of the product.
Speaker 4: Yeah, there's probably some of both. I mean, one thing
Speaker 4: one thing you want to do is execute really efficiently
Speaker 4: without people knowing what you're doing. Another thing you want
Speaker 4: to do is just know what the big flows and
Speaker 4: big crowded trades in the market are and generally be
Speaker 4: trying to achieve the client subjectives, but ideally by buying
Speaker 4: something that's getting sold too much as opposed to selling
Speaker 4: something that everybody else is selling. Right, So those two components,
Speaker 4: that's a kind of a strategy design aspect, and then
Speaker 4: there's just an execution implementation aspect that's again really important
Speaker 4: and people just aren't incentivized for it. Like when you
Speaker 4: think about these the buffer ETFs derivatives using ETFs, it's
Speaker 4: really kind of a Wild West type of boomtown scenario
Speaker 4: right now, right, And I would say, you know, generally
Speaker 4: the first to market has an advantage, and it's all
Speaker 4: about distribution and very and you know, implementation details are
Speaker 4: very secondary. Right. The people have been really successful are
Speaker 4: marketers and distributors hitting the street hard. They're not you know,
Speaker 4: vall traders who are designing these things.
Speaker 1: All the influencers. I'm just going to throw out random
Speaker 1: derivatives products. So if you could just define them, what
Speaker 1: is the wheel and why does it have an E
Speaker 1: t F named after it?
Speaker 4: Yes, this is this is fantastic. So it kind of
Speaker 4: goes back a little bit to the mean stock options crave.
Speaker 4: You know they're ticker. Is it? Is it w h
Speaker 4: H E L Wheel?
Speaker 1: Isn't it?
Speaker 4: I think it's four letter. I think it's w h
Speaker 4: H E L.
Speaker 1: If you no, I think it's it's w E E L.
Speaker 2: O w E L. That's peerless option wheel, peerless that
Speaker 2: they put peerless, Yes, tell us about the wheel.
Speaker 4: Yeah. So the a lot of the original mean stock
Speaker 4: option traders who made a bunch of money in g
Speaker 4: M and you know AMC back in the day, some
Speaker 4: of them sort of migrated from that into getting really
Speaker 4: interested in options selling, and in particular kind of a
Speaker 4: strategy called the wheel, where the idea is you're going
Speaker 4: to sell against short data options. You're gonna start out
Speaker 4: selling cash secured puts, so you're gonna sell some puts
Speaker 4: on the S and P or on your favorite stocks,
Speaker 4: and then you're going to keep doing that unless the
Speaker 4: market goes down enough that you get a sign on
Speaker 4: that put and you take a loss. Then you long
Speaker 4: that stock, and then you're gonna sell some calls against
Speaker 4: it and have a covered call strategy until the stock
Speaker 4: rallies enough that that call gets assigned, your stock gets
Speaker 4: taken away, then you sell a put, and so it's
Speaker 4: sort of you know, the end. The way they'll describe
Speaker 4: this is it's almost as if it's this continuous money machine,
Speaker 4: because all of these outcomes are good. If the stock
Speaker 4: doesn't move, you get the premium, that's good. If the
Speaker 4: stock goes down, you get the stock cheap, that's good.
Speaker 1: And you're sort of you keep moving with the market, right,
Speaker 1: and the one thing you know is the market's gonna move. Probably.
Speaker 2: It seems like there's some assumed mean reversion here. The
Speaker 2: cycle of life.
Speaker 4: Yeah, there's very much like a cycle of life. There's
Speaker 4: this idea that no matter what scenaari, there's a justification
Speaker 4: for how anything that can happen is sort of good.
Speaker 4: You know, the stock goes up, you made money. You
Speaker 4: didn't make as much money as you would if you
Speaker 4: hadn't sold the call, but you still made money. And
Speaker 4: then if it goes down, the same thing like you.
Speaker 4: And ultimately, what's not described in these pitches is how
Speaker 4: this is a it's a short volatility trade. What you're
Speaker 4: exposed to is the stock going down a lot and
Speaker 4: then back up a lot, and then down a lot
Speaker 4: and back up a lot. Right, Because what happens is
Speaker 4: stock goes down a lot, you're going to lose money
Speaker 4: on your short put. Now you're gonna get assigned the stock.
Speaker 4: You're going to sell a call. What if the market
Speaker 4: goes back up a lot. Well, now you didn't make
Speaker 4: money on the reversion because you're short of call and
Speaker 4: you're just getting chopped up by this volatility. Right. So
Speaker 4: people love to pitch options trades in ways that don't
Speaker 4: have anything to do with volatility, when they're inherently volatility trades, right,
Speaker 4: they like to pitch them as you know. One of
Speaker 4: my least favorite phrases, right is people will say, these
Speaker 4: influencers will say, selling a put is just like having
Speaker 4: a limit order out there in the market to buy
Speaker 4: a stock really cheap, but you get paid for it,
Speaker 4: So it has nothing to do with the price, has
Speaker 4: nothing to do with it. If this is like a
Speaker 4: good risk reward for the premium that you're getting, it's
Speaker 4: as if you can just buy a stock for really
Speaker 4: cheap when it goes down and you get paid for it.
