1/x Alright, if you haven’t read @choffstein most recent piece, do it. & if you have, go read it again. It speaks to a concept that I‘ve been preaching for 4+ years now. & if you’re involved in fin markets, even tangentially, I don’t think there‘s a more important topic right now
2/x The main thrust of the piece points, rightfully so, to 1) Federal reserve liquidity & a) The moral hazard that it causes (due to the fed put) & b) the scarcity of opportunities that it creates.These 2 pressures drive massive market wide compression of risk premia by way of
3/x forcing participants to move up the risk curve, increasing carry trades & the leveraged selling of convexity. The net effect of this is to move all risk from local variance, to the tails. As Corey, is fond of saying , ‘risk cannot be destroyed, only transformed’.
4/x The net result is mismatched leverage/liquidity on the wings with less probable yet significantly more dramatic tail events... 2016 & 2017 were the first obvious signs that this had become the essential driving force in markets as 2017 RVol was 30% lower in the SPX than any
5/x other time in history. Not in 50 years, not in 100 years... EVER... but the important part to understand is that low idiosyncratic risk wasn’t the driver. Correlations were the lower than any other time in history. Not in 50 years, not in 100 years... EVER...
6/x this is no coincidence.Idiosyncratic risk was alive & well. But SPX was pinned, due to the lowest Ivols in history. & when the indexes are pinned & 1 stock reports a cure for a disease or a case of fraud, by definition, another stock has to move in the opposite direction.
7/x So with Risk Premia compressed & longterm liquidity guaranteed to companies otherwise incapable of surviving liquidity crises, the rise of the large growth name as winner is no surprise.Companies like Amazon, Tesla, and Uber (or any well healed SPAC) can easily access capital
8/x as they do not need to generate cash flow to support operations and can actually make long term growth investments & take loss leaders in order to disrupt & crowd out other players. This untethers them (& broadly the market) to short term market realities & allows them to
9/x diverge from reality for extended periods of time (WeWork).This momentum factor, as @choffstein points out, is a divergent strat & the secular move to passive as @profplum99 has pinpointed as another driver of this trend reinforces & institutionalizes these trends to extremes
10/X The end result is a market that is built on a strong liquidity bubble. An almost impermeable ballon, floating higher & higher, seemingly safe & protected by the watchful eye of the fed & its reinforced low risk premia liquidity casing...
11/11 But idiosyncratic risk doesn’t disappear. Viruses happen, wars happen, elections happen, inflation happens, & politics happen.... And it’s a long way down when they do....

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More from @jam_croissant

17 Sep
1/x When I had my vol market making firm, the best trades were always to trade with the smart directional players. You almost always wanted to avoid the retail directional flow. This may seem counterintuitive. Why would you want to trade against the smart directional players?
2/xWhen a good directional player buys deltas, as a MM, you sell them their soft deltas & hedge w/the underlying.Therefore, Generally, your exposure wins when they do.& when they come to take a profit & you have the added benefit of flow pushing the trade in your favor as well.
3/xhistorically w/retail the opposite is true on 2 fronts. Not only are they generally directionally wrong, forcing you into poor positioning with the underlying, but they don’t sell at a loss. They just keep repeating the same losing trade at worse & worse levels....
Read 4 tweets
16 Sep
1/x A little Pre-VIX Print SOTU: What we know:
-The Markets are still technically very weak, as they have been unable to recapture 20 day, despite significant Vanna/Charm flows past 1.5 weeks
-little retail or institutional capitulation & Short interest @ extremes
2/x-Index Vol structurally compressed due to recent Low rVol during high Sep OpEx decaying away in front of lower expiries behind. -VIX exp often marks low in vol & end of Vanna flow market support
3/x -low Sep VX rolling off & higher event Oct VX front month, naive demand in VIX complex for already rich post event vol could shift Vega higher.
-Street broadly short vol dispersion (extra long in indexes, short in names)
-Fundamental election risks looming under Biden sweep
Read 5 tweets
16 Sep
1/x I think most people look at IVol as a simple mean reverting fxn...They think when IVol is low it’s smart to own it & be hedged & when it’s high it’s smart to sell it...& although there is undeniably a mean reverting process at work, what most don’t understand is that for the
2/x most part over the longterm(since 1990), if you follow this process, you will get into big trouble... Other than a handful of high vol spikes w/ forced buying, when vols are low (think smoothed VIX of <17) it‘s historically, in risk adjusted terms, the most profitable to sell
3/x In effect, the risk adjusted returns of selling vol look like a big “U”, with a handful of highly profitable stressed extreme vol circumstances, paired w/the overwhelming majority of low vol occurrences representing the profitable tales, and the middle range (think VIX 17-30)
Read 8 tweets
14 Sep
1/x Alright time to revisit this from a week ago, as well. I don’t think I have to tell anyone how well this one worked out... Another great example of how important it is to understand dealer positioning! The question now is will this Vol compression into a down market continue?
2/x This is a tough question. I would suspect through Wed (Fed) it will... But it‘s important to note that IVol & skew have both dramatically declined in the last week to levels that are simply too low given the technical picture. Our spot here in the market Is not historically
3/x a natural resting place. We are below 20 day &1 stdev down on 20 day. This is no man’s land. This market will either retake the 20 day soon & find itself on solid footing that could push being momentum back to the highs, or (more likely) roll over below recent support of 3300
Read 4 tweets
8 Sep
1/x A couple of important notes from Vol-landia today:
1) Fixed strike $SPX vol imploded today w/straddles -$21 to -$32 across OpEx. Given size/speed of $SPX move & technicals this was extreme.Vol compression accelerated into close w/$5-$7 decline post-equity close on market lows
2/x Much like buying felt forced into the close at the top. This selling was beginning to feel forced. 2) skew declined considerably w/1 std dev put wing -$3, 1 std dev call wing +$1. But coming off high levels, it feels more fairly priced now. 3) maybe most importantly,
3/x There was a major break in price change for Vol post 11/4. With straddles 11/20 on back -$16-$17, where as 11/4 (Election Day)was only -$7. this post election Vol has been insanely high due to fear surrounding a disputed election/constitutional crises post election.
Read 4 tweets
12 Aug
@pat_hennessy @Isa90495157 @Reveretrading @SqueezeMetrics 1)Yes. I agree. To me it seems like common sense. If you are buying puts, you are buying them for a spec or a hedge, especially in the US where the skew is significantly higher than the rest of the world and historically caries a significant risk premium. There is lots of analysi
@pat_hennessy @Isa90495157 @Reveretrading @SqueezeMetrics 2) that basically shows that 90%+of HF ‘alpha’ can be explained by short put exposure. Every quant, prop, and HF I know has some version of the high sharpe/ negative tail trade on with some tail cutting trigger built in. Why wouldn’t you, especially if the Fed has your back.
@pat_hennessy @Isa90495157 @Reveretrading @SqueezeMetrics 3/This is mostly anecdotal evidence, but in the absence of empirical evidence, I have been trading these markets as a major player for decades & my ML models definitely see the flow. My view is the market is increasingly a series of leveraged carry trades, Harvesting risk premium
Read 4 tweets

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