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The Retail Rally Trap | Kris Sidial on Market Fragility and the Risks of Buy the Dip
00:59:52
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- [00:00]
A
This type of price action is completely indicative of what you see in bear markets. The whole point of a tail risk hedge, it's so that you have something in your portfolio that ends up making a lot of money when markets become dislocated. Everyone was bearish, but everyone was positioned bullish. I don't think the reflexive bid that is needed to drive equities higher is there anymore liquidity has definitely changed. That's something that we noticed on in both directions Monday where the S and P went to the absolute low of this recent move. Right. We were just throwing out all like we were throwing these offers out left and right and just saying, if you want it, come get it. Usually when you get those big moves where volume clusters, it tends to have this, this memory and like, the market will trade it back there super high. These volume regimes can last way longer than people think. What makes this so different than like previous things is that there are real macroeconomic factors that are at play here.
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B
Chris, thank you so much for coming back on.
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A
Thank you so much for having me.
- [01:06]
B
I was really excited you said yes to this because, you know, I'm kind of a value investor. You know, obviously we've gone through a really turbulent period in the market, you know, following Liberation Day, and I'm a value investor seeing all this craziness go on in front of me, but I have no idea what's happening behind the scenes. And I know you've got a front row seat to this. So I'm really excited to talk about what you've seen and what maybe investors can learn from all of it.
- [01:25]
A
Yeah, yeah, absolutely. I'm happy to dive in, but before.
- [01:29]
B
We do that, I want to talk about what you do in general because a lot of people may not be familiar with tail risk funds and some people who are may have misconceptions about them. So there was a great tweet that came out recently and many people believe these types of funds, they pay out really well, they perform really well during tail risk events, but it's not worth it because they lose money in the other periods. And, you know, I think it's fair to say, based on some of the performance stuff about you that's been posted on Twitter recently, that that is absolutely not true about what you're doing. So I was hoping maybe you could talk just to start about in general, how do, how do tail risk funds work?
- [02:01]
A
Yeah, absolutely. So when you think about like the whole point of a tail risk hedge, it's so that you have something in your portfolio that ends up making a lot of money when markets become dislocated, right? And that small piece that you may allocate to something like this ends up covering the losses on the other side of your portfolio, right? So let's say you allocate 5% to this. You know, you're 95% invest in the S and P. If the S and P crashes, this thing could balloon so much in a very convex way that it just offsets the losses, right? And over time, what you realize is that you can compound returns at a higher rate and the ending return value ends up being higher, right? So it's really appealing for a lot of people. But then there, there's like a caveat to it, right? Which is like, if done incorrectly, you end up bleeding significant amount of capital over time, right? So what could end up happening is like, let's say you invest a million dollars in something like this, and if the bleed is substantial, maybe you go three, four years without a tail event. So then your capital goes all the way down to like 250k crash finally happens. And maybe, you know, you just get back to like 750k, which, like, you know, that's, that's kind of tough over a period of time of, you know, 10, 15 years of doing this. So, like, for years, people have become very intrigued with putting together what we call tail risk solutions. And there's like a really big difference in this. So like, a tail risk solution is like just saying, okay, I'm going to go and I'm going to, on the first of the month, buy a 5 Delta Vix call. Because what I realize is that in a back test, this five Delta VIX call performs really well over the last three tail events that have occurred, right? So you say, okay, I want to, I'm always going to be buying this, and I'm going to buy it on the first of the month and I'm going to sell it if it goes up five times or 10 times, and like, that's my tail hedge. And then what ends up happening is you run into a month like April, right, Where like S and P goes down like 20%, Vix goes up a lot, then the S and P closes flat. And you look at their performance on some of these things and you're like, wow, this did insanely bad, right? And like, this has been the case for years. Like the institutional, the institutional market has become very dissatisfied with like long volatility and tail risk programs and hedge funds because it's the same dilemma over and over. Right. Like you give these managers money, they just lose money non stop. The tail event happens, they don't make a lot. It's like very weird, right? But like the biggest thing when we were starting the business would we tried to point out to people was that like there's a way to do this that doesn't just lose money all the time, right? And like the way to do it is by understanding and actively trading the edge that exists in, in volatility markets. So like if you think about like all the really successful prop trading firms in Chicago that are derivatives based, they all have very similar P and L attributions which it resembles something what we do, which is like during normal markets maybe you make a couple percent, maybe you're flattish from trading a lot of principal based flow in and out of stuff, but you're inventorying these tails so that if volatility goes up a lot, you make a lot of money all at once. And I think, you know, when we brought this to the institutional space like a lot of allocators were sort of scratching their head because they're like, you know, we haven't seen this and we were scratching our heads because we were like, we've seen this our whole lives. Like this is, this is literally the space that we come from, right? So when you're sitting here and saying this is novel, we're like, you know, I had bosses that trained me how to do this. So. So I think that's like the big disconnect with within that space, right. Is like there's not a core focus on trading this stuff. It's more about packaging a solution and putting it in a very rigid way. And I think that that's where we defer is that. And I think that's kind of why the performance is demonstrated that because if you do this in a more trading focused way, there's a way to remain flat in normal markets and make a lot when dislocations occur.
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B
And I think people also underestimate how important how, how much these allow you to take advantage of rebalancing. Because the idea is if you have something, if you have an equity portfolio and you have something that's paying out when equities are down big, like the ability to balance back, rebalance back into equities is such an advantage for people.
- [06:26]
A
Yeah, absolutely. Like over the course of a full market cycle, like over the course of 5, 10, 20 years, what you realize is being able to do that, it compounds these returns at a higher rate and the ending return Value becomes significantly higher than just saying, okay, I'm just going to hold the S and P and just, you know, wait for forever, right? And I think where some people tend to get things wrong too. And I was thinking about this a lot during this crash because everybody obviously, you know, retail, looking at some of the numbers, the big story on the street is that retail bought the dip, right? And one of the things that I was thinking about was like, okay, well, sequence risks that exist because I had like, you know, friends reaching out and saying, hey, should I buy the dip? Right? And it's, it's always good on paper to be like, yeah, you know, you should buy the dip because over, you know, the, the next 20 years, you're going to make money. But there's a period of time that it takes to actually get back, to break even if you're buying the dip in the incorrect spots, right? Imagine buying the S and P at 500, right? Let's just say spy, for example, you buy spy vet 500 and let's say you go 10 years or five years, where spy's going to down to like, you know, 300 or then back to, you know, 400, and then eventually in 15 years, it goes to 700. Right. You've just wasted such a long period of time, which is why it's, to your point, the rebalancing thing, having something that makes money when markets go down, you take that, you rebalance, you buy discounted assets. That's the whole, like, that's the whole investing game, in my opinion.
