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to another edition of the All Thoughts podcast. I'm Tracy Alloway and I'm Joe Wisntal So Joe, we've been talking and writing about this a lot, which is kind of weird because essentially we're talking and writing about nothing, like nothing is happening in markets, at least when it comes to a very specific measure of volatility. Yeah, it's definitely. Uh, it's kind of like the Seinfeld markets. I guess right where the thing that's going on is that nothing is
going on. That's good. That's good. I just made that up. Um. But no, you know we've talked about this on this podcast before. How we have this uh you know, we have a morning call that you and I participate on that you lead very ably. I met my dad where we talk amongst many of us in the newsroom about what's going on in markets, and every day it's like
kind of not much. Yeah, every day the story is usually about how nothing is actually moving that significantly in markets, and the thing we look to when it comes to gauging market movement or market volatility is of course something called the VIX index, which occasionally gets called things like wall streets fear gauge. A lot of people take issue with that name. The VIX is one of these sort of technical things in markets that seems to have some
popular currency. There are probably people who are sort of tangentially aware that this thing called the VIX exists, and but there's a lot of debate about what it really is. Most people probably have no idea how it's measured, whether it really signals anything useful about anything at all, and so in addition to being widely quoted and widely discussed,
it's also extremely controversial. Right, So today we are going to dig into all the details about the VIX how it works, but we're also going to dig into why market volatility is so low as judged by this one measure. And I'm not talking about things like, oh, well, we have good economic growth, so people are, you know, relatively comfortable with their investment positions. I'm talking about the actual market for trading volatility because in many ways. Volatility is
now an asset class in and of itself. Right, This is an important concept that a lot of people talk about. But you know, a lot of these things are not particularly well understood. What does that mean that volatility is an asset class, or more specifically, what is volatility itself? What? You know, we throw the word around a lot, but I doubt a lot of people really have a firm
grasp of what that is. So I'm confident that our guest today is going to help us clear away the smoke on all these topics and actually shed some light on what can be a very confusing subject. All right, well, let's get into it. Our guest today is Provate Shinto Wong Vantage. He is head of derivative Strategy at Macro Risk Advisors, and he writes about volatility on a basically every day private. Thanks so much for joining us. Thank
you for having me so private. Let's start with Joe's question, because I think that's the big one, and it's the right one to be asking what exactly is volatility? So when people talk about volatility, they're either referring to what we call implied volatility, So that's essentially the market cost of volatility or what's sometimes called realized vultility or in essence,
which is how much are markets actually moving. Um So the VIX which you guys have been discussing as a measure of implied vaulatility, it's a measure of what people are willing to pay for vultility or essentially, you know, it's the markets uh gauge or measure of the cost of owning vulatility. Let's dive into that a little bit more that specific question. So volatility, intuitively is it just a measure of the degree to which markets are going
up and down. So it's not necessarily a directional idea. But if you imagine a sort of oscillation, or you imagine a sort of one of those e k g s that measures your heartbeat, it's a kind of a
measure of how dramatically the line is just moving. Absolutely, and another way that volatility can can be measured, or another thing that it measures is the potential for large moves for example, you know, head of the US elections or head of the French elections, you also had volatility rise a little bit, not necessarily because people are expecting high volatility, but maybe because they're expecting one large move from a future event. So break it down for our listeners,
what does it mean to be long volatility? And what does it mean to be short volatility? So what does it mean to be long volatility? It's a really interesting question. You know. People often talk about buying volatility, like they see the VIX at eleven or ten or nine or you know, god knows how low it's going to get, and they say like, oh, I want to own volatility. That seems like a really good trade to me. Um, But the thing is, you've never really own volatility, you know.
I like to say, you can't own volatil, you only rent it. Um. So what that means is that how do you go out and buy the VIX. Well, you can't just go and go to the store and buy one share of vix and and that's that right Um. In reality, volatilities traded through option contracts, and that's really I guess the key to understanding volatility trading is it's it's linked to options. Options are time limited contracts. Every
bet on volatility is implicitly time limited. Our listeners are very very smart, but nonetheless I sometimes think it's you know, I would never want to insult the intelligence of our listeners, who are the smartest of all podcast listeners, clearly. But just to really simplify this, you talk about options, and they're time limited, so they're essentially an option is essentially a bet that an underlying asset we're talking about a stock here, just to keep it simple, will hit some
level by some time. And if volatility is higher, then that makes it more likely that that underlying asset can travel to that point. So if we have a share of IBM and we are betting that it's gonna go from a hundred dollars to five dollars, in theory, the higher volatility is, the more likely it is it will travel that distance in that defined area of time and move.