Speaker 1: Do we have any historical data on how these have
Speaker 1: performed in the past, so most of them are new.
Speaker 1: So I imagine we have finite information about performance.
Speaker 4: Yeah, totally. If you look at benchmark indices for things
Speaker 4: like call over writing or cash secured put selling, those
Speaker 4: have been around for a very long time and they
Speaker 4: know back tested, way way back. So there's something called
Speaker 4: BxM index on Bloomberg that you can pull up, and
Speaker 4: something called put put index on Bloomberg that you can
Speaker 4: pull up for call writing and put writing. And what
Speaker 4: you see there is it actually tells a really nice story,
Speaker 4: which is from about nineteen ninety line going up from
Speaker 4: about the lines going up from about and you want
Speaker 4: to compare that to just the SMP. So from nineteen
Speaker 4: ninety to about twenty twelve they look pretty good. They
Speaker 4: kind of keep up on average with the SMP, but
Speaker 4: on somewhat lower volatility with a little bit lower draw downs.
Speaker 4: And that was really the pitch that investment consultants and
Speaker 4: pension fund consultants started making after the credit crisis to
Speaker 4: their clients.
Speaker 2: Is this what made off claim to be doing some
Speaker 2: sort of like right.
Speaker 4: He was claiming to be doing like conversions and like
Speaker 4: diagonal spreads and stuff, so like a little bit funkier stuff.
Speaker 4: But yeah, he was out there saying, oh, we're doing
Speaker 4: this kind of really cute option stuff. So this stuff again,
Speaker 4: it it looked recent decent in this sort of back test,
Speaker 4: and but the whole point is of you know, very
Speaker 4: much like any back test in finance, option selling looked
Speaker 4: good when nobody was doing it in size right, there
Speaker 4: were it was not you know, option markets were backwater.
Speaker 4: There were funny little things that some hedge a few
Speaker 4: hedge funds did and a few kind of people, but
Speaker 4: there were no giant pension two hundred million dollar pension
Speaker 4: funds doing like option selling. And then those pension fund
Speaker 4: consultants started writing white papers and they started pitching to
Speaker 4: their clients' boards, and by like twenty eleven, twenty twelve,
Speaker 4: twenty thirteen, they started to get some traction, and you
Speaker 4: started to have you know, giant two hundred million dollar
Speaker 4: pension funds saying sure, we'll put ten percent of our
Speaker 4: assets and move it from equity into option selling. And
Speaker 4: that grew and grew and grew and grew and grew,
Speaker 4: and so what you ended up with then is volatility
Speaker 4: term structures steepened, which means that short dated options that
Speaker 4: were getting sold really heavily went down in price because
Speaker 4: that's what everybody was selling. And what happened was you
Speaker 4: see the performance then of in kind of the out
Speaker 4: of sample period, if you want to think of it
Speaker 4: that way, from a back test for BxM and put index,
Speaker 4: which are the benchmarks for this kind of stuff, then
Speaker 4: really deteriorated relative to S and P, where they sort
Speaker 4: of had very similar risk but much less return. And
Speaker 4: that was like, how does this actually look once real
Speaker 4: money goes into these strategies, Because at the end of
Speaker 4: the day, derivatives' markets are big and deep in liquid,
Speaker 4: but they're not primary markets, right, They're derivatives markets. You
Speaker 4: can't they're not designed for like global asset allocation for
Speaker 4: twenty percent of the of all the money in the
Speaker 4: world to go into selling them, right.
Speaker 1: But this is the big debate, right to what extent
Speaker 1: is this kind of options trading or derivatives trading action
Speaker 1: affecting the underlying which would be the market or you know,
Speaker 1: something like the VIX and you hear different sides to
Speaker 1: the story. So you have some people arguing that actually
Speaker 1: one of the key reasons the VIX has been kind
Speaker 1: of subdued recently is because of all this short dated
Speaker 1: trading then you have you know, entities like the CBOE
Speaker 1: arguing for obvious reasons, perhaps that actually the gamma exposure
Speaker 1: from the short dated options isn't that big, certainly not
Speaker 1: big enough to move the full huge market. It sounds
Speaker 1: like you land on the first one.
Speaker 4: Yeah, the size of short dated options selling is very,
Speaker 4: very large. It's very very one way, and there's different
Speaker 4: flows in different parts of the option market, right, But
Speaker 4: if you look at one month range options that are
Speaker 4: not that far out of the money, call it like
Speaker 4: twenty five delta put wing to call wing, the overwhelming
Speaker 4: end user of that product is selling it for income
Speaker 4: or for you know, for a asset allocation type of strategy.
Speaker 4: And what that means is, you know, the all of
Speaker 4: the flows on the floor for brokers and banks are
Speaker 4: giant trades to sell constantly, and the people that are
Speaker 4: buying them are people like us who are buying them
Speaker 4: because they're too cheap, not because we have any other
Speaker 4: reason to buy them. Right, So go ahead, job, No.