- [07:58]
B
This next thing I kind of want to talk to both of you about, because you both were sort of saying the same thing coming into this year, which is, Chris, you had, before all of this even happened, you had said you thought this would be a big year for volatility. And in our separate podcast that I do with Brent, he was talking about a lot of the warning signs he was seeing behind the scenes that might lead to the same thing. So I guess Chris, first, like, what did you, what did you see coming into this year that made you think this might be a big year for volatility?
- [08:23]
A
Yeah. So the biggest thing on the institutional side was that we realized a lot of the pensions, a lot of the foundations. You know, I have a bunch of buddies that trade at the multi strats. Everyone had mentally prepare their Trump 2.0 playbook. And the Trump 2.0 playbook was he's going to be positive for equity markets, and equity markets are going to go higher and to @ Amber, like our view was that, okay, positioning is going to be leaned in one direction, like very heavily. Right? Because everyone's just like, stocks are going to go up, stocks are going to go up. You had foreign investors really interested, like everyone was interested in buying stocks because Trump is going to come in, he's going to be positive for business and equities would just go haywire, right to the upside. And whenever that's the case, like, it leads to this one sided positioning. Right. It's sort of like a seesaw effect. But then in the interim, what we started realizing, you know, as he got elected and as he started relaying more or signaling towards more policy, we were like, okay, these policy reforms are going to be quite large. And one of the big things that we're very, we're very vocal about is that we do not trade on fundamentals, we don't trade on any type of macro thematics, we just trade on flow and positioning, that's like the biggest thing for us, right? So like, we had no real view like, okay, if tariffs are going to net and net, be great for the economy, be bad for the economy. It had nothing to do with that. It was just that when you have positioning so one sided and you have very large policy reform, it's like shaking up a can of soda. Like you're bound to get. Capital markets don't do a good job digesting that. And that's exactly what we witnessed right, over the last few weeks was that capital markets saw all these policies, they were like, all right, we're not sure about this, we're selling equities, maybe we're going to buy equities. Right. And I think we're still in that stage where people are trying to digest something that doesn't definitively have a path right now. So that's why we were like, okay, crazy positioning, crazy policy reform, that usually means volatility is going to go up.
- [10:36]
B
How about you, Brent? You were kind of seeing something similar, right? And options as we came into the year?
- [10:41]
C
Yeah, I mean, I don't have anything to offer that's anywhere near as eloquent as what Chris has offered. But you could see in just a lot of the data that, you know, kind of indexified data that, that things were just very wonky. You look at correlations and, you know, just different relationships. And also I think just the volume premium and, and so I think what I saw is just sort of the manifestation of a lot of things that Chris is talking about. And I, I think if I'm correct, he you know, I don't want words in your mouth, Chris, but it seems like you think that we're not quite out of the woods yet here either. I mean, today as we're talking, the Liberation Day move is now completely unwound. And so Mr. Value Investor Jack has not realized that anything has happened, even though it had one of the biggest big spikes in, you know, in, in some time.
- [11:26]
A
Yeah, I mean, you know, I've been pretty vocal about this that I, I personally don't think that the move is over. Right. So, like, at Amber's, trading flow is different than like my personal view. Right. So, like, I'm not just gonna sit there and just press the button and just, you know, bet the. Bet everything. Stocks are going down. Right. Because that's, that's, that's a silly thing to do. Right. We're very process driven and very focused on how to run a good fund from a trading standpoint. Not based on my own views, but personally speaking, based on my own views. Yes, I do think that this is going lower for a couple of reasons, but I think the bigger, and I honestly, I think this rally higher is affirmation, like, more than anything. And I see people on Twitter talking about things like, oh, well, you know, like, you know, they'll get on people that were saying, hey, you know, stocks are going to go down. You know, get a lot of like, people trolling and stuff on Twitter. They're like, hey, look at this move. You know, I told you markets are going to buy you back. Right? And like, this type of price action is completely indicative of what you see in bear markets, right? It's like literally the opposite. You don't see this in bull markets. Like, some of the nastiest rallies come in bear markets. So from a volume standpoint, like, when I'm looking at this from a volume standpoint, I'm looking at this and I'm looking at these flows. I'm like, okay, this is more affirmation than anything. Like, if the market would have taken its time and like based and leveled and, you know, flow slowly came in and came out, like, that would be a different. I'd probably have a different case. I probably, like, maybe we are, you know, bottoming, I don't know. But like when you give me, you know, nine straight days of just consistent buying and big TWOP orders coming in the order book and you're looking at things like that, you're like, okay, this probably is indicative that things are going to go lower. But one of the big reasons, again, from A flow standpoint that I personally think that equities are going to go lower is that I don't think the reflexive bid that is needed to drive equities higher is there anymore. So like when people are, are and like, for years I, I'm, I like, I was like, oh yeah, stocks are going up. You know, I make jokes and stuff on Twitter. Vols going down. Stocks are going up, right? Because when you look over a certain time horizon, they do, right? Like you're kind of silly if you don't think that, that, that is the case. But it's, it's not magic, right? What, what you need to have transpiring in equity markets is a persistent bid to get that. So, okay, so you have to ask yourself, where does that bid come from? Comes from large domestic pension plans or it comes from sovereign wealth plans. It comes from rebalancing from foundations, endowments, target date funds in the US domestic RIAs. Right? These are huge flows that come in and, and reflexively drive asset prices higher. So when you look over the last like two years and you see stocks just going higher and higher and higher, part of that is because of that process, right? But what ends up happening now is that that reflexive bid steps back. So stocks go down. You get a big, you know, a group of big participants that come in and say, okay, here it comes, it's coming back up, right? They buy, buy, buy, buy, buy. And then when that reflexive bid of all those other market participants don't make their way back in, then everyone sort of looks around and they're like, okay, we're at a certain price and nobody else is buying, right? And that's where you lead to this like chop period where the market digests things and then ultimately makes its way lower. And that's been consistent in the data not only from like historical moves, but also anecdotally talking with, you know, pensions and talking with endowments and talking with these larger money managers. There has been a reduction of US Equity exposure. And that flow is not so focused on getting back the same way how domestic US Investors are, right? A lot of retail participants bought this dip. And the reason why is because they are unsure about US Policy, because us, the US Administration is unsure about US policy, right? So like, that's why I think, you know, it's not fundamental, it's not macro based, it's from a flow standpoint, I don't think US equities are going to have that reflexive bid needed to get it back to all time highs. The Same way how we've seen over the last few years. Because, because of that, that dynamic.
