Banks and market makers get short say an 80%-60% put spread every year due to the annual Hacienda hedge. If the market drops, vol beta is strong...but what if the market trades below that 80% strike...
Now the hedgers are short an ITM puts and long an OTM put. In other words, they went from being short a PS to being long skew on risk reversal. The inventory causes the call skew to firm, and the vol beta to decline to the downside as dynamic hedgers are no longer stressed lower
So if you are are quant just looking at this market anew, your analysis of skew behavior will be confusing without the memory of the who and why of the open interest.
In nat gas, the price of coal acts as a floor as utilities switch to gas for gen as natty falls. This support reduces the stress to the downside but it's only in play at low prices of gas.
So the skew behavior depends on outright price levels of gas as well as coal curves
Sell-side cross commodity research from banks always does a good job covering the dynamics I described in oil and gas so none of this is a mystery. The point is regime switches trace back to economic incentives and real world decisions (also not surprising)
(when I say hedgers in this tweet I mean dynamic hedgers, the vol folk. Sorry for the code-switch from the first tweet)
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The best trading/mm firms aren't just capturing spreads. They use market intel to read the table and make big bets. Obsession was finding real EV knowing they had bankroll to bet big when they found it.
It ties back to a lesson I've mentioned before and makes sense when your bankroll is large
if you make money every day you're leaving money on the table
You don't close trades unless your getting edge to do so.
Like Darrin said on @choffstein pod...if you sell a tail you must collect the whole premium otherwise the times you lose multiples mean you def have neg ev
Building sims instead of backtesting as a way to get more samples. Table stakes to get a fingertip feel especially when you don't get the apprentice experience
(btw, doing this gig w/o being an apprentice sounds impossible so huge props to Darrin)
The idea of pricing out financial products to the penny. Darrin called it "back-office" kinda stuff that retail doesn't do. Corey said he does this too.
This is exactly what you do at a mm/arb shop. Giant spreadsheets pricing fair value for financial products. Not optional work
I remember haggling over some trinket in Khan el-Khalili 16 years ago.
The seller opened at equiv of $50. I negotiated down to $2 and still felt ripped off.
I remember telling the guy off
"You would have let me pay $50 for something you were willing to sell at $2"
It didn't bother me that much (negotiating in my bad Arabic felt like a fun game) but I realized how much I internalized the concept of open outcry and if your bid/offer was inferior to one that was shouted it was technically illegal. Made me appreciate how our markets work.
The reason I remembered the story was a convo I was having at lunch with a friend yesterday. We were discussing compensation. Employers and employees navigate semi-transparent labor markets.
Here's a story that starts with Costco and ends with a broader question.
After a recent shopping trip I was telling a friend how good the Kirkland tequila anejo is. I was wondering which spirit brand they laundered the Kirkland name thru.
After some raving about Costco and how you can literally drop $300 there on a casual Friday morning and not feel bad about it my friend shared a story of Costco's buying power.
She was privy to Costco's dealings with the Hidden Valley brand. She told me that years ago Costco in an desire to be more healthy didn't want to sell a product with msg...the magic ingredient in HV Ranch dressing.