Comments
Transcript
-
LCMichael G. is by far (with Raoul) the best interviewer on RV... I would really love to see him even more often. Great series by the way and right level and depth of discussions. one small request: would it be possible to cover the energy (oil, gas, coal, copper, EUA, power) and precious metal vol markets as well? thanks cheers Laurent
-
SCIrrelevant but I have to say. What a horrible room is this? the carpets, the wall art... Ugly ugly ugly
-
JCI've listened/read this interview 3-4 times since release. Brilliant content--thank you Eifert and Green!
-
NSBeast of an interview
-
ODMichael Green is the best, great interview, learnt a lot
-
SA"People remembered how bad it was to be short convexity"... I can guarantee you 95% of the finance community does not know what "convexity" means. The word "convexity" didn't become part of trader lexicon until Trump won the election and 2017 put short vol on the map. The other part is these "overlays" they keep talking about - these are option protection strategies on top of basic equity holdings - these people pay option premium through the nose on this. So I don't know how people that pay option premium all day cast themselves as "short vol" heroes. Go figure. Love Mike Green who is an exceptional articulator of very complex concepts, but his guests need to tone down the jargon. I can't stand jargon from people who can't even get the basics right. Also this guy seems to think hedging started in 2010. I know Mr. Eifert is a millenial and probably would be shocked to find out that option trading did exist prior to his professional career. In fact, alpha and beta "overlays" were done before 2008 and most of the hedge fund riches out there were both long stocks and long volatility and making money hand over fist in both from the mid-90s to the mid-00s because both the core position and the overlay made massive amounts of money. Post-crisis traders can only wish to be so lucky. The only thing that was different after 2008 is that the FED went all-in to suppress vol after the 2008 debacle (and for good reason) which made short vol a big winner in the last few years and has really decimated the hedge fund industry.
-
ETGreat interview, thanks!
-
BBRelated article on FT: "Korea’s yield-seeking pensioners are shaking world markets" https://on.ft.com/2IFVsvf
-
BBThe Michael Green interviews are the *best* content on Real Vision - unique and interesting content not found elsewhere. Thank You!
-
SAAbout 2017, the VIX futures curve was steep because the investment community was panicked about Trump and his coming tariffs which kept the back part of the curve at high levels (as Eifert says that is where institutions hedge). At the same time, realized vol was at historic lows as institutions were not going to sell stocks ahead of tax reform. So realized vol was pushing expected vol (VIX) down and you had a record contango (spread between 2nd VIX future and 1st future) and roll yield (spread between 1st future and spot VIX) that year. That meant that something like XIV that makes money on those spreads would be raking it in big time. XIV was up like 70-80% through June in 2017. Once tax reform got the green light in September, institutions stopped hedging and the VIX futures curve collapsed to its lowest levels in history. The curve was flat (meaning there is no automatic gain) and very low (high mean reversion risk). The contango trade was bled dry so the right trade at that point was to be long vol and bet on mean reversion move after tax cut was signed. I run a retail VIX advisory service (vixcontango.com) and my subscriptions doubled up in the middle of 2017 - there was so much interest in the short vol trade. Who doesn't want to make 10-20% per month? We will probably never see again such a weird combination of institutional panic which resulted in high levels of hedging and institutional euphoria (because of future tax cuts) which resulted in record low realized volatility. The short vol trade of 2017 is a unique moment in investment history.
-
HvMichael Green: consistently the best listener, crypt-pinning questioner and sexiest finance-beast out there. Love his interviews and style. Thanks for showcasing his intelligence and knowledge, RV. Well done.
-
JHSuperb. Thanks guys. Amazed at how much of this I actually understood, as an engineer with a strong interest in finance but no formal training.
-
PCBerkshire Hathaway
-
REWell done and a great topic to cover. Kudos
-
PJI like Mike Green and think he is one of the best interviewers around. I got the gist of about 40% of what he and Benn were talking about, but the rest went way over my head. It would be really good if Mike or someone else at RVTV could do a layman's synopsis video to this discussion and flesh out the risks and possible consequences of what they were talking about so me and possibly others in the same boat could gain a better understanding.
-
CNCan every month be Vol Month?
