ANDREAS STENO LARSEN: Hi, everyone, and welcome to the Real Vision Daily Briefing. I'm Andreas Steno from Real Vision, sending to you live, Wednesday, August 31st. Today, we're going to debate volatility, because realized volatility is as high as ever, basically, at least if we look at energy markets. And today, I'm joined by an options expert, also a volatility expert, my friend, Imran Lakha, the founder of Option Insights is with us today. It's good to see you again, Imran.
IMRAN LAKHA: Hey, good to see you, man. How are you?
ANDREAS STENO LARSEN: All good. I hope you're good as well. Imran, to take things from the top here, if we look at the current realized volatility, for example, in energy markets, how do you actually utilize volatility as a trader when it gets as crazy as currently?
IMRAN LAKHA: Yeah, there's a number of ways. Obviously, a lot of people get freaked out by volatility and a lot of the problem is that they don't volatility adjust their sizing, they don't think about where their stops should be in the context of how much an asset is moving and things like that. And so when things suddenly stopped moving, they're getting stopped out a lot of the time in their positioning or they lose a lot more money than they anticipated they could lose and stuff like that.
The way I like to think about it is just from a basic standpoint, if you've got a core long term position, an allocation, let's say, in your long-term portfolio, then trading around that position in a certain portion, let's call it anywhere between 30% and 50%, trading around that position is a way of utilizing volatility. You don't take the entire position off, but as you get big swings in both directions, you either lighten up with-- you add back if the market gives you that opportunity, or that's basically how you think about it.
That's a simple way to benefit from volatility and choppiness in markets without using optionality. If you want to use optionality, it's a bit more complicated but you can try and buy options when implied volatility is cheap. And we got there about two weeks ago, when the market rallied, squeezed all the way up to the 200-day moving average on the S&P for 3.25. And the VIX got sub-20, briefly. And the street, the dealer community in options look like they were getting a bit long and they were bit uncomfortably long in the market just stopped moving for a little bit.
As soon as that expiry at the end of August, or at the middle of August went away, markets were free to move again. And they went a bit more in line with fundamentals given what the rates market was doing and we've seen the selloff basically. I'd say now, the opportunity is in selling actually. The opportunity is in selling implied volatility. If you look at some of the metrics that we look at, Brian, if you want to bring up the dashboard front page, so we do an analysis every day looking at all the cross-asset volatility measures across different assets that we care about.
And right now, it feels like yeah, markets are moving a lot. But compared to the implied vols we're seeing, it's quite orderly. You're getting what we call a lot of positive carry in options, i.e., you can sell options at an implied vol that is quite a bit higher than what is realized if you look back at a 10-day realized period, basically. You're seeing positive carry in things like European indices, in commodities, in some of the major effects pairs. That's suggesting that actually, implieds have overpriced the movement right now. And there's some juice to be had in actually selling short-dated options.
ANDREAS STENO LARSEN: Imran, if we look at the price action over the past four days, I think it's the fourth day in a row that we close in red figures for the main US equity indices. What's your view on the market right now and the spillovers to volatility watching the price action?
IMRAN LAKHA: I was pretty convinced the market was wrongfully priced up at 4300. I categorically said that two weeks ago on camera. That turned out to be right, we've now repriced obviously to below 4000, we've done it pretty quickly. The market may need a little bit of a short-term bounce just to unwind some of that oversold condition. But as long as rates continue going higher, as long as the Fed does take rates higher than the rates market is pricing in, assuming they do, that's not going to be amazing for equities.
Equities are going to probably remain in some downtrend. In terms of how volatile that gets to the downside, well, that depends on obviously a number of things, how aggressive they're going to be, what we see in terms of growth rolling over, what we see in terms of inflation prints, that's all going to play a part. The interesting thing right now that I've noticed is in the last few days that we've sold off, we obviously got our first move down, and then we had a little bounce.
And since then, we've sold off from roughly 4060 on the S&P, to where we are now at like 3970, let's say. It's about a 2% selloff. And normally in a 2% selloff on the S&P, you'd expect vol to be quite well bid, people wanting to buy options. And whilst the VIX index is there or thereabouts slightly higher, the actual fixed strike options, which are options that have the same strike. If you look at the 30th of September, for example, the one-month option, struck at the money at 3975. In the last day or so, that's actually got hit quite hard in terms of implied vol.
What that's telling you is that the dealer community is not reaching for options. If anything, they're offloading some. That's not a market that's particularly stressed and is reaching for vol and is really in quite a bad situation. Now, if we were to go down to 3600 and below, I think that picture changes quite dramatically. I think the street will find itself very short very quickly, that move down below 3600 will induce more clients to buy more protection, and you're going to start to see a snowball effect.
And that's when you can start to see the VIX going into the 35, 40, 50 type levels if we were to break the 600. But I think for the next couple of 100 points between here and 3800 on the S&P, things will probably remain quite orderly. That would be my anticipation.