- [15:37]
B
Do you have enough granularity in your data where you can say when we see a big bounce back like this, like it is probably retail doing this and it's probably not institutions.
- [15:46]
A
So I think you could back out of some of this stuff by looking at ETF flows. All right. Certain products and, and designators on certain products will, will help give good color there also just like lot sizes and things like that. But, but it's an assumption, right? Like you could never be like 100% sure and say OK from, from here. One of the interesting things that, that I thought was that or, or that indicated that that was the case was that you saw a lot of buying in these upside levered ETFs. Usually the main demographic of, of of participant in that is the retail community. It's actually not like you know, the, the larger macro based hedge fund that runs like you know, $15 billion or something like that. Right? It's like smaller people that were buying in. I also saw larger inflows into the inverse, you know, VIX products. Right? So the short, short volume products, some of those ETFs, like the S Vix, the SVXY, et cetera, et cetera. You, you know, you notice that there was a, there was a larger inflow that, that came in there. So that's more indicative to me that retail was shorting volume. Retail was also trying to be buying the dip. And then I think Goldman and a couple of other desks put out some, some data. They may, they may have more granularity on that.
- [17:04]
C
Chris, can I ask, how do you think about just liquidity overall? So you know, I mean the, a lot of Goldman data said this is the worst liquidity that we seen in early April, you know, maybe ever. And that was against, you know, massive volumes. But do you think that structurally, even if you look for a little bit before, you know, this, this April period, that liquidity just even general metrics, you know, top of book liquidity is, is, is fairly robust or you know, do you think it's drying up for some of the reasons you mentioned is it does, does liquidity change? Because we can just be more quantitative about you know, how much size we post and you know, the liquidity is more transient. I mean what, what is your sort of general overall take on that?
- [17:45]
A
Yeah, so liquidity has definitely changed. That's something that we noticed on, in both directions on certain days. And it was kind of surprising to see like the order book just start flatlining in certain places and the depth of the order book started just like really contracting and then noticing the type of size in the futures market that it, that it took to move markets was like nothing, right? You like, you could, you could have like a smaller based hedge fund actually end up moving markets in certain point in time. And it was just a bit, a bit weird. It was almost like everyone in the room just froze and was looking at one another like, okay, I don't know what you're gonna do, I don't know what you're gonna do. But like, I don't know, we're waiting for someone to make a trade. That's honestly what it felt like during down days. Like some periods during down days and then some periods during updates. It's pretty weird. So I do think liquidity is drying up. I also think that a part of this is the fact that the market maker community has become so concentrated, right? So like 20 years ago you may have 30, 40 different deaths of market makers that are widely dispersed. And some of them, you know, got taken out, some of them would be aggressive with taking on risk, some of them grew. But now it's really just like six to eight deaths that really control a bulk of that flow. And on the day where Trump walked back the tariff news and we saw the S and P go up, I don't know, was it like 10% or something like that was one of those days where you saw MMs reprice that stuff like super, super fast. Funny enough, the day that he announced the tariffs, remember stocks went up initially like that, that the liberation date, like stocks went up. And so I can't say for, for 100 surety, but the rumor on the street was that that was actually an mm. Who, their, one of their, their, their systems actually just drove price higher. And then when people didn't follow through, they just, you know, puke that stuff out. So it's like you definitely do have these, you know, these, the smaller market maker community shifting around prices a little bit. And then also some of the end user community is able to shift prices around. So it does feel like liquidity is not what it used to. I mean I even think back to like 20, 2015. All right, like markets felt a little more fluid. And this is an antidote. You know, I don't have core data behind this, but markets did feel more fluid in both directions. Now you saw, you kind of look at how some of this stuff is trading on big days up and big days down and you're like yeah, I don't know, it feels like we could move markets around. Right. Like a smaller size hedge fund. Yeah.
- [20:25]
C
I, the reason I was thinking about this too is because in August of last year, you know, we had The Vix print over 60. Right. And I know there's all sorts of that didn't really have whatever Vix marked over 60.
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A
Right.
- [20:38]
C
And that felt so much like the liquidity just totally disappeared, you know and that wasn't necessarily tied to an official policy or you know, like, like the tariff issue. Right. But, but if you just look back over the last 20, 30 years, we, we've not had two instances of the VIX moving, you know, like that over 50 in such a short amount of time. You know, I think you have to go back to like kind of 2008. And so far if you look at the top of big top of book liquidity on the ES metric, you know that the CME provides that the top of liquidity hasn't come back in. And so we seem to be at a lower level than even the low levels that we had. Kind of to your point coming into this, what do you think would bring that liquidity back or strengthen that liquidity? You know, does it take signed deals or just time? Like you know the, the volatility has to roll out of the realized window kind of thing.