-
MCMG high quality as usual. One comment: at some point, to emphasize on the dumb systematic vol selling story telling, BE says people were selling SPX implied vol below realized, back in Jan18 b4 the Feb18 VIX blowup. That's incorrect: SPX realized vol was below 8 for most of Jan18. Vix fut (front) traded above 10 during that period. Although at historical low realized/implied, implied was above realized, and therefore long vol gamma hedging was negative PnL back then (not saying it s smart to sell vol at 10 though, however low realized may be). => As opposed to impression given by the short vol critics, there is rarely easy no brainer positive carry coupled with positive risk free lunches in market
-
AMAwesome stuff.
-
DSGreat as always. I love these in depth, deep water options interviews. It shows that this is for professionals only and maybe not even them. Thanks. DLS
-
WBAs a former market maker who stood in the pits of the CBOE and saw this flow I found this fantastic. Benn is spot on. The systematic vol selling in the near contracts buries market makers with long options. I do remember a time when we relied on this flow to get options back, but then as the business grew it became very difficult to trade with as a market maker because there was no longer any balance of buyers and sellers in the market. I get really annoyed when you see option gurus on TV or twitter always assume that big prints of options are bought by the public. In my experience, way more institutional option flow is sold to open than people realize.
-
OCGreat interview, these are the topics that are complex but extremely important to be aware of. Keep up the excellent work!!!
-
ABGreat interview. Plenty of pausing to catch the nuances, but well done Michael on asking the right questions. Do you look in the mirror and see the "Put Bomber"........???
-
HKMatt Green. Brilliant as usual and interjects just the right amount at the right time. Very insightful interviewee as well, of course.
BENN EIFERT: There was really a large psychological overhang after the credit crisis- psychological and real, where people remembered how bad it was to be caught short convexity during a huge equity market selloff.
There was academic research obviously on the volatility risk premium and the historical tendency of implied volatility to be above subsequent realized volatility on average.
I think it's a very long cycle, though, because the types of folks that have large state pensions. From the time where they get interested that this might be a good idea to the time that they actually are able to decide what to do, approve the program and roll it out can be years.
MIKE GREEN: Mike Green. I'm here in Las Vegas at the EQDerivatives Conference. I'm going to sit down with Benn Eifert of QVR Advisors. Benn is a PhD, absolutely brilliant in the option space. And we're going to spend a lot of time talking about some of the technical features of option rebalancing and the structural vol sellers in the marketplace. In addition, we're going to try to talk about some of the characters that are involved, hopefully, add a little bit of color to it. Looking forward to sitting down with Benn, I hope you enjoy it.
Mike Green. I'm here in Las Vegas at the EQDerivatives Conference with Benn Eifert of QVR Advisors. Sensor.
BENN EIFERT: Quantitative volatility research.
MIKE GREEN: Alright, and then is a volatility specialist. I play one on TV occasionally, but you do the real deal. So, we just got off of a panel where the two of us presented and you brought up one of my favorite topics, this idea of volatility suppression and volatility selling. Help me understand how you got to a role in life where you focus on this and what it means to you and the day to day dynamics of your activities.
BENN EIFERT: Yeah, absolutely. So, my background is I have a PhD in Economics from Berkeley. I was an old school, emerging markets macroeconomist back in the day. I ended up on the Wells Fargo prop desk for a while, which was quite fun. And nobody actually knew that there was a Wells Fargo prop desk, which makes it even more fun. And then ended up running macro volatility strategies there and elsewhere and started this firm a couple of years ago out in San Francisco.
MIKE GREEN: What period were you running the macro volatility strategies at Wells Fargo?
BENN EIFERT: That was 2010, '11, '12, '13 at Wells Fargo and then a partner and I left Wells Fargo to start a fund in New York called Mariner Courier, a Mariner Investment Group platform managing a global volatility portfolio for three years, and then I moved back to California to start my own firm.
MIKE GREEN: Now, when you moved on to the prop desk, the macro strategist, you were working on the prop desk prior to the GFC? Is this-
BENN EIFERT: We're right in the middle of the GFC was when I first was getting involved.
MIKE GREEN: So, you came out of academia, you went into chaos?
BENN EIFERT: Exactly. It was great fun. And actually, the Wells Fargo prop desk was a really interesting place. Because you would think of it as probably the 23rd best prop desk on Wall Street at the time, but it also happens-
MIKE GREEN: It's officially 22nd.