Speaker 2: This is sort of where I was going to follow
Speaker 2: on to Tracy's question. I mean, if we were having
Speaker 2: this conversation in twenty nineteen, what are the fingerprints that
Speaker 2: are visible in the market. Obviously, volume is clear, I mean,
Speaker 2: but in terms of the fingerprints of when it comes
Speaker 2: to price, what are the fingerprints of all of this
Speaker 2: retail and now institutional money flowing into this space? And
Speaker 2: I presume to some extent the reason you have a
Speaker 2: business is because there are these fingerprints.
Speaker 4: What do they look like? Yeah? Absolutely so. Taking this
Speaker 4: example of short data options selling, for instance, the first
Speaker 4: thing you want to look at is the relative price.
Speaker 4: And what is that In the world of options in volatility,
Speaker 4: it's the term structure of volatility, which means where is
Speaker 4: implied volatility for the S and P for example, which
Speaker 4: is one of the biggest parts of this ecosystem for
Speaker 4: very short term options one month, two month, three month,
Speaker 4: six month, one year. And what does that term structure
Speaker 4: look like if you compare it to history, And what
Speaker 4: you'll find is really in the evolution that you've had
Speaker 4: in that post twenty twelve regime has been the volatility
Speaker 4: term structure getting steeper and steeper and steeper, so lower
Speaker 4: in the front and steeper and steeper kind of all
Speaker 4: the way out to the back. And the reason for that,
Speaker 4: again is that the front is being sold very, very
Speaker 4: very heavily, and people who are getting put into a
Speaker 4: lot of the front, like market makers and like volatility arbitrazures,
Speaker 4: then have to go further out the curve to hedge.
Speaker 4: You see that very distinctly. Another thing you can look
Speaker 4: at is volatility risk premium, which is something you kind
Speaker 4: of have to estimate and look at empirically. It's not
Speaker 4: just the shape of a volatility term structure. That is
Speaker 4: what is implied volatility relative to subsequent realized volatility. So
Speaker 4: implied volatility is supposed to be forecasting realized volatility how
Speaker 4: much the market actually moves, and the spread between those
Speaker 4: two is a risk premium. If you're selling options, you
Speaker 4: should get paid a risk premium. It's a risky, long
Speaker 4: beta kind of thing to do, so you should get
Speaker 4: paid some amount of money for that. In the old days,
Speaker 4: before twenty twelve, you used to get paid a decent
Speaker 4: amount of money for that, maybe three volatility points on average.
Speaker 4: In the more recent years, that compresses and compresses down
Speaker 4: to one point or half a point, and then you know,
Speaker 4: kind of to Joe's point, that will blow out a
Speaker 4: little bit after a major market crash for a little while.
Speaker 1: And then you dive in exactly. Okay.
Speaker 2: One other I think you said you die, that's actually.
Speaker 1: Either dive in.
Speaker 3: Okay.
Speaker 1: One other thing I want to ask about is, of course,
Speaker 1: multi strategy hedge funds. So we did a bunch of
Speaker 1: episodes on these and options trading derivatives came up quite
Speaker 1: a bit, especially in things like the dispersion trade, and
Speaker 1: one thing sticks with me. We spoke to a guy
Speaker 1: called I think it was Krishna Kumar. Is that right,
Speaker 1: Krishna Kumar, and he made the point that at multistrat funds,
Speaker 1: you're not trying to maximize long term returns. You're trying
Speaker 1: to maximize returns per unit of time, in which case
Speaker 1: options sound pretty good for doing that.
Speaker 4: Yeah, that's absolutely right. So, you know, multistrats are a
Speaker 4: very interesting business. But I think part of what you're
Speaker 4: getting at is one thing that they do very well
Speaker 4: from a business standpoint is they have a very short
Speaker 4: leash on portfolio managers and on pods. They're notorious for
Speaker 4: firing you very quickly if you start to lose any
Speaker 4: material amount of money, and that's a risk management thing
Speaker 4: for them, right, And so there's this idea that gosh,
Speaker 4: I'm probably only going to be here for like a
Speaker 4: year or two or three, So I sure better just
Speaker 4: make a whole bunch of money as fast as I can,
Speaker 4: and if it goes really poorly, then it goes poorly, right.
Speaker 4: But and so you're incentivized to do negatively skewed things. Now,
Speaker 4: the multistrats have very good risk management. They know this.
