Glad you enjoyed! Unfortunately these thoughts spin endlessly in my mind as well - getting them down on paper allows me to move on to the next fixation.
This is the story I tell about credit default swaps leading up to 2008. AIG was basically playing green and raking in money--until red came up. The problem is that then they ran to the government, or, rather, the government ran to them, because they were too "systemically important" to fail. Meanwhile, those playing red evidently didn't give enough thought to the possibility that there would be no money left to pay them their winnings, because they were all spinning essentially the same roulette wheel.
Counterpart risk (or sponsor risk in the case of ETPs) is real! Just ask folks who sold vol via VXX and got blown out in March when Barclays stopped making the market for them
Great work. Thanks. Another recency bias, which I've written about recently, is that there hasn't been a real bear market in nearly a lifetime. And by "real bear" I mean something like the 30-year bear, and still ongoing, in Japan.
People have come to believe bear markets last a brief while, almost all in one direction, while shorts all skyrocket then we're off to new ATH or double-triple previous ATH in weeks, months or a few years. Worse, they believe the Fed or gov't has any control over it whatsoever. The Wizard of Oz comes to mind.
Eventually we'll get the real deal too. Like the esteemed Dirty Harry asked, "Do you feel lucky?"
Yea, I think the key here is that we have been in a falling interest rate regime since the early 1980s, and so each recession/bear market has been followed by even lower rates - leading to consistent multiple expansion and appreciation of fixed rate financial assets in general.
IF we are at the start of a long-term uptrend in rates (which I'm not positive about, but could be the case), then we should expect a long-term compression in multiples which will more than offset nominal earnings growth.
Nice analogy for the probability distribution, congrats! Poetically, the first piece that brought me here is your Volatility Squeeze, Part 1 posting. What a long, winding - and as you aptly put it undulating - road it has been since then. Feels more like a serpentine climb into nothingness right now. It is one steep hill.
Gotta be prepared for that one bet on red and not lose your pants, or stay out of that part of the game.
Ha, yes the Vol Squeeze Part 1 remains my most viewed article. One of the fun challenges of being in the public prediction game is that you can't run away from your predications if they don't play out perfectly.
Vol has been a challenge for me. Many of the things I expected have indeed happened, and yet so many others have not.
Its certainly been a journey for me - I'm just publishing my thoughts along the road. Glad you are along for the ride.
I can’t help but mention one of the most accessible examples of the more nuanced dynamics of buying and selling vol that I’ve come across. It’s an example you may have come across, but in last weeks wild card game after the Chargers went up 27-0, someone bet $1.4 million on them to win the game to net $11,200.
I just thought this demonstrated very clearly how there are some positive expected value bets you shouldn’t actually make. Especially, when the underlying distribution is a power law and there is no telling what part of the distribution you may end up in.
I’m so glad you mentioned this example because I was actually considering including it in the post! We see examples of selling vol in different arenas all the time and this was a great example.
Great article and succinctly explains the lack of play in Vix. Will read the others - thanks for putting the links here. As for WHEN, Cem Karsan posits that a potential 'downward surprise' might occur after the Jan CPI release on Feb 14. As you say though, no-one knows the WHEN for sure.
At this point, perhaps options aren't even needed for UVXY/UVIX type instruments if you're going long. It "seems" like there is so much room to go up. That being said, I'm a fan of UVXY June 16 23 $26 calls. So far every time I make such a bet on the options I lose, but I believe when it hits, it will really hit. Great writeup and thanks.
Perhaps the volatility measuring devices are infected with a virus. In reality, you cannot constantly follow the crowd because they create the supposed volatility and they are mostly crazy. Infected with the twin mind viruses of fear and greed.
Following the crowd can work in plenty of scenarios - momentum strategies in equities worked pretty darn well for a while there. The key is to know when to zig as the crowd zags
Excellent post. As an otm ES put writer, I have to remind myself that my nice returns for past seven months were due to iv declining, not necessarily me being a genius. Vol can spike any time and put buyers will have their day in the sun, but I will be stopped out and surviving (hopefully).