And so to own volatility and to go long volatility, what you essent you you do is you're betting that you know these options will rise and value because the underlying assets will travel to these points faster in times. That sort of the idea that that is a really good way of explaining it. Um you know, So to get back to traces questions, how do you how do you own? How do you what does it mean to be long volts? In your short vuatility. UM. Yes, buying
options is one way to do it. When you trade an options contract, there's something which is called the implied vaulatility. You can think of this again as the markets expectation for future vultility. That's that's priced into these contracts when you when you pay I don't know, a couple of dollars for an S and P put option, there's implicitly of vulatility that you're paying, and that is how one
goes long vaulatility. But I think, you know, I don't want to digress, but I think a very important concept is that because options are time limited UM, the concept of decay or rent or or burden will carry costs, whatever you wanna call it is it's factors into being long volatility. And that's super important. In other words, if I buy a put option on the SMP so in other words, of contract, that's that will pay out if the market um goes both ends below a certain level
at some point in time. If the market never goes below that level, then I just lose my money on the put option. And you know, if I want to be long volatility, essentially one way of doing it would be to constantly buy these put options by the market, every sells offen, I'm just gonna keep losing money on these things. So in order to be long volatility, there is a carry cost. Right, we know that the VIX can never go to zero, options can never be worthless. Therefore,
there's always gonna be some carry costs. For every day that I'm long volatility or owning the VIX, I'm paying away a rent or or a decay. And and that's key to understanding volatility trading. Likewise, if I'm short volatility,
I'm actually being paid rent, I'm earning carry. That leads quite nicely into what I was going to ask next, which is, given that you have this carry cost when it comes to buying volatility or renting volatility, as you put it, walk us through of the ecosystem here, like what kind of players are actually buying and what kind
of players are actually selling? Mm hmm. So traditionally, and if we think about option contracts, traditionally, the buyer of vulatility is going to be um like institutional asset managers like hedge funds who want to protect their portfolio. So, okay, let's say I own I don't know, a billion dollars worth of stock. Well, how can I protect it or how can I outperform the market and justify you investing
in me versus going investing in next ones. Well, one way to do it is for me to own hedges, right, for me to say, for example, own put options on the SMP, so that the next time we get two thousand eight or twenty eleven or some kind of you know, market volatility event um, I will outperform in in the event of a sell off. So that's been the traditional buyer vulatility is essentially um. You know, I think big
asset managers. Um. There's also like insurance like variable nuity programs that need to pay out a certain amount out um. Those those people are are often implicit buyers of volatility, but that's kind of traditionally been the institutional bid um for for basically financial protection or financial insurance. And then the sellers, so the sellers of alatility have typically been
the banks, like the dealers. Right, So if you know, if you're hedge fund X and you want to go buy options, then you you quote up your dealer and say, okay, I want to buy these put options, and they'll more than likely be happy to sell them to you. But uh, I think like I think, what you guys are getting at is the concept of volatility as an investable asset class,
and especially posts to as an aid UM. You know, with new regulations, banks actually can't take as much risk as they used to be able to um A lot of that vulatility selling risk has now been um laid off to uh, I guess other people on the buy side. So before whereas it would mainly be I guess, like the dealers taking the other side of all these financial insurance bets a lot of times, now it is other by side institutions coming into basically, you know, instead of
investing in stocks or investing in bonds or what have you. There, they're basically becoming sellers of insurance and and that's how they develop deliver their alpha. Now. Uh we started off the introduction by talking about how volatility is very low, how every day we have these chats about what's going on in the market. Well, there's nothing going on the market. You've been you've spent a career trading derivatives and analyzing volatility and all this stuff. So what do you tell
us characterize the current market environment? Put it into perspective relative to what you've seen. So that when we tell our listeners of all is very low these days, what does that actually mean? How does it compare to six years ago, ten years ago, twenty years ago, whatever. Well, you can look at the VIX and I think, you know, I'm not going to get into how the VIX has been poorly understood, But essentially the VIX is a measure of short term options pricing. That's really all it measures.