Speaker 4: They're you know, they're not silly, So they're not going
Speaker 4: to just let you go sell a whole bunch of options,
Speaker 4: you know, naked and a bunch of puts and see
Speaker 4: how that goes. But you can definitely try to do
Speaker 4: more creative things that look a little bit more like
Speaker 4: relative value and maybe sneak through the risk systems a
Speaker 4: little bit better, at least in some size. You know,
Speaker 4: Dispersion can be one of those things. Depending on again
Speaker 4: who's looking at it and how sophisticated they are. You
Speaker 4: can have a dispersion trade where you're buying some single
Speaker 4: name options, you're selling a lot more index options. You're saying, look,
Speaker 4: this is really correlation, it's not volatility. But depending on
Speaker 4: the hedge ratio that you're using, it might just actually
Speaker 4: be a very short ball behaving thing where you tend
Speaker 4: to make money for a year or two or three,
Speaker 4: but then it goes really poorly eventually, and you see
Speaker 4: a lot of that. There's dispersions very popular in the multistrats.
Speaker 4: You know, a year or two ago, there were many, many,
Speaker 4: many pods at some of the big multistrats that we
Speaker 4: all know about. Dispersion that's shrunk very dramatically because P
Speaker 4: and L has been relatively poor. It's very cyclical. Multi
Speaker 4: strats are a fascinating thing in that regard that the
Speaker 4: end result to the you know, to the buyer of
Speaker 4: the multi strat tends to be pretty good because they
Speaker 4: cut off the tails by doing this rapid sort of yeah,
Speaker 4: stop out of PM, but it comes with a lot
Speaker 4: of weird incentives.
Speaker 2: An episode that I'd love to do that will probably
Speaker 2: that will probably never do, is talk to a multi
Speaker 2: strat PM essentially about how they gained the risk parameters
Speaker 2: that are imposed on them by their manager. Maybe we
Speaker 2: could talk to a risk manager and a retired pe yeah,
Speaker 2: and how they sort of try to find pennies in
Speaker 2: front of steamroller strategies that will work for a year
Speaker 2: or two before they get fired, before they're just sort
Speaker 2: of identified as having done that all right, here's another question.
Speaker 2: I don't get certain assets like bitcoin or micro strategy,
Speaker 2: which is you know, an exotic wrapper of bitcoin in
Speaker 2: some way are extremely volatile that and that's part of
Speaker 2: the fun, I guess, like that, why is there the
Speaker 2: appetite for even layering on more volatility? So there exists,
Speaker 2: like you know, there's like a three x micro strategy ETF.
Speaker 2: Who is the like customer for like, you know what
Speaker 2: micro strategy? Just not volatile enough for me? Not enough
Speaker 2: daily not enough daily swings here or like what's good?
Speaker 1: Like it reminds me of remember the like multi blade
Speaker 1: razor commercial and why we have three blades? We have
Speaker 1: four blades?
Speaker 2: Why why not have a ten xm micro strategy ETF?
Speaker 2: Why stop at three?
Speaker 4: Absolutely no, that it's it's really fascinating. My best sense,
Speaker 4: you know, from watching Twitter and people asking me questions
Speaker 4: is you know, there's this there's a community of people
Speaker 4: and kind of a voice for Hey, look I've only
Speaker 4: got twenty thousand dollars. Yeah, and I don't want to
Speaker 4: work my job at Starbucks anymore. Yeah, how am I
Speaker 4: going to really make it? And this idea that you
Speaker 4: can really make it and you can kind of get
Speaker 4: rich from only having twenty thousand dollars, and how are
Speaker 4: you going to do that? You need as much leverage
Speaker 4: as you can possibly imagine. Right, So cryptos and attractives
Speaker 4: because of this, because some of the things in crypto
Speaker 4: that you can do get one hundred times leverage or something. Right,
Speaker 4: So if that's your benchmark, actually three x mstrs is
Speaker 4: relatively boomer. Exactly, it's pretty boomer. But yeah, these ETFs exist,
Speaker 4: and they're really fascinating because normally the way that a
Speaker 4: leverage GTF works is that the ETF fishuer will do
Speaker 4: a swap with a bank and get some get two
Speaker 4: x leverage or get three x leverage, and it's a
Speaker 4: fairly simple and clean thing. But no bank is going
Speaker 4: to give you three x leverage on micro strategy, right
Speaker 4: because the wipeout risk possibility is very is very real.
Speaker 4: The collateral is not going to cover a massive move
Speaker 4: down in micro strategy. And so what you would think
Speaker 4: of is vanilla things is just a leverage GTF. It's
Speaker 4: not a crazy derivatives thing. Actually it is, because they
Speaker 4: have to buy call options in order to have a
Speaker 4: risk profile that's acceptable, but generates the leverage that they need.
Speaker 4: And so what that means is these things are really
Speaker 4: big and they actually dominate the options market on you know,
Speaker 4: some of these underlyings and you know, micro strategy can
Speaker 4: go up a bunch and this huge etr this triple
Speaker 4: levered ETF has this giant call options position that's now
Speaker 4: deep in the money and illiquid, and it has to
Speaker 4: go out and like roll and buy a ton more
Speaker 4: of this of you know, call options on micro strategy
Speaker 4: when there's very little appetite from the dealer community to
Speaker 4: provide liquidity on that. Yeah, and it's a you know,
Speaker 4: a big.
Speaker 2: Mess other options on the three X micro strategy ETF.