ANDREAS STENO LARSEN: If we look at cross asset volatility over the past, say two to three quarters, it's been quite noteworthy how big of volatility we've seen in energy markets, obviously, but also in interest rate markets. If we look at price volatility in the front end of interest rate markets over the past couple of quarters, it's been very high from a historical standard, at least in comparison to the last decade or so. If you look at interest rate volatility in relation to equity volatility, what do you make of the divergence we've seen between volatility across those two asset classes?
IMRAN LAKHA: Brian, if you were to bring up the second slide, where we've got all the different assets there on volatility and skew on that scatterplot. This is something we look at where we compare where the vol is in terms of absolute level across all the major assets that we look at, cross asset, equity, commodity, FX, and bonds. And we also look at skew which is the put vol minus the call vol to give you a sense for where the tail risk is being priced.
I totally agree with you that bond volatility has been the main driver of asset class volatility for a while now. And a couple of weeks ago, we were basically saying that TLT vol was trading at the same vol as the S&P. It was pretty unusual. Normally, you'd expect a bond vol to be a bit cheaper than equity vol, at least by two or three vol points. And it was pretty much bang in line. They were both at around 16, 17 vols a piece.
Further selloff that we've just had, the S&P has now gone a bit higher. We are seeing a more normal spread. We're seeing S&P vol at 23 against TLT at 20. That's more normal. We're also seeing skew stretching back out in equity, so people getting a bit more fearful of the downside tail, particularly in Europe, European skew is higher than S&P skew. But in general, that tail risk and that fear is coming back a little bit.
But the real standout trade a couple of weeks ago when TLT vol was rich versus the S&P, if you wanted exposure to rates vol, it was to buy dollar/yen vol. FX vol, there seems to be a very strong correlation between what dollar/yen is doing and what 10-year yields are doing. You are able to buy dollar/yen vol at around 10 and effectively get the swings that you're getting in bonds but via that channel through what the Bank of Japan has been doing and the way that things playing out.
That vol has returned up a little bit now to around about 12. It's not looking quite as cheap as it was. And also things have stabilized a bit in dollar/yen. We haven't had the breakout to the upside that maybe some people are anticipating. So this is what I'm looking at all day long, trying to find the best expressions of how do I own the vol that is actually worth having, and are there better proxies to own that like dollar/yen versus bonds or in Europe right now, I'm seeing a good short trade in European equity roll, where you could basically sell upside in the front end and harvest some theta and earn some carry if you're that way inclined.
Because the realized vol in Europe is surprisingly low compared to what we've seen in the S&P recently. You got 10-day realized on Euro Stoxx at 15 whereas the same thing in S&P is at 23, which is surprising but the reason is because we didn't squeeze as much. The S&P squeezed like crazy to 4300, Europe didn't participate in that rally as much, so post Jackson Hole when we sold off, Europe didn't need to come down as much either. So net, net, Europe's hung in there and not done too much but the implied vol in Europe is still pumped, because everyone's really scared about what's happening in the energy side in Europe.
For me, selling the upside area in the front end of Europe is the safer way to harvest that carry because if the market melts down, the position evaporates and goes away and it's not too much of a problem.
ANDREAS STENO LARSEN: Makes a ton of sense, Imran. Speaking of FX volatility, we're currently trading around this very important psychological level of parity, one to one between the Euro and the US dollar. When we look at price action in FX spot, it's sometimes linked to important strike levels in the FX options space. What do you make of Euro/dollar right now trading around parity and the link to the FX option space?
IMRAN LAKHA: FX vol has been grinding up across the majors. Let's say I thought dollar/yen was the clear standout thing to own because it had that relationship with rates but the Euro has actually performed quite well in terms of vol. That vol has gone up. The pair is holding really well actually and that's because people are expecting some pretty aggressive hikes coming out the ECB by the looks of it.
It does look a bit exhausted to the downside right now. I think every man and their dog is bearish Euro medium term, so probably the pain trade is a bit of a pop from here. I have been bearish. It's worked pretty well, I haven't really lightened up yet, maybe I should. I've been considering it. But because I've got some put options on the Euro, I'm struck at 0.98 but they don't expire until January next year.
Because they're quite far out, I don't really feel compelled to mess about and meddle with that trade. Even if we get a pop, I think it'd be quite short lived and I think the trend will resume so I'm happy to carry that. But if it was a short-dated position that expire within next month, I'd probably be banging it out and taking profit because I do think in the short term, we could get a little rally in the Euro.
ANDREAS STENO LARSEN: Yeah, I think that makes sense also seeing from my chair here. I wanted to play a soundbite for you, Imran, in relation to this debate on Europe. I spoke to Dario Perkins, the head of macro strategy TS Lombard just last week, and the interview will air on Real Vision this week. And interestingly, he's getting super bearish on European bonds as a consequence of the current energy crisis. Let's listen to the soundbite and get back to the debate on Europe.