I don't think it should be used to measure you know, fear or you know, like an economic you know whatever. Uh. It's just really a measure of short dated option prices. And if we look at the VIX um, it's really back to two thousand seven levels um, kind of like mid uh sorry, two thousand seven mid two thousands seven um, early nineteen nineties levels um. If you look at realized vault,
so how much stocks are moving? I think that's really interesting because I think this is the probably the longest stretch of realized vault we've low realized vall we've had UM since I want to say, like the early May nine. I mean, it's one thing for for volatility to be to be low, for like a week or two. But it's another thing for for vaultil to be low for like six months at a time or one year at a time. UM. And we really haven't seen this, I
guess since uh. I guess for the since the pre crisis period and also since the early nineteen nineties UM. And I think the common thread there is really that UH if you look back at those those two other low ball periods, is that the feders hiking rates. And do I think that the FED hiking rates causes low fultility? No, I don't. I think it's coincident. I think the FED hikes rates when the economy is good. When the economy is good, realize all tends to be inequity sends to
be a little bit lower. And I think that ultimately then leads into implied ball on the VIX being lower. I want to take a quick break for a word from our sponsor, but knowledge to work and grow your business with c i T. From transportation to healthcare to manufacturing. C i T offers commercial lending, leasing, and treasury management services for small and middle market businesses. Learn more at
c i T dot com. Put Knowledge to work and we're back with private ching twang advantage of macro risk advisors. You know, there was something that you said that was very interesting, uh, in the first half where you talk about how a lot of the VALL sellers these days are people who, you know, it's kind of an alternative to uh, straight up investing, and so that you have some of these people who might have been portfolio managers
now making money selling VALL. And in a sense, a diversified portfolio is a short VALL strategy without buying derivatives. So that if a typical person they have uh, you know, a portfolio of stocks and bonds and commodities, and it's an attempt to smooth out the cycles and the fluctuations of markets. That that is a de facto short VALL strategy. And so the idea of actually selling VALL explicitly shorting volatility is kind of not that different from traditional investing.
Oh percent agree. I mean, if you look at the if you look at the payoff profile, the kind of the the distribution of returns for being long stocks, you know, or long ons or like long uh let's say, like long carry the carry trade in f X, it's all very similar to being short volatility. I think being short volage is a more explicit way of assuming that risk.
But yeah, it's it's all the same risk. I mean, if you're if you're like a credit manager, you know, who buys how yeld bonds, you're implicitly short invall just just through the fixed income space. Or even if you're just long stocks, I mean you're implicitly short vall. I mean you get two thousand and get draw down. I mean, that's not really that much different from from shorting ball. But wait, let me take the other side of that argument, because I have seen critics who have said, we have
all these new sellers of volatility in the market. Some of them have called them, uh, tourists in the volatility market. And the argument that they sometimes put forth is that these this might be, you know, kind of patronizing. But they say, these guys aren't experts. They might not know what they're doing when it comes to selling ball, using specific you know, options instruments, that sort of thing. Do you think there's any basis for that. I think there's
some basis to it. I think it's matten maybe a little bit overblown. In general, the people who sell all are are quite careful about doing it. It's one other words that I think people who sell all generally, they generally like to size things based on a worst case scenario.
So if you're, if you're, if you make a living sell involved in generally you're always thinking about, well, okay, like what if the next two thousand and eleven happens or August when you remember when on the Monday when markets were down I don't know, like five percent, basically no reason the doubt crashed. I think a thousand pointed exactly supposed were a limit down overnight. Um, You're you're always thinking about those type of events, and I think
that's how you size your risks. So if it falls very low, then you're gonna keep in mind that vall has a much larger, much more room to rise, and you're you're gonna implicitly size down your beds. But I do think there could be something to be said for just more people or or more different people who normally wouldn't be looking at ball so closely. Um, kind of getting into the short vall game. Um yeah, I think there is some risk for that, and I think you've
seen it in the dynamics of all. Like if you look at is how quickly the VIX can spike from low levels and how quickly it reverts back down. Um, I think that's there's something to be said for kind of I guess money that's that's quickly coming in and out of the space. Um. So yeah, I think volatility of all itself has has kind of risen um and I think it it could be partially due to just
short of all becoming a more popular strategy. Now, all right, we talked about how how cheap vall is or how low VALL is, and so I think that naturally raises the question, well, is this a good time to buy protection. I'm not going to ask you to make a call right now, but but thinking about that, Okay, so volatility is cheap, it's people know there seems to be a mood of sort of um complacency, perhaps suggested by the low volatility. But as you pointed out, you can never
really buy vall. You can only rent it, so it's not like you can just lock in these prices and forget it. Uh So what does that mean for someone who's like, yeah, I'm pretty optimistic, but vall is cheap here, so I'll just buy some to protect myself. Does that kind of thinking work. I think it tends not to work. I think I think the smart way to think about
buying protection is to budget for in advance. In other words, you're thinking, Okay, I'm I'm willing to pay you know, I'm willing to pay X percentage of my a U M on on protection, and to think about this in advance, right, So think like, Okay, I'm gonna buy some protection and I'm willing to lose I don't know, fifty BIPs on this this year. I don't really think it makes a
ton of sense to buy all just because it's low. Because, um, I mean, we've done a lot of kind of studies on this, and we found that actually, uh volved being low is a good predictor of evolving low going forward. Um So, it's a good predictor of itself. Um And you can end up kind of getting burned on this carry cost for a very long time. Uh So. I think that's that's the danger, is that you end up getting stuck into a trade that you never kind of
budgeted forward to begin with. But there's something to be said for just that, you know, the beginning of the year or the beginning of the cord deciding Okay, I'm going to spend next on protection this year. I think that makes a lot more sense than than buying involved just because it's low. Okay, well, speaking of buying protection, Uh, there has been I guess something of a celebrity created in the volatility market, and that has to be a
person known as fifty cent um. And the reason forever yes, we are now going to talk about early two thousands hip hop Joe um No. Uh. The reason he's called fifty cent he or she is because they've supposedly been buying you know, these roughly half a dollar clips of VIX call options on a regular basis, and people started noticing it private. Actually, I think was one of the first, if not the first, to really write about it private. Why why did become such a talking point in the market.