Speaker 4: I would actually have to check some of the leverage
Speaker 4: some of the LeVert ETFs actually do. And yeah, we
Speaker 4: it's kind of a running joke, right is you've got
Speaker 4: like the you've got like the triple levered you know
Speaker 4: et F on the thing. You've got the covered call
Speaker 4: selling ETF on that thing. You got people running the
Speaker 4: wheel strategy on that just in sort of an infinite
Speaker 4: recursion of you know, option selling abyss.
Speaker 1: Amazing just going by to options influencers. So one thing
Speaker 1: that you see a law is not necessarily like here
Speaker 1: is an options trade that will make you a bunch
Speaker 1: of money. But here's how you really make money in
Speaker 1: options by selling? Yes, how do you make money in
Speaker 1: options by selling? Like I get the sense that it's
Speaker 1: not just it's not just you buy a put, it's
Speaker 1: something else.
Speaker 4: You're exactly right. So normally, the way a derivative trader
Speaker 4: would think about it trade is what is this trade?
Speaker 4: What is the price, what's the upside, what's the downside?
Speaker 4: Why should I do this trade? That's not really the
Speaker 4: approach with options influencing. It's this idea of this cheap
Speaker 4: code in markets, right where people just don't know this
Speaker 4: one cool trick and I'm going to show you for
Speaker 4: only ninety nine dollars a month, right, And the typical
Speaker 4: pitch again is you're just going to be doing some combination.
Speaker 4: Maybe you're selling puts, maybe you're selling calls, maybe against stock,
Speaker 4: maybe not. And the idea is they're pitched in terms
Speaker 4: of the premiums that you're selling are like income, and
Speaker 4: we just talk about how much money you're making solely
Speaker 4: in terms of how much premium you're generating from option sales.
Speaker 4: And that's why it's like, oh, I can make two
Speaker 4: hundred thousand dollars a year on a two hundred and
Speaker 4: fifty thousand dollar account. But obviously that's not your profit
Speaker 4: from the trades. You're just doing trades and you're selling
Speaker 4: that pinion. But you might lose money. You might lose
Speaker 4: money on those trades. Yeah, right, you're that's not income.
Speaker 4: And you know, I get a little bit triggered by
Speaker 4: the use of the word income with respect to this stuff,
Speaker 4: because like, income to me is like you own some
Speaker 4: treasury bills, right and you're making four percent and you
Speaker 4: don't just suddenly lose thirty percent on your income thing, right,
Speaker 4: Like it's you know, these are trades, but this community
Speaker 4: is not expressing what is this trade, Why is it good?
Speaker 4: When is it good, what's the price? What's going on.
Speaker 4: It's just saying, look, you can just sell these options
Speaker 4: and this is income, right, which is totally crazy.
Speaker 2: So people come to you from time to time. Your
Speaker 2: a voice of reason. When we had you back on
Speaker 2: a few years ago, you know, people reach out like, oh,
Speaker 2: I really want to learn more. I imagine that getting
Speaker 2: into options is a little bit like converting to Judaism,
Speaker 2: where the rabbi is supposed to send you away three
Speaker 2: times and say no, just buy a S and P
Speaker 2: five hundred index CTF. Don't do it. But and then finally,
Speaker 2: if they keep knocking at their door, then like, okay,
Speaker 2: maybe we'll teach you something. Where should you start? If
Speaker 2: you're like actually serious and like you know, I do
Speaker 2: know most of the time you're like, just buy an
Speaker 2: ETF and.
Speaker 4: Live your life. That's what a perfect analogy. Thank you?
Speaker 2: Well, where would you say? We're going to get DMS?
Speaker 4: After this?
Speaker 2: I want to learn more about how to do it right?
Speaker 2: Is there a way to start to learn to do
Speaker 2: it right?
Speaker 3: Yeah?
Speaker 4: Absolutely. Usually the first thing that I do is I
Speaker 4: send people kind of collect a thread that has a
Speaker 4: collection a lot of people contributed to on good reading
Speaker 4: material and stuff on how to educate yourself about options
Speaker 4: and how to use them and what they are and
Speaker 4: how to think about the risk and all this stuff.
Speaker 4: So that's a really good kind of first thing to
Speaker 4: do to just have some kind of clue what you're doing.
Speaker 4: And then you know, the next thing that I tell
Speaker 4: people is what do I think are kind of reasonably
Speaker 4: safe uses of options that if you really want to
Speaker 4: dedicate time to figuring this out, you might kind of
Speaker 4: start with right, And so I'll say, look, if you
Speaker 4: have some kind of fundamentally driven or tactically driven process
Speaker 4: with for coming up with a view on STEF, and
Speaker 4: you have a timing view, then sure could you use
Speaker 4: a call spread or a put spread to express that view?