Good article. One thing to factor in that factors this effect is that when absolute level of vol goes higher, skew tends to flatten out, and when absolute vols come in, skews will start to curve up. Before covid and some of these other shocks you had vix sub 12 so naturally there should have been much steeper skews to the downside to factor in large movements, when vix is 20 and 30, part of those large movements are priced into the extra vol that you see in the the at the money level of the vix, without the need to put additional vol in the out of the money strikes. My guess at the peak of the selloff in 2022 with vix north of 30 and the skew at all time highs that was massively overpriced for skew, now its not so clear if its underpriced with vix still at 20 level anda clearer view of the world then 12 months in regards to interest rates inflation etc.
I think that's an important point. TDEX shown here is a better index than the CBOE Skew because TDEX normalizes for absolute vol - and so neutralizes this factor you are raising. No indicator is perfect, but together they can paint a pretty good picture.
Worth noting though that Skew (as measured by SDEX here) peaked in late 2021, before the bear market began though.
The tough thing is determining what is overpriced and underpriced - a point I tried to draw out in the article. In the end, everyone is taking an (educated) guess based on historicals, models, etc. IMO it seems that tail risks are being disregarded by a variety of measures.
But as I conclude, even if something is underpriced, you should still expect to lose.
It's called crime. When a system is rigged so that one side loses then it's just a matter of time before the criminal side destroys everything. Their greed doesn't have any bounds. If they can steal 10M then why not 100M or 1000B? If no one is going to stop them then why not? Why not buy up all the land? Tons of gold? News networks? regulators?
As more and more criminals jump on board the bandwagon the faster we ride in to hell.
Thank you for your analysis and insight. I noticed this morning that 5% out of the $ spreads on the S&P are much cheaper on the put side then call. I would be curious to know if you read anything into this or if this is another example of traders betting more on green? Appreciate your work.
What’s nice read for Friday afternoon with a coffee. Thank you for all the work TLBS!
TLBS and coffee are a great pairing
Great writeup Bear, been thinking about this subject a lot lately as well. thank you for all that you share!
Glad you enjoyed! Unfortunately these thoughts spin endlessly in my mind as well - getting them down on paper allows me to move on to the next fixation.
This is the story I tell about credit default swaps leading up to 2008. AIG was basically playing green and raking in money--until red came up. The problem is that then they ran to the government, or, rather, the government ran to them, because they were too "systemically important" to fail. Meanwhile, those playing red evidently didn't give enough thought to the possibility that there would be no money left to pay them their winnings, because they were all spinning essentially the same roulette wheel.
Counterpart risk (or sponsor risk in the case of ETPs) is real! Just ask folks who sold vol via VXX and got blown out in March when Barclays stopped making the market for them
Great work. Thanks. Another recency bias, which I've written about recently, is that there hasn't been a real bear market in nearly a lifetime. And by "real bear" I mean something like the 30-year bear, and still ongoing, in Japan.
People have come to believe bear markets last a brief while, almost all in one direction, while shorts all skyrocket then we're off to new ATH or double-triple previous ATH in weeks, months or a few years. Worse, they believe the Fed or gov't has any control over it whatsoever. The Wizard of Oz comes to mind.
Eventually we'll get the real deal too. Like the esteemed Dirty Harry asked, "Do you feel lucky?"
Yea, I think the key here is that we have been in a falling interest rate regime since the early 1980s, and so each recession/bear market has been followed by even lower rates - leading to consistent multiple expansion and appreciation of fixed rate financial assets in general.
IF we are at the start of a long-term uptrend in rates (which I'm not positive about, but could be the case), then we should expect a long-term compression in multiples which will more than offset nominal earnings growth.
Nice analogy for the probability distribution, congrats! Poetically, the first piece that brought me here is your Volatility Squeeze, Part 1 posting. What a long, winding - and as you aptly put it undulating - road it has been since then. Feels more like a serpentine climb into nothingness right now. It is one steep hill.
Gotta be prepared for that one bet on red and not lose your pants, or stay out of that part of the game.
Ha, yes the Vol Squeeze Part 1 remains my most viewed article. One of the fun challenges of being in the public prediction game is that you can't run away from your predications if they don't play out perfectly.
Vol has been a challenge for me. Many of the things I expected have indeed happened, and yet so many others have not.
Its certainly been a journey for me - I'm just publishing my thoughts along the road. Glad you are along for the ride.