- [21:31]
A
Yeah. So you know, back like two years ago we wrote that paper on like is the VIX becoming more leptokurtic? Right. Is spot Vol. Beta changing in the US equity market? And like that was, that was to, to us, like that was our favorite paper even though it didn't get a lot of love because I feel like we are literally seeing that whole thing play out now. And, and all we were saying was was that when S P drops a certain amount, you could see volume explode at higher levels than you have historically or vice versa. Right. When the SP goes up, you'll see vault dissipate in lower levels. And a lot of that was based on this what we call dealer hot potato with market makers moving stuff up, moving stuff down. Right. And changing ball prices based on the aggressiveness from the end user community. And the one interesting thing about like VIX pricing is that it all comes off of SPX options. Right. So like for, for, for people who, who don't know, the VIX calculation is, is a strip of SPX options that go off of the bid ask and it calculates every 15 seconds. So it's a rolling 15 second period that, that flashes and takes these valuations and then it prices the index. And what that means is that if people do not make markets on those lines, right, if the spread the bid has spread on those lines go wide, the index will price higher, right? If the, that's literally how the calculation works. So like during, during August that was one of the big things. You had a bunch of people or this one quote unquote, this one like Asian participant who was offside who was trying to come in, in, in the overnight session, they couldn't find liquidity. And because the SPX market is traded overnight, you could buy or sell, you know, these, these, these XPX options. Overnight the calc was running off of that and the market makers just remove themselves from the market, right? So the screens just came super wide and that's where the prop, this is the way the liquidity problem translates into vault, right? Because screens go super wide, the index calc super like, you know, really, really high. And yeah, you know, I, I'm not sure if the, I'm not sure if like getting deals done will bring the liquidity back either. I think this is a micro structural thing and I think like one thing we're seeing are the NLP programs like really run, right? So, so these natural language processing programs have, have run for, for years on, on some of these market making desks, right? So some market making desks can, can act in, in the respect of actually wearing risk, you know, from, from a proprietary trading side, right? So sometimes they'll have their, they'll be making markets and then they also have other things that take directional risk, right? And some of these things run off of just headlines and stuff like that. And that's why you know, you'll get some headline about like oh, Trump likes China and then boom. S and P goes up a percent, right? Like, and we've seen that over like significantly over the last few weeks, right? So I think the market microstructure has changed and the liquidity is a byproduct of, or the liquidity thinning out is a byproduct of the fact that that change is, is really making its way through art.
- [24:35]
C
If I could just follow that thread a little bit. Do you, I'm sure you've heard of Chris Cole, Art of like Artemis and.
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A
All the famous papers that he wrote.
- [24:43]
C
I don't know if you read this one and Jackie can strike this from the record if you haven't seen this one, but he wrote this paper called like what is Water? I don't know if you've ever read that one. No, and it's a, it's it's 10 years old now, 15 years old now. But basically the paper just sort of outlines that we all swim in this liquidity in this medium that's called liquidity, right? And if you ask a fish, you know, kind of what is water? They wouldn't be able to tell you because it's just like, you know, they're, it's their, it's their ether is what they exist in.
- [25:10]
A
Right?
- [25:10]
C
And so, so much of what in trading we rely on is that liquidity. Like I can't get the exit that liquidity is there and VIX and a lot in a large way, volatility is just a function of liquidity. And so if the liquidity goes away, then, you know, then there's a whole set of structural problems that, you know, arise from that that a lot of people may not kind of account for. Which I think is interesting for two reasons. Number one obviously is the volatility we've been talking about. But then it leads to this other thing that I'm curious about. When you get a volume spike like we just had in April, you know, it can be very hard to get filled on orders, right? So your book may be screaming that's looking good, but those bid has vibe out and all that sort of thing. So like how do you guys think about, you know, monetizing the move? Like how able are you to monetize moves in that situation and kind of like, you know, sell into that volatility in the way that, you know, makes your fund so successful.
- [26:03]
A
Okay, so really, really, really good questions there. I'll start off by saying that one of the things that we've been working out, working at on the data side is, is we have this view that the VIX market has become, VIX options have become much more illiquid. So we, and, and this is like starting from, I want to say like seven months ago, me just looking at this one month 25 Delta Vix call and I'm like, why are these screens so wide? And I think we have continued to observe more things about just that bit that, the percentage between the bit, the bit ass spread, right, that MBBO and that being wider. And I think it's a byproduct of the market making community just being like, we want to make markets when we want, but when we don't want, we're backing away. And like that's, that's what it is. So I think there's a real dynamic that's, that's occurring Right. Now, in terms of monetization, that's like, that's like the biggest thing for a long volume, right, Is like, how do you monetize? How do you think about monetizing? And like, that's why some long volume funds have really went out of business, right? Is that you get these big ball spikes and you don't know how to monetize. You don't know how much to monetize. You look at like some of the, we, we've started to see across from some other allocators of ours, just performance of some other tail risk funds and, and programs and it's, it's terrible this month, right? Like, because a lot of people were not able to monetize. Okay, so how do you think about monetizing? Well, the first thing is it goes back to understanding historical volume levels and where the prices are today in relation to what is quote unquote fair, right? So if you look at let's say a 20 or let's just say a 1 month 10 Delta S and P put maybe historically that may trade at a 30 volume if you wake up. And that's trading at 150 volume. And that's never traded that, that, that spot before. Those are the, those are the line items you want to sell back to the market, right? So when we're thinking about selling back, most people think about this as a target return, which is like the worst way you could think about it. You're like, okay, the fund is up 100%. I'm just selling, you know, half of that across the board. That is like the la that you should not do that at all. And most of these programs operate like that. What ends up happening is you have to have an understanding of what is the volume pricing when you bought these things and where's the volume pricing now and where was it at historically? Because if I bought an Apple for a dollar and there's some guy on the side of the road saying he wants to pay a thousand dollars for that Apple, I'm going to sell it to him, right? Like there's never in the history of the world been an Apple that sold for a thousand bucks to my knowledge, right? So those are the line items that I want to sell back. So that's how we think about monetizing. It's like picking the spots where the market aggressively wants that exposure and selling it back to them at a massive premium that now it comes into play. Okay, well, sometimes screens are super wide. How do you get executed? Right? And a part of that is just throwing out what we call stink stink offers. So, like one of the best times to sell your risk back to the market is when the market first opens up. Because it's like basic auction 101 principles, right? Like everyone comes into the room, they're just like, I don't know where stuff is. Who's the guy that's off sides, what is he willing to bid, right? So that like Monday, you know, when we were coming into markets, I'm forgetting the exact day, but it was a Monday where the S and P went to the absolute low of this recent move, right? We were just throwing out all like we were throwing these offers out left and right and just saying, if you want it, come get it. Like, here's an orange for $50, come get it, right? Like, here's this vix call that's like, you know, way, way, way out the money, you know, you want to come get it at this price. So. And I think that's part of trading, right? Like, that's literally part of trading. Like if you're, if you're trading, these are the things that you need to be, you know, good at. Have good infrastructure to understand what the prices should be. Have good infrastructure to understand where to get executed at. Have good infrastructure to understand how to clear on that execution. And that's kind of what we do. So it was like, you know, you walk into the market and you see who is the guy who's really offsides. Why is he overpaying for this stuff and just quickly try to sell him that risk that you were inventorying. But, but yes, I will say, and I will speak on behalf of every equity vol. Trader in the world. Like executing this time around on this like spike was, was. Was tough because there was some low liquidity there. Like we would have liked better liquidity for, for the better and the worst. Because like on some of these things we got filled at crazy prices. But then there were some other lines that we were like, man, you know, wish the market was a little more liqu. You would like to get that one off.