Speaker 4: You say, oh, I really like earnings on this on Tesla,
Speaker 4: like next week, could you buy a two week call
Speaker 4: spread around the range where you think the stock could
Speaker 4: trade to And you can obviously make money or lose money,
Speaker 4: but you know exactly how much money are risking. Yeah,
Speaker 4: it's kind of a safe thing. You're not going to
Speaker 4: just blow up one day on that. I think that's
Speaker 4: kind of okay. If you really need a little bit
Speaker 4: of kind of cash efficiency or leverage, again not too crazy.
Speaker 4: You know, you can do things like buy a combo
Speaker 4: in the option market, or buy a call and sell
Speaker 4: a put that give you a very similar profile to
Speaker 4: buying a stock but are a little more cash efficient.
Speaker 4: If you just really feel like you need fifty percent leverage,
Speaker 4: you know, or something like that. And if you want
Speaker 4: to be really thoughtful about options selling, you know, to
Speaker 4: try to generate yield over time, there's ways to do that. Too,
Speaker 4: But you really have to read up to understand how
Speaker 4: to think about the risk award of a trade that
Speaker 4: you're doing, not just believe there's something you can do
Speaker 4: all the time because somebody told you it's a great idea.
Speaker 1: Your favorite options blow up or derivatives blow up. And
Speaker 1: I'll say I'm partial to Vallmageddon in twenty eighteen because
Speaker 1: I wrote a lot about it, and I'm still traumatized
Speaker 1: by the reaction of vol twit when I said it
Speaker 1: was going to blow up when the vix was going up.
Speaker 1: But what's your favorite?
Speaker 4: Well, Vallmageddon is a great one. You know, you've talked
Speaker 4: about that. Everybody everybody else has two, So I'll give
Speaker 4: you something else. I mean, I think possibly my favorite
Speaker 4: was was alions Structured Alpha, which blew up in twenty
Speaker 4: twenty in March, and the reason was, you know, the
Speaker 4: Allions is a huge sort of safe conservative firm that
Speaker 4: everybody would look and say, oh, they would never be
Speaker 4: doing something kind of crazy, right, because it's you know,
Speaker 4: they're very buttoned up, they're very serious people. They own
Speaker 4: Pimco and so they but they had these French kind
Speaker 4: of option traders and Joe laughs. It's always there. It's
Speaker 4: always the French. There's just something in the DNA. And
Speaker 4: you know, they were doing something where they would effectively
Speaker 4: they would usually sell downside put spreads. They'd sell a
Speaker 4: put and then they'd buy back a lower strike. That
Speaker 4: was the main They'd do a few other things like that.
Speaker 4: Didn't think of that as like the core thing they
Speaker 4: were doing, right, and that's kind of safeish, right, you're
Speaker 4: getting some a credit if you're earning some premium, but
Speaker 4: like you're supposed to know how much you can lose. Yeah,
Speaker 4: and then but their returns were pretty good. They actually
Speaker 4: kind of kept up with equity markets, which didn't really
Speaker 4: make a whole lot of sense. And it turned out
Speaker 4: the way that they were doing that was that they
Speaker 4: were just not buying back the downside put or buying
Speaker 4: or they were buying it back but like way way
Speaker 4: way lower strike than they said that they were buying
Speaker 4: it back, right, so that's obviously one way to make
Speaker 4: more money. Kind of that sounds really bad. Yeah, that
Speaker 4: was really bad, and they they were doing that for
Speaker 4: years and years and they actually it's really great. There's
Speaker 4: a whole SEC complaint about this. You can read all
Speaker 4: the details. They had to show this to investors what
Speaker 4: they were doing, right, because that's part of the business.
Speaker 4: And so they had spreadsheets with all these kind of
Speaker 4: hard coded cells and made up numbers to sort of
Speaker 4: be able to lie to investors and say that they
Speaker 4: were doing what they said they were doing when they weren't.
Speaker 4: And because that's complicated to manage to have all these
Speaker 4: big spreadsheets faking your returns and faking your risk and everything.
Speaker 4: Then they had a word document with an eight team
Speaker 4: points on like how to do all of the lying
Speaker 4: and number printing for all their analysts to be able
Speaker 4: to follow, and you know it instructions on how to
Speaker 4: not hover the how do you structured alpha Greg Toront
Speaker 4: and it's like, you know, don't hover your mouse over
Speaker 4: a formula. It's supposed to be a formula, but it
Speaker 4: is hard coded because the investor might see the stuff
Speaker 4: like that, right, And you know, with very detailed emails
Speaker 4: on all this kind of how to lie kind of
Speaker 4: kind of stuff, the fun and then what happened was,
Speaker 4: you know, obviously in March of twenty twenty, the market
Speaker 4: went down a lot, so their fund was down much
Speaker 4: more than it should have been because they weren't actually
Speaker 4: buying back the insurance that they were supposed to be,
Speaker 4: and so what do you do obviously in that circumstance, Well,
Speaker 4: maybe you could hedge, or maybe you could kind of
Speaker 4: come clean. What they actually did was they went to
Speaker 4: the vix options market and they say, gosh, why don't
Speaker 4: we just sell a massive amount of vix calls because
Speaker 4: then when everything comes back, we'll just make that money
Speaker 4: back and we won't have to tell anybody we lost money.