I can’t help but mention one of the most accessible examples of the more nuanced dynamics of buying and selling vol that I’ve come across. It’s an example you may have come across, but in last weeks wild card game after the Chargers went up 27-0, someone bet $1.4 million on them to win the game to net $11,200.
I just thought this demonstrated very clearly how there are some positive expected value bets you shouldn’t actually make. Especially, when the underlying distribution is a power law and there is no telling what part of the distribution you may end up in.
I’m so glad you mentioned this example because I was actually considering including it in the post! We see examples of selling vol in different arenas all the time and this was a great example.
Beautifully put. Was a tough week for those of us still betting on red!!
Need to be prepared for the long game if you want to play Red. Glad you enjoyed the post
Great article and succinctly explains the lack of play in Vix. Will read the others - thanks for putting the links here. As for WHEN, Cem Karsan posits that a potential 'downward surprise' might occur after the Jan CPI release on Feb 14. As you say though, no-one knows the WHEN for sure.
Indeed. Variance is the killer - even your best guess as to WHEN is likely to be wrong. Cem is great though
At this point, perhaps options aren't even needed for UVXY/UVIX type instruments if you're going long. It "seems" like there is so much room to go up. That being said, I'm a fan of UVXY June 16 23 $26 calls. So far every time I make such a bet on the options I lose, but I believe when it hits, it will really hit. Great writeup and thanks.
$26 is like 5x OTM. From what I’ve seen recently I think you can get similar bang for your buck at a lower strike, but perhaps at a nearer expiry
Great writing! And the thought experiment with the GREEN/red wheel is excellent. 🙏🏻
Thanks alot Nick! Glad the analogy was useful
Perhaps the volatility measuring devices are infected with a virus. In reality, you cannot constantly follow the crowd because they create the supposed volatility and they are mostly crazy. Infected with the twin mind viruses of fear and greed.
Following the crowd can work in plenty of scenarios - momentum strategies in equities worked pretty darn well for a while there. The key is to know when to zig as the crowd zags
Excellent post. As an otm ES put writer, I have to remind myself that my nice returns for past seven months were due to iv declining, not necessarily me being a genius. Vol can spike any time and put buyers will have their day in the sun, but I will be stopped out and surviving (hopefully).
And that stop loss that will accelerate the vol spike for the remaining short vol holders!
Indeed this was the trade of the year for 2022, so long as it doesn't lead to complacency.
Thanks for reading and the kind words.
Good article. One thing to factor in that factors this effect is that when absolute level of vol goes higher, skew tends to flatten out, and when absolute vols come in, skews will start to curve up. Before covid and some of these other shocks you had vix sub 12 so naturally there should have been much steeper skews to the downside to factor in large movements, when vix is 20 and 30, part of those large movements are priced into the extra vol that you see in the the at the money level of the vix, without the need to put additional vol in the out of the money strikes. My guess at the peak of the selloff in 2022 with vix north of 30 and the skew at all time highs that was massively overpriced for skew, now its not so clear if its underpriced with vix still at 20 level anda clearer view of the world then 12 months in regards to interest rates inflation etc.
I think that's an important point. TDEX shown here is a better index than the CBOE Skew because TDEX normalizes for absolute vol - and so neutralizes this factor you are raising. No indicator is perfect, but together they can paint a pretty good picture.
Worth noting though that Skew (as measured by SDEX here) peaked in late 2021, before the bear market began though.
The tough thing is determining what is overpriced and underpriced - a point I tried to draw out in the article. In the end, everyone is taking an (educated) guess based on historicals, models, etc. IMO it seems that tail risks are being disregarded by a variety of measures.
But as I conclude, even if something is underpriced, you should still expect to lose.
It's called crime. When a system is rigged so that one side loses then it's just a matter of time before the criminal side destroys everything. Their greed doesn't have any bounds. If they can steal 10M then why not 100M or 1000B? If no one is going to stop them then why not? Why not buy up all the land? Tons of gold? News networks? regulators?
As more and more criminals jump on board the bandwagon the faster we ride in to hell.
Great read!
Thanks Kasey!
Thank you for your analysis and insight. I noticed this morning that 5% out of the $ spreads on the S&P are much cheaper on the put side then call. I would be curious to know if you read anything into this or if this is another example of traders betting more on green? Appreciate your work.
I think this just demonstrates the point of the article. More people are demanding options for upside leverage, rather than downside protection.