- [30:49]
B
How much of that is quantum when you, when you're monetizing, how much of that is quantitative and how much of that is your experience and discretion? Like, is your computer telling you, you know, this is worth this, but I could sell, you know, this is what the market's trading at, or are you just looking at this yourself and use your experience to decide what to do?
- [31:03]
A
No, so it's a quantitative, It's a quantitative framework, right? So it's like 70% quantitative and 30% discretionary. So, like, one of the big things about being on a discretionary side is, is like understanding the reason for the dislocation and having some type of a view there. So, like, on the quantitative side, you could have all these good systems that say this is a screaming sell and you should be giving that back to the market, right? But like, on the discretionary side, it's up to us to understand is someone offsides, right? And this comes with, like, talking to the voice trading community, right? Like calling up some of the agency guys and saying, hey, do you know why this is trading here? Do you have a guy who's a buyer? Do you have a guy who's a seller? Right? Like, that's like part of the discretionary side, understanding the dislocation and the reason why, you know, and I like to, I like to say this to my junior trader that like, S&P going down 5% on the Fed hiking rates is very different than S and p going down 5% on a nuclear bomb, right? And you have. You need to be able to decipher the difference between the two. So the quantitative side gives you the prices. It gives you like, you know, historical levels. It highlights to you that this is going on. And then ultimately, on the discretionary side, myself and the other co cio William, were able to look at this and say, okay, we. We should be selling that back to the market or not. And this is a really fast process, by the way. Like, this is like within minutes, right? Of like making these sort of things go on. And especially that day, you know, we like, that's. That whole weekend, we got no sleep. Like, everyone was just because there was so much news coming out here and there. Besson said this lutness like that, you know, Bessant went on, on as one podcast, relayed this whole thing. Trump's tweeting this, right? Like, so you're like a part of us was like in the, in the overnight session, we're like, oh, man, I hope this doesn't rebound by the morning time. Like, that was like one of the biggest things was like, we want to Delta Hedge some of this exposure, you know, and like, you could. You obviously do it in the futures market as well, right? But like, we were just like, you know, where are we going to be at when we open? And for us, one of the good things is that we open. You know, the market started going lower and we, we had a chance to like, collect ourselves and sell that risk back to the market.
- [33:11]
B
Do you Have a feel for. You mentioned the beginning that everybody was off size with positioning. People have talked a lot about how the short volume trade is huge. Do you have any feel for if that changed or if that got washed out with this decline at all?
- [33:22]
A
So, yeah, I think, I think fall positioning now, it's, it's weird because I feel like it's a little more neutral from what the data is showing. But then what we feel is that it feels like people are more shortfall. It feels like the retail community shorted volume. It feels like like some of the tactical hedge funds that, that opportunistically short volume shorted more volume. But then we kind of look at the data, it's like it kind of feels neutral. So, so we're, we're kind of mixed there, trying to figure out like, okay, is the street really more short volume positioned or has it been more of a neutral lean? I will say it's definitely more of a neutral lean compared to like where we were, you know, last year. There were some time periods last year where people were like, shorting ball left and right. But, but ultimately I'm, I'm curious to see that, like, where that shakes out. But I do think that if the S P goes lower, volume is going to react. That's, that's one thing. Like, I think the positioning being neutral to more slightly short volume, it's too severe of a, of a situation right now to not have volume go higher, especially because you had that massive move. Usually when you get those big moves, we're volume clusters. It tends to have this, this memory and like, the market will trade it back there super high. So, like, if the S and P were to go down 3% a day, the market would, would reprice volume very high.
- [34:51]
B
Yeah. And you think it's going to be pretty sticky this year. Right. There's actually an interesting tweet you wrote which we'll put up, and I can't read them all right now because there's a lot of them, but you had all the examples of situations where volume stayed high for a long period of time. And like, someone like me from the outside wouldn't have known there's this many. But, you know, you started with 1987 and worked through and there were just tons of them.
- [35:08]
A
Yeah, that. So that's the thing that gets me so upset when I get on these like, pension calls and stuff like that, because you have to talk to this analyst and the NS will be like, well, there, you know, historically there's only been three volume spikes. And volume just goes up and then it goes down. And that's not true, right? Like, you've had many situations, if you actually go through the data and look at this, where volume stayed elevated for a very long period of time. Like in 2008, you talk to someone, they're like, oh, yeah, Vix went to 80 and then went right back down. No, it stayed in the 60s for, like, multiple months, right? It hit 80 on, I think it was like, five different occasions. And it's funny because you need to look at, like, an actual, like, daily chart to showcase this, because some people will pull up vix, they'll pull up, like a monthly or something like that. All these sorts of, like, weird things. But these fall regimes can last way longer than people think. I think we're just so cognitively biased towards this because, you know, the last decade and a half, it really wasn't like that. You had Vmageddon. It went up and it just went straight down. You had 20, 20 went up and it went straight down. This past August went up, went straight down. Like, you have to sort of read the room in some of the. The. The bigger things here. We're at the point where, like, people are making memes, like, okay, nothing ever happens. Right? That's a really good antidote. That's a. As much as I joke about that stuff too, it's like, it's a really good answer. It tells you where we are. Back in 2017. Back in 2017, when I was on the desk, like, one of the biggest reasons why I knew VOL was going to blow out eventually was because I swear I could put my hand on the Bible and say this. There was. There was a cup. I came into the desk. I came into the desk one time and there was a cup that said keep calm and short vault. And. And that would. During 2017, that was the thing where it was like, keep calm and do this. Keep calm and do that. Right? That was like, the whole thing. And people were like, now you headed to a point where, like, certain deaths would have keep calm and short volume. I was like, okay, this is like you had. You even had, like, you know, these like, VOL conferences, like EQD and stuff like that. You know, when people go to these conferences, they didn't even want to hear long volume. They were like, oh, long volt tail risk hedging. Are you crazy? Give me the guy who's made 30% shorting volume. I need to talk to him. Right? Like, so there are these. These antidotes that exist today. Right. Now, in this, in this environment where I look at this and I'm like, people think volume just goes up and it goes down. Goes up and it goes down. But if you look at the data, you'll see that there are very long periods of time where equity volume specifically can stay elevated.