Speaker 2: This SEC complaint is amazing. Defendants reduced losses under a
Speaker 2: market crash scenario in one risk report send to investor
Speaker 2: from negative forty two point one five zero five seven
Speaker 2: four eight nine seven five five seven four seven percent
Speaker 2: to negative four point one zero. They just removed a number.
Speaker 4: That's rights. They just took off a decimal took off,
Speaker 4: that's right. It was all just hard coded. They didn't like,
Speaker 4: they didn't have some sophisticated methodology for this. They literally
Speaker 4: just type the numbers into the spreadsheets.
Speaker 2: Sometimes and it gets this gets to the I mean,
Speaker 2: to be honest, you don't really even need to be
Speaker 2: French to do that's right, Like any I could have
Speaker 2: come up with I could have come up with this one.
Speaker 2: I don't need to go to strategy, I don't need
Speaker 2: to go to air call polytechnique to come up with They.
Speaker 4: Just go to sell C six. So you just overwrite
Speaker 4: the number.
Speaker 2: Some people do screw up math, like some even sophisticated
Speaker 2: traders like sometimes math is tough.
Speaker 4: At this level. Yeah, but no, this was not sophisticated.
Speaker 4: This was just you type over the cell. And so
Speaker 4: what happened was they sold lots of vix calls with
Speaker 4: the front month of exed futures at about twenty five,
Speaker 4: and then the front month of fixed features went to
Speaker 4: eighty five, and so they were they were liquidated middle
Speaker 4: of March in the huge catastrophic explosion that people like
Speaker 4: us were shown the auction and everything, and they drove
Speaker 4: the relative price of the Vick's options and futures to
Speaker 4: twice as high as it had ever been relative to
Speaker 4: S and P. In this sort of spectacular implosion, you know,
Speaker 4: they went to zero. They lost billions and billions of
Speaker 4: dollars for you know, teachers, pensions and all this kind
Speaker 4: of stuff in just total and utter fraud again at
Speaker 4: a very big buttoned up place, and actually one of
Speaker 4: the one of the funny takeaways from it was in
Speaker 4: all of the lawsuits, you know, leons stepped up and
Speaker 4: settled lots of lawsuits and paid investors back, you know,
Speaker 4: all this money and cost them many billions of dollars.
Speaker 4: And so actually, in a twisted sort of way, the
Speaker 4: logic of investing with the big safe place actually worked.
Speaker 4: But it wasn't because they managed the risk or had
Speaker 4: any idea what these guys were doing, and it was
Speaker 4: just that you could sue them and they would pay you.
Speaker 1: Since you mentioned PIMCO, one of the interesting things about
Speaker 1: PIMCO is, as you said, there is this perception that
Speaker 1: they're sort of like an old school just buying bond
Speaker 1: type fund burgers and bonds. That's right, But actually if
Speaker 1: you look at their portfolio and talk to people who
Speaker 1: are actually doing these trades, there are a lot of
Speaker 1: derivatives involved. There is like Euro dollar futures and swaps
Speaker 1: things like that. Do you see the explosion of derivatives
Speaker 1: trading reflected in fixed income as well? Like the type
Speaker 1: that we see in equities that we've been talking about,
Speaker 1: is that happening in fixed income too?
Speaker 4: Very much? So? So I actually had a little poll
Speaker 4: I put out on Twitter the other day, which was
Speaker 4: you know, who do you think is the best derivatives
Speaker 4: trader of all time? And my choices were Bill Gross
Speaker 4: of PIMCO, Warren Buffett, Who else was it? Oh Yaes
Speaker 4: of Susquehanna and Jim Simon's of Renaissance. And everybody was
Speaker 4: really confused because they're like, none of these people are
Speaker 4: derivati Well, jeff yass is a derivative trade, but all
Speaker 4: these other guys are what are you talking about, Warren Buffett?
Speaker 4: But yeah, Bill Gross has traded more derivatives notional than
Speaker 4: the GDP of the world. They're you know, massive traders
Speaker 4: of things like futures. As you point out in fixed
Speaker 4: income also, Bill Gross and PIMCO was by far the
Speaker 4: biggest option seller in the fixed income complex for many,
Speaker 4: many years, or tens of billions of dollars of piano.
Speaker 4: People don't really think about this, right, They think, oh,
Speaker 4: it's kind of boring bond stuff. But no, there's massive
Speaker 4: involvement of you know, big sophisticated institutions in you know,
Speaker 4: all of these spaces. So like retail investors aren't involved
Speaker 4: in fixed income volatility because they don't really have an
Speaker 4: instrument to do that. I mean, they could trade like
Speaker 4: treasury futures options, but that's kind of like a weird
Speaker 4: funk thing. They don't You don't really have listed options
Speaker 4: that people can sell as easily. But you know, big
Speaker 4: institutions have been involved in this stuff for a very
Speaker 4: long time.
Speaker 1: I guess it's probably coming. If it makes people money,
Speaker 1: I'm sure there's going to be you could sickorize it. Yeah.