There's a really interesting question, I think. Firstly, then the name. Honestly, it is a catchy nickname, um, but just like among traders, so among people who watched this space closely, it was quite fascinating to see such, honestly, such huge flow and outright VIX call by and we've never seen for for years, I mean, we had seen people main buying called spreads or or trying to limit their you know, limit the premiums they pay. But for someone to just come in
and just repeatedly, uh, just buy these vixed calls. And you know when you when you trade like that, everyone knows it's you, right, Like people come up with nicknames about you. Um So, for someone to just come out and out right just always, every single time, by fifty vixed calls for fifty cents, I don't care what strikes, just pay fifty cents and that's very unusual behavior. Um So that that type of that type of trading, the type of flow, it just definitely gets noticed by market participants.
Is that a good idea? Is that a good strategy? Is there a type of investor for whom it makes sense to just have this permanent bid in? Yeah, I mean it makes sense for someone who wants to own protection. Do I think that's the best way of owning protection? Well? Probably not. I think there's maybe more other things you could there's other ways you go about trading and maybe be less obvious about it as well. But um this is definitely not like some kind of doomsday trader like that.
I guess that's kind of what I've seen in a lot of the articles going around as people people trying to paint it is, you know, that makes it sound more exciting, but in reality it is probably just I think like a large sovereign wealth fund or institutional asset manager that's that's executing a hedge for their books. So they definitely have something else against it, like maybe they're just long stocks, or who knows, maybe they're actually short
VAUL and massive size and and that's their tailhage. And just to be clear, would you say it's a vixed call, That means it's a option tied to the VIX correct In other words, if the VIX should go above twenty I think that's been his average strike, then then they'll they'll pay out. We have time for just a one or two more questions, Tracy. Don't you want to ask your question about whether the VIX is broken? You've just
handed me a loaded grenade. Okay, Yes, I have a question if the VIX is pervasively low, despite what are ostensibly a lot of concerns in the market, and despite you know, we do see some abrupt moves in various asset classes every once in a while, UM does that mean the VIX is broken. And also, sorry, let me just add one more thing onto that question, because that's not enough for you. The the proliferation of products, exchange
traded products tied to the VIX. There's some criticism that those specifically are basically creating a feedback flute to the VIX, which is artificially suppressing it in some way and increasing volatility of volatility as you pointed out, is there any any logic in those claims? Both very good questions. Um, let me just address the first part. Do we think
the VIX is broken? Um? So this is really something we've seen a lot more more attention paid to people kind of contrasting the low level of VIX with the high political uncertainty. Uh, it's mainly political uncertain that people point to, but there is a little bit of you know, economic uncerty out there as well. I think the important point to remembers that the VIX only measures short term option price, short term option price specifically over the next
thirty days. So do we think something's going to happen over the next thirty days, Well, maybe not. We don't know the exact timing. We don't you know, there's now been a special counsel appointing to investigate Trump. I mean, who knows when the next memo or leak is gonna hit, but we don't know the exact timing of that, and so that that makes these these short term bets and volatility very expensive. And people don't want to own short day protection for that reason because most likely it's gonna
expire worthless. You know that the rent is super super high if you try to trade short term volve. Um. So I think that's that's the reason why the VIX is maybe a little bit lower than people think it should be, is because it's a measure short term volve and these these uh, this uncertainty that people are worried about is more general, it's a more long it's a more long term uncertainty. Um. Do I think long term volve You know, that's that's another that's another tangent in itself.