- [37:41]
C
I mean, even 2022, you could argue that it stayed, you know, at least relatively higher than what we've seen in the last 10 years. And, you know, so sticky. Sticky in the 20s, I guess it was.
- [37:51]
A
So, yeah. Which is a.
- [37:53]
C
Which is a mile from where we just were.
- [37:55]
B
And what was interesting to me too is this is not just down markets. Like, I mean, you had 1999, spent much of Q1 in the low 30s. Like, a lot of people would not have think thought of that being a period where volume was high.
- [38:05]
A
Yeah, for sure. Even it was 97 and 97 or 98 too. We had like a couple of periods where this thing was like, in the forties. I, I wish I had it in front of me too, because I don't remember each exact data point. But, like, it is, it is pretty crazy how it's just a. It's just this cognitive bias that we have. And I think there's like a cycle. Like, there's a psychological reason for that too. Right. Because as humans, we like to evade things that make us feel uncomfortable. That's why, like, repression exists in the first place, because we're just so innately focused on getting rid of the things that make us feel uncomfortable. So, like, you look at these data points, you're just like, yeah, that's not what happened. But, like, if you really look at it and you put yourself through it, you're like, there's a little more. There's a little more to that story. And also thinking about, like, the bear market things. Right, Right. If, if we are in a bear market right now, right. We'll look back and we'll be like, oh, yeah, remember the S and p rallied like 10% off the lows, like, just like every other bear market did it. Right.
- [39:03]
C
So is that this other kind of interesting point too? Is that really post 2008, it's always been. It's been bailout nation, Right. So every crisis, every big down move is met with Fed put or, you know, something kind of like similar. And in this environment right now, we arguably don't have that put. Like, maybe the put is Trump backing off from the policy that led us to, you know, the edge of the abyss, so to speak. Right. But, you know, at what point do we get a rate cut? And, and you know, does that look like 2022? Because that's all we were waiting for, right, is like the Fed to stop doing something to us in terms of raising rates and inflation, flat out. But now you're like, when do we actually get something that alleviates the unknown, right? Like, when do we get a lower rates or whatever it may be. And so, so maybe all that is like symptomatic kind of to your point of, of repression. I guess it's like my, my dad has my back or whatever, Like, I don't have to worry about it, you know?
- [39:58]
A
Yeah. I think the other thing too is just like, this stuff takes time. In all the data. It takes time, right? It's just like, it's never just one and done and that's it. And I think what makes this so different than like, previous things is that there are like, real macroeconomic things that are at play here. And I think that if you look at the base case too, of just like tariffs, right? You say, okay, 10% tariffs. How in the world is, is 10% tariffs net and net good for growth stocks or, or equities in general? I can't, I, I just can't understand. And again, I'm not a macro guy, I'm not a value guy, right? So maybe I'm the wrong guy to be talking about this. But like, even if you get to the base case of what the United States is trying to do, that's still a pretty big impact on growth. That's still a pretty big impact on global trade, right? So, like, you have to think that there's gonna eventually be some type of impact here. The other big thing that, or the big data point that we're focused on is just job reductions, right? So, like, as they're, you know, as, as the administration has said, okay, we're trying to cut a bunch of jobs, you know, we're cutting the fat on, on some. And, and this is like Besson's plan, right? I sat there and I listened to this whole interview with him. Laying out the plan is like, okay, they want to reduce jobs across the board, right? And the, the government, the government jobs across the board, right? And then what they're going to do is after that, they're going to deregulate the banking side to then stimulate the private sector. And when they deregulate the banking side to stimulate the private sector, that's when all those jobs will get picked up again. So the administration is very vocal about saying, hey, there will be job reductions. This is where this matters for equities. Because US Consumer, or, sorry, US Household, investedness in US equities is the highest it's ever been. Right. Okay, so what happens when people lose their jobs? There's less rebalance flows coming from 401k plans. There's less incentive to invest in equities. Right. And that whole retail community that just can consistently buy the dip, it sort of removes itself. And that's a big impact on stocks. When people lose their jobs in today's market, where everyone in the world is invested in US Stocks, it has more of an impact on the reflexive bid in equities. And I think over the course of the next few months, you'll see, you know, more jobs being pulled away. And you know that the impact on some of these people, it's really sad to say too, right? Because like, you hope people don't lose their jobs. But the reality is, is that if the administration is focused on this, there will be job reductions. And that means that the guy who loses his job, he won't be more inclined to invest in the stock market. He'll be more inclined to save because he's not sure if he'll be able to get another job somewhere else.
- [42:50]
B
Warren Pies had a good tweet about this too. How it works. It's working a lot in the other direction too. So because people own more equities than they have historically, the wealth effect is more now. So when the stock market goes down, the impact on the economy is more. Because people have more of their money in the stock market that's going down. So it kind of. It seems like it works in both directions right now.
- [43:06]
A
Absolutely. Yeah. I definitely agree with that.
- [43:10]
B
I wanted to ask you about this AI thing because I saw you tweeted it and it's been around everywhere recently. This whole thing that, you know, everybody is bearish and the AI thing is the most bearish it's ever been. And you had a great quote in response to it. I just wanted to ask you about it. You said the ultimate sentiment indicator is pricing in the derivatives market. So could. Can you explain that?