DARIO PERKINS: I think there's still a roll for bonds, so I don't think we're in permanent stagflation, I think there's still going to be a helpful correlation between bonds and equities.
When you get a recession, when you get a panic in financial markets and equities go down, there's still going to be an insurance hedging property that comes from bonds. But over a five-year period, I think returns in bonds are just going to look horrible, I think real returns in bonds are going to be nasty. And we're also, even if we don't get really high inflation, persistent inflation, we're going to get much more volatile inflation because we're going to have big commodity shocks.
We're going to be moving to intermittent types of energy which are going to be much more volatile so you're going to get big swings in energy prices. We're going to get more disruption from climate change. The actual physical effects of climate change is going to cause more supply disruption, more droughts, more famines, more of that stuff. All of that is going to make inflation much more volatile.
This period of transitory inflation that we've had this year, and last year, we're going to get more of that. And we're not going to have central banks reacting to every transitory swing in inflation. There's going to be a bit of financial repression that goes on in those periods, and so real returns in bonds just get absolutely killed, I think.
ANDREAS STENO LARSEN: The entire interview with Dario Perkins is already available today at the Real Vision platform for the subscribers. Imran, back to you. Dario is clearly very negative on the prospects for European bonds as a consequence of the energy crisis. I know that you are born and raised in the UK, so let's make a live assessment here around the current energy crisis. The UK is one of the countries hit the worst by this current crisis in natural gas and electricity. What's your assessment of what's going on right now?
IMRAN LAKHA: Yeah, it's crazy. Some of the repricing in energy bills that people are having to face is just astronomical, and it's basically putting people out of business. I think there will be a backlash. I think there already is. There's people basically saying they're just not going to pay the bills. The government is going to be-- once there is a government, once we know what the government looks like, probably the first thing on their docket is going to be to come up with some sort of subsidies or some sort of assistance for people.
Similar to the type of stuff they did with COVID, where they furloughed and supported businesses, this is something they're going to need to do something about, because it's literally going to put ridiculous numbers of businesses out of commission, and even just regular people just can't afford to pay these bills. When I see that chart of TTF gas, I get very happy when I see it coming back down because we need it, all of us need it back down. There doesn't seem to be an easy solution here.
It seems like Japan and Germany are waking up to the idea that there's no other choice but nuclear. But that's not a short-term fix, unfortunately. I think that's where we're heading. And I think that's why we're seeing these pretty big pops in uranium lately. The thing about uranium is a funny one. I've switched over to this direction about uranium randomly, but I just think it's quite topical right now. And it's been a retail favorite.
And you've seen quite a lot of correlation between uranium and say, like the ox stocks. The retail favorites, the meme stocks. And that's broken down pretty dramatically in the last week or two. We've seen the meme stocks get crushed, and we've seen uranium go up 20%. When you see that decorrelation, that's quite encouraging, because you're now saying, well, whatever retail are doing, there's something else driving uranium now.
It's more the fundamental story might be taking hold. That's what I'm hoping because I've got reasonable allocation to it full disclosure. I've got reasonable allocation to uranium myself, but I thought that was quite interesting over the last couple of weeks to see that decorrelation.
ANDREAS STENO LARSEN: Yep. I'm long uranium too, Imran, so we're in the same boat. It's interesting to follow the debate in Germany around this question. I think a couple of days ago, the Economy Minister from Germany, Robin Habeck, basically admitted that they are now close to taking a decision to prolong the nuclear capacity they otherwise planned on closing down this year. And I think that's one of the reasons why we've actually seen a quite sharp retracement in the price of German electricity one year ahead.
We priced one megawatt hour above 1000 Euros and we're now back at 550 or thereabout, the last time I checked the screens on Bloomberg. Quite a retracement in a couple of days, still bizarre price levels, but a retracement from even more bizarre price levels. But speaking of this electricity market with an obvious link to the natural gas market, is it something that you can see spilling over to other commodity assets in terms of volatility, Imran?
IMRAN LAKHA: Well, it certainly has had impacts on the likes of agricultural commodities and some of the fertilizer stocks. They were absolutely roaring a few months back. They had a pretty steep correction but then there was a cheeky buying opportunity. I think they're up 30% from local lows. Fertilizer stocks are definitely responding to what's going on in natural gas.
The AGs had been a bit of a mixed bag. You had corn rallying pretty hard but wheat surprisingly hasn't done and done a lot. It's almost retraced the whole Russian spike and you've had Chicago wheat, I think has been alright in terms of yields. That's arrested some of the concerns there. AGs are pretty hard to trade off it. I think I probably have a bit more confidence in my fertilizer longs that I've got into on the dip. I don't really own any AGs right now.
In terms of the volatility, nat gas volatility is crazy. It's about 100 implied vol. It moves around like an animal. I wouldn't touch it with a bargepole. Because it's just too sensitive to geopolitics. And I've got zero edge in