But do I think long term vall is too low? I think it's approaching low levels. And look, I think it's worth buying at something I've been writing about that people should maybe look at owning long term volve because that's really where you get the uncertainty premium that's where uncertainy premium should be priceing is maybe like one year vulatility or even longer than that. So I think that's
that's where people should be looking. UM that the short dated stuff is just really going to be affected most by that that high carrier or rent costs that we've talked about, and it's so hard to time this stuff in the very short term. So your next question about exchange traded products, UM, I think that those have kind of been the primary vehicle for for the so called
vault tourists to enter this space. UM. So in other words, UM, exchange traded products like the x I V or the the S V x Y, these are e t f s which which essentially will go up will increase in value UM when when the VIX or vixed futures decrease, and they're they're basically going to be implicit UM recipients of that carry costs. So yes, we have seen a lot more interest in those products, and probably from people
who don't know that much about vall trading UM. And uh, you know this is getting a little bit too technical, but yeah, like due to the way these kind of lever products have to rebalance themselves at the end of the day, um, they can contribute to high volatility in the VIX itself. And I think that's the main change you've seen as these products of gain traction is is really that the VIX it self tends to spike much much more rapidly and also come back um from from
high levels much more quickly. I just want to make one really quick observation and ask a very tiny question before we go. So the x I V which is that short vix et f betting shorting volatility? Since late it's up nearly sevenfold, whereas the S and P itself hasn't quite doubled. So short involve has been extraordinarily profitable trade, even if you're just a tourist and do it through an exchange traded product. Profit Intang Niche of Macro Risk Advisors.
Fascinating topic, great perspective. Really appreciate having you on. Thank you so, Joe. I don't know about you, but I will never call the VIX the fear gauge. Ever again, I probably will just because I'm not like that sophisticated it and when you're in I say stupid stuff. But no, I think I'm pretty disciplined about a not calling it a measure of fear. I try not to say cliches like, oh, it's really scary how complacent everyone is. That's a sign
that everything is going to fall apart. I think, I think I don't fall into some of the obvious VIX traps, but I'm sure I fall into many. Yeah, but it is. It's a really good discussion to have because so many people point to the VIX and say, oh, you know, like markets are complacent because the VIX is at a thirty year low, and they never really have the conversation about what's happening both within and around the VIX. And as Profit was pointing out, a lot has changed over
the past six or seven years, right, Yeah. I think there are two really sort of important things that I took away. One is just this idea that well, you know, the VIX is low because volatility is low. Volatility is low because you know, sort of the general environment. So it's not necessarily the VIX per se saying something, but it's the overall market. But I love that discussion about this that you sort of, you know, asked about the structure of volatility markets. Who are the natural buyers who
are the natural sellers. How have the natural buyers and sellers changed with some of these opportunities for vault tourists. I think that is sort of a credibly important topic that I imagine will we'll be talking about a lot in the future. Yeah, but Joe, I do worry about UM.
I guess the tail wagging the dog here, right, and the idea that you do have products, lots of products that are now tied to this one index that seemed to be affecting it um, either you know, by suppressing it or on days when the vix starts moving up by UM making it move up faster than it otherwise. Would that that worries me a little bit? Maybe I'm
like fifty fifty on this question. So I think there's probably stuff lurking out there in the market that one day, you know, we could have more events like August or God forbid October, or we have these automatic things in
place that exacerbate moves rather than curb them. On the other hand, I think stuff is quiet because stuff is quiet, and we every day we look at the what's going on in the SNP, the dow and it's up two points are down two points, and so in light of that, it feels very intuitive that, uh, we're not seeing any
sort of signs of life and volatility of markets. But there's but your general idea that there could be things under the service that if the coil springs, that will accelerate the moves rather than curb them, I think is a pre legitimate worry. And I think it's worth pointing out that, you know, we're recording this podcast several days before it, uh it's actually gonna air, So who knows, we could be in a complete by the time people are listening to this, We could a be in a
completely different volatility regime. We may have even JINXD this low volatility period. So that's your insurance policy, Joe. You are literally buying volatility protection on the podcast right now. That's exactly right. I have just essentially bought a de facto, de facto fixed contract on the option on the podcast to guarantee to hedge against this podcast being worthless. Exactly right. Alright, that is it for this episode of the Odd Lots Podcast.
I'm Tracy Alloway. You can follow me on Twitter at Tracy Halloway, and I'm Joe wisntal You could follow me on Twitter at the Stalwart, and you should follow our fabulous producer, Sarah Patterson at Sarah pat With Two Teas. Thanks for listening. Put knowledge to work and grow your business with c i T. From transportation to health care to manufacturing. C i T offers commercial lending, leasing, and treasury management services for small and middle market businesses. Learn
more at c i T dot com. Put Knowledge to Work