- [43:26]
A
Oh, yeah, yeah. I mean, the, the interesting thing about this, this whole go around was that everyone was bearish, but everyone was positioned bullish. It was re. It was really fascinating to watch, especially because we would have calls with like, potential investors. And, you know, when you get to talk to potential investors, you get to talk about like their, their, you know, their current holdings and their outlook on things. And everyone was like, Yeah, I think that, you know, the world is coming to an end. Trump's doing this, he's doing that. And then it's like, no, no, we're not selling stocks. You know, we're not, you know, so it was the, it was funniest thing. It was the funniest thing ever. You read Twitter, right? Like everyone was like saying the world is coming to an end. Like even obviously I've had a bearish view, right? But like positionally all these people couldn't be bearish. Like there's no way. But, but I think that the volume market is, is the best sentiment indicator for, for just like bearishness and, and, and sentiment because one of the things that really stood out was that equity tails never really got going. And I know that's like really surprising for people to, to believe, but if you look at something like 3 month correlation didn't really go up a lot, you know, and like that part of the vault surface didn't really come under real stress, right? You didn't have people who were aggressively begging to buy this for protection. You didn't get a ton of margin calls that you would usually see. You didn't get people getting taken out. So it was one of those things where we were looking and we're just like market doesn't think that this is going to continue. And even if you completely discount what I just said, the VIX futures market told you exactly that, right? So the VIX futures market naturally prices in this type of mean reversion, right? Which is why like it usually trades at this, this cotango versus backwardation in the term structure. And like the reason why Spot VIX was here and the futures were here was because the market was saying we don't think that VOL is going to continue. Right? So from a pricing standpoint, the market show you the whole way down that it didn't believe that this would continue. And I mean, I guess ultimately you know, it ended up being right for now. But usually a good, how to say this, a good sentiment indicator that is a lot of fear and we might be close to a bottom is just a very simple spread of volatility risk premium. It's just like when implied volatility gets significantly higher than realized volatility, that's usually a good sign people are really scared, right? And people are aggressively bidding for protection. And we didn't see that. As a matter of fact, we saw the widest, one of the widest relationships ever in the complete opposite direction where 1 month S&P realized volume was in the 30s and the 40s. And then you had Vix trading in the 20s, which is just like, okay, market really doesn't think this is going on. And I think that that's also a byproduct of the fact of how we've traded for the last few years. Right. Which is just buy the dip, short volume, it always comes back. Nothing ever happens. We're at that stage where a lot of market participants are, are like, this isn't going to turn into anything big. It's the same old thing we've seen for years.
- [46:40]
C
Couldn't, couldn't you make that argument that condition still exists? I mean that. I think that spread the risk premium is quite negative still. I mean, we're talking here. Vix is at 22 right now on, on Friday and the S and p is up 1.8%. So, you know, it's like there doesn't seem to be. Even though we're just ripping the upside, there's still like a lot of volatility. Right. So it's like people don't really respect that. And, and do you think that's kind of required to like drag these people back in, clear out the positioning that that kind of makes for maybe a, a more painful downside move?
- [47:14]
A
I'm not sure that's a, that's a really good question. I, I think that eventually, kind of going back to what I was saying with, with the whole reflexive bid thing, when people buy equities at this rate and then the follow through doesn't come, I think then it will sort of be this, this effect where people start saying, okay, maybe stocks aren't going to continue to go higher, or maybe they just chop around, right, for a couple of weeks to a couple of months and then they don't go higher. And then that, that reflexive bid needed to just keep it up and keep it going higher just doesn't show up. I could be totally wrong on that. But if there was ever a market environment where it feels like that reflexive bid won't be there, it feels like this is one of them because of how aggressive Trump has been with relaying the policy stuff and with how tactical investing and passive investing has changed throughout the years.
- [48:08]
B
You mentioned the volatility risk premium actually gets at what I wanted to ask you next because this is something you tweeted that I thought was really interesting. And it was from Midwestern Hedgy who said every major bear market since the dot Tom bust has been hugely telegraphed in advance. Things were falling Apart, but indices held up until the tidal wave actually hit the shore. And you retweeted that and said this has been true even with data prior to the dot com bubble. Today it's even more relevant given how reflexive passive flows can help sustain higher equity prices. So I'm wondering if you could just talk about that a little bit.
- [48:34]
A
Yeah, totally. So if you, if you go back, I don't have all the data points in front of me. I don't remember them off top of my head. But you know, you go back to like just certain thematics in like the 40s and the 50s and 70s and all that. And what you'll see is that like equity markets don't really react immediately as people think and digest the whole thing when people like, like at that. And I think back to Covid because that was an environment that I did extremely well trading in. And my view on Covid was wrong. Like honestly I was one of those people at the beginning of COVID where I was like, maybe this is over in like three, four months. But like my trading was different. You know, I had the best trading period of my entire career was during that. And it was because like I was able to buy such super cheap ball the whole way through. And especially as things were cracking, Vol remained somewhat cheap. And I think that like, you know, because, because think people knew about COVID in December, there were, there were news about Kobe coming out in January and there was, there was warnings about COVID in February. Right. It wasn't until that like late February period that S and P started to crack. And then obviously in the early parts of March is, is when the market really digested it. So I think naturally speaking, you know, you do have people that try to fade this because of how they've been rewarded over the last, you know, few years. But then also the passive flows do play a part in this as well, right? Like the rebalance flows that come in, you know, hedging flows that come in, all those sort of things create this, this reflexive impact. But I also think that the reflexive impact won't be as extreme and stretched to get equity valuations at those extreme levels that we've seen in the past. Like it'll be really challenging to see the equity market go to all time highs, right? And, and people ask me like say okay, well Chris, you know, you say that you trade through this stuff, right? Like in you don't really have these sort of like biased views, right? Because you're a trader and you trade through this stuff. So but where do you view this as you being wrong? And my like reaction on that is the market's going to have to really show me I'm wrong here. Like we're going to need, I'm going to need to see like all time highs before I really feel like okay, my, my view on market microstructure was completely wrong and like yeah, I guess we are going into a bull market and. Okay. And the reason why I have that view is because bear markets operate just like this. Like this is literally how they operate. They, they, you have big pulls down, big reflexive burst back. People come in, you have passive flows coming in which are more emphasized today than they were 20 years ago or 10 years ago. So it's expected that you get two way volatility. I have this thing that I always say, I say like upside volume is still volume but it's so true. It's like two way volatility is more affirmation than anything. Even though, you know, vix might be going down, like realize volume tells me that we're not in an environment that people are going to be putting exposure to on high leverage and consistently rebalancing.
- [51:37]
B
Do you have any tips? You were talking about how you were wrong personally about COVID but you did really well on the trading side. Like that's something that I think applies to investors, applies to traders, applies to everyone because everyone lets their emotions get in the way. They have their personal opinions, they have their political views. And I'm just wondering if you have any tips for people in terms of how you're able to separate that, like what you feel personally with what you're seeing in front of you and how you're trading.