Speaker 4: Absolutely. They made a vix for fixed income called move
Speaker 4: mov Oh.
Speaker 1: Yeah, yeah, yeah, Well, Ben, that was so much fun
Speaker 1: and we so enjoyed having you back, and you're going
Speaker 1: to have to come back on the show relatively soon,
Speaker 1: as soon as we have a blow up.
Speaker 3: Come back.
Speaker 4: Yeah.
Speaker 2: We'll definitely be calling Ben the next time there's a
Speaker 2: blow up.
Speaker 4: That's actually a recurring theme in our right. I do
Speaker 4: a talk with you guys about something, and then it
Speaker 4: blows up, and then you bring me back to talk
Speaker 4: about how it blew up.
Speaker 1: Consider this a warning.
Speaker 2: Can I just this one more quick question?
Speaker 4: Of course?
Speaker 2: Why like you lay out these with the buffery tfs
Speaker 2: and all this stuff, and like how really like they
Speaker 2: don't get you what they think? Do you have a
Speaker 2: theory for I get it for retail, the person at
Speaker 2: Starbucks who wants to find a way to get leverage
Speaker 2: on that much cash, Now, why is it so big elsewhere?
Speaker 4: So a big part of it is that the kinds
Speaker 4: of institutions involved in these type of trades are just
Speaker 4: are very slow moving and very backward looking, and they're
Speaker 4: not that sensitive to performance outside of like catastrophic events. Yeah. Right,
Speaker 4: So if you think of like a typical pension fund,
Speaker 4: it took the consultants like three years to get this
Speaker 4: call overwriting stuff through the board in the first place,
Speaker 4: and then they put on the trade that they put
Speaker 4: it on with a couple of managers that they like,
Speaker 4: and they go out to dinner with them once a year.
Speaker 4: It's in the it's a footnote in a long report
Speaker 4: on performance. And as long as it's just kind of
Speaker 4: my underperforming expectations, like, nobody cares if it blows up.
Speaker 4: That's a different thing. But this kind of thing doesn't
Speaker 4: really blow up, not the kind of strategies that the
Speaker 4: institutions are doing. Yeah, that retail is different, but you know,
Speaker 4: call overwriting, you know, call unlovered, call over writing doesn't
Speaker 4: blow up. It just underperforms in their performance. It's gonna
Speaker 4: take them ten years to ever decide to stop.
Speaker 1: All right, Ben Iffer until the next blow up.
Speaker 4: I guess wonderful guys, really fun.
Speaker 1: Joe. That was fun.
Speaker 2: I love talking to Ben because he's a funny, fun
Speaker 2: guy and also just explains things really well.
Speaker 1: I'm wondering, should we get the she Wolf of Indian
Speaker 1: options on together with Ben to fight it out.
Speaker 2: Yeah, let's just do just a rigorous one on one
Speaker 2: debate about whether you can really earn one hundred ten minutes.
Speaker 2: It's really funny that they actually like as a regulator,
Speaker 2: They're like, you have to stop this, that you have
Speaker 2: to get out of the market.
Speaker 1: Yeah. But I also think it's an important episode because
Speaker 1: if I was going to pinpoint one thing that has
Speaker 1: really changed in the market recently, it would be I
Speaker 1: guess a pervasive sense of short termism on the part
Speaker 1: of investors, and options fit perfectly into that, right, Like
Speaker 1: why wait ten years to make a decent reliable return
Speaker 1: when you can buy zero DT options and make a
Speaker 1: bunch of money in a day.
Speaker 4: You know.
Speaker 2: The line between investing and speculating or investing in gambling
Speaker 2: has always been a blurry one. Right, that's just a fact.
Speaker 2: But then you see things like, you know, prediction market
Speaker 2: platforms where you can invest, you know, make bets on
Speaker 2: where the FED is going to go right alongside, like
Speaker 2: bets on you know, who's going to win the coin
Speaker 2: flip of the Super Bowl and stuff. Or you see
Speaker 2: like Robin Hood selling futures on who's going to win
Speaker 2: Super Bowl football game or whatever. The line is gone,
Speaker 2: like it's still a spectrum, I guess, but the idea
Speaker 2: that there's any sort of bright line or line at
Speaker 2: all between the two things like there's no line anymore.
Speaker 1: Yeah, well, shall we leave it there.
Speaker 2: Let's leave it there.
Speaker 1: This has been another episode of the Authots podcast. I'm
Speaker 1: Tracy Alloway. You can follow me at Tracy Alloway.
Speaker 2: And I'm Jill Wisenthal. You can follow me at the Stalwart.
Speaker 2: Follow our guest Ben Eiffert. He's back on Twitter after
Speaker 2: a hiatus. He's at Ben Piffert. Follow our producers Carmen
Speaker 2: Rodriguez at Carmen Arman, dash O Bennett at Dashbock and
Speaker 2: Kelbrooks at Kelbrooks. For more odd Lots content, go to
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