- [51:59]
A
I think being intellectually honest with yourself is like really important. And I think a lot of people in the trading community who are good traders, they have that same sort of, that same sort of view where they're like okay with understanding the realities to things. I think sometimes it might take some work, might take some psychological work. But the good thing about markets is that they tell you if you're right or wrong. Right? Because like the ending is the P L, you know. So like there, there is no, you know, there is no gray. It's like you've made money or you lost money. Right? But yeah, I mean like every hedge fund manager like his job is to okay is, is to obviously manage risk and obviously trade through stuff. But you're going to, you're going to have these sort of political views, you're going to have These internal views on things. And you have to realize that what you do is just process driven and really stick to the process and if you really believe in the process. So I, I like sometimes I read these like, these like old trader adages and things like that. I'm big into like the old school trading books, like the old market wizards book, Biggest Loser by Tom Huggard and stuff like that Way of the turtle, like some of the old corny ones that a lot of people would just like cringe at. Like, I love it because I think the, the trading psyche is, is a really big deal because it helps you realign yourself and give yourself the positive affirmations needed to not get too attached to a view that can ultimately harm yourself or your investors.
- [53:34]
B
You mentioned passive clues earlier and I just wanted to ask you about that because that's something we've had Mike Green on like four or five times now and we've talked about his thesis, which I'm sure you're probably familiar with, about passive flows and this idea that it's just this constant bid, you know, driving the market up. But that if, if passive flows, you know, with everybody putting money in their 401ks, if that ever reversed, that could be a really, you know, significant negative event for markets. And you come at this in a completely different place than I do, seeing stuff behind the scenes. So I was wondering if you had thoughts on that, like that idea in general.
- [54:01]
A
I totally agree with it. I think Mike's take on, on it is spot on. You know, we sort of are in the same band camp. I know this like, this view seemed like very novel five or six years ago, but I think now it's really hard to deny that data. I mean you're seeing it on a day by day, right? You're seeing, think about like how many bank desks put out research on like end of month rebalancing and like CTA flows and stuff 10 years ago, not that many, right? Like now this has become a thing, right? Like Brent to your thing, right? Like how many banks were talking about dealers hedging gamma like 10 years ago, right. Like now it's like, you know, everyone tries to put out stuff on that from, from the banking side. And so like these flows are, are very, are very relevant and the passive investing thing is very relevant. And I think it works in both directions too. We just haven't seen the other side of it yet.
- [54:57]
C
I was just thinking about the COVID crash, which is. This is a bit out of sequence, but to your point, it Took a long time for the market to, to sort of react. I, I don't know. And this, you know, whatever you're. If you ever had a thought onto why all of a sudden the market just came to such a quick reckoning at the end of February. And if there's any kind of like parallel to, to now where it's sort of like this is the moment where suddenly the market wants to price in like all this downside risk. Like is there like a, is there like a signal that the average investor can look at? It's like this is the signal that this is all about to kind of start to break down.
- [55:35]
A
You know, I'm not too sure if I could give like a direct signal like that. But I think historically one of, one of the signals that is just so vanilla but seems to have just good efficacy behind it is just a tangle to backwardation signal. It's just like if the front. Yeah. And VIX and vix. So just like you could take a weighting of the two front month futures and we call it vxw which is VIX weighted and then just price that to actual spot vix and whenever that's in backwardation that's just like a hazard sign that okay, no good things happen here. Some people look at it the opposite way where they're just like, oh yeah, we like to short volume when it's high for us it sort of feels like that's like the areas that tell you like you should not be shorting volume. Which is why like, you know, I said this on Twitter a lot too like when Vix was in the 30s and obviously it's come down from that point. Right. But I was saying like I would not be shorting volume here, I'd be long ball here. And people are like why would you be long volume here? Because like the term structure is rolling higher. You're literally getting free convexity. You're getting paid to, to, to take on that convexity. Right. Which is just something that's like very abnormal that that didn't seem to work out because obviously the equities went higher. But like when generally in those environments where like the you know, spot VIX is higher than 2 front month and you're able to buy that at a really low period where realize Vol is higher. It's a really good bet. You know, it's like that's like someone giving you you know, seven or, or 100 to 1 odds on something that is a 60% hit rate. You're going to take the bet it may land on 40% hit rate, right? Like, and you lose, but like, still a good bet. And that's how you get paid as a trader eventually over time, taking win.
- [57:27]
B
Does the level of VIX tell us anything at all about the future? Like, whether you should be long or short volatility? Like, are there any rules at all of saying, like, when it's low you should be long, or when it's high you should be short? Or is that basically meaningless in terms of the way people should look at it?
- [57:41]
A
You know, it really depends, like, which, which quant you're asking. You know, VIX is one of those things that's like bimodal, right? It's like mean reverting, but it also clusters, right? And it's. That's like a mental paradox. Like, how could it be both of those things, right? But I think you have to break down volume moves per environment, you know, so, like, the way how the term structure reacts when VIX is in the 13s is very different than the way the term structure reacts when VIX is in the 30s. And then you also have like a sample size dilemma because, like, when you're in the 30s, you know, in the 40s and the 50s, you don't have, you know, hundreds and thousands of different data points than you had in, you know, in the teens. So it's, it's a tricky thing, I would say. It's just the absolute level of VIX is good for telling you where the market's fare really lies. Personally speaking, some people be, oh, you got a bunch of nerds that will argue the semantics around. Is it the fear index? Is it this is that. Look, if Vix is at 50, people are clearly scared, right? You know what I'm saying? For that time period, they are clearly scared. So I think you could just look at it in a generalized way of thinking about it in that frame.
- [58:49]
B
Chris, thank you so much for joining us. This is awesome. It was really great to be able to see what's going on behind the scenes for someone like me who, who doesn't. So we really appreciate your time. If people want to find out more about you, where can they go?
- [58:58]
A
Yeah, they could go to ambersgroup.com or my Twitter. K S I D I I I. Yeah, please be aware of the, the fake Twitter accounts and stuff. Apparently people are like falling for that, which is like, really weird. I only have one Twitter account. Just go, go to ambersgroup.com if you'd like to chat. We're always happy to chat, especially about volatility trading, long volatility and tailor is hedging.
- [59:21]
B
And Brent, thank you for doing this. Thank you for hopefully making me not look too dumb on these topics. I appreciate you jumping and helping.
- [59:27]
C
Yeah, absolutely. It was fun to talk to Chris and learn a lot. So thanks.
- [59:31]
A
Yeah, you guys.
- [59:32]
B
Thanks everybody for joining us and we'll see you next time.
- [59:33]
A
Thanks so much for tuning in to this episode. If you found this discussion interesting and valuable, Please subscribe on YouTube or your favorite podcast platform or leave a review or a comment. We appreciate it.
- [59:44]
B
No information on this podcast should be construed as investment advice. Securities discussed in the podcast may be holdings of the participants or their clients.