BENN EIFERT: Maybe 22nd. Yeah, exactly. But that's right, Lehman got taken out of the mix. But importantly, it was the prop desk at the bank that didn't know what a synthetic credit derivative was. And had no- obviously, had real estate exposure and home loan exposure but had none of the really toxic stuff. And so, the Wells Fargo generally was fine, actually, in late 2008. And the bank was willing to really support the desk to go take advantage of a lot of the opportunities that were out there in the market in late '08, early '09. And so, that was great. Whereas many of the higher ranked prop desks in the world were getting liquidated and blown out of their positions because their banks were in trouble.
MIKE GREEN: Well, and there was a substantive risk change then as well as in terms of the regulatory environment. So, while you were able to take advantage of some of this because you had a relatively clean book, you wouldn't have been able to engage in the type of behaviors that existed pre-2007.
BENN EIFERT: Yeah, that's exactly right.
MIKE GREEN: So, when you came in, and you talked about taking advantage of these opportunities, what were those opportunities? What were you seeing?
BENN EIFERT: Well, I think the Wells Fargo prop desk was the last buyer standing for convertible bonds and for secured loans. And for a lot of the credit products trading at five or 10 cents on the dollar at the bottom of the market. And think of how wide for example, cash synthetic basis got to the credit markets though, because of funding. That's really a funding trade. We look at bonds trading a much wider spreads than the CDS that hedges those bonds, because effectively, if you're going to buy a bond and buy CDS against it, you're taking counterparty risk and you have to post balance sheet and you're getting paid a tremendous amount of money if you have any balance sheet.
And Wells Fargo was one of the few folks that actually had balance sheet to deploy. So, a lot of those types of trades, particularly on the credit side were huge opportunities. Within equity land, you can also think of, if anything about the dividend swap market, there was a huge basis between index dividend pricing and the pricing of all the single name dividends that aggregated up to be equivalent to the index dividends and risk. And that came because there was one very, very large player that was long way too much of the index and had to sell it in a huge fire sale, and there was nobody to buy it because everybody again was getting shut down.
So, many of those types of opportunities where if you have balance sheet and risk-taking capability, you could take great advantage of the situation, because so few people have balanced sheet and risk-taking capability at that point.
MIKE GREEN: That was exactly my experience. And I was extraordinarily fortunate and being in a situation where I also had some access to balance sheet, although, for reasons similar to you describing, I was forced to basically create an overlay on top of that. The exact same dynamics that blow out of basis, that effectively meant that people didn't have the capacity to hold what they otherwise knew were good investments at normalized by and large circuit 2012 into 2013. How do you think about the dynamics of the structural cleaning of that market, the cleaning of balance sheets as the passage of time, and the shift that we've seen post-2012, 2013 on really, in terms of how people have chosen to trade these vehicles?
BENN EIFERT: I think over time, what you've seen, you particularly coming to the point you asked about systematic option trading, there was really a large psychological overhang after the credit crisis- psychological and real, where people remembered how bad it was to be cut short convexity during a huge equity market selloff, or even folks who weren't short convexity, but just were long a bunch of stock and it went down 60. It was incredibly painful. And it created really a persistent bid for options by hedge funds, by real money institutions, by pension funds.
You saw the rise of tail hedging programs, systematic tail hedging programs and tail funds, where investors wanted to be protected against the next leg down and everybody was thinking about what's the next thing that's going to take the market back down 50%. And that, not surprisingly, led to a lot of that type of risk being very expensive, because there was this one-way market for protecting your tails across the board. And that, to your point, really started to shift by, say, 2012, 2013, when a lot of those institutional programs had maybe budgeted one or 2% per year for loss against those programs, I actually lost four or five. And their equities were doing well.
So, it was okay. But after several years of that, just the patience for hedging fell apart. Too much money have been lit on fire. And one by one, those big tail risk hedging programs got shut down. And they were replaced by the opposite in some ways, by option selling strategies among large institutions, not necessarily tail risk selling but think of index call overwriting, for example, which was something that investors have participated into some extent or another for quite a long time. It was always popular to say you own a stock and you're willing to sell off the upside beyond some point and retail investors like to do things like this.
But institution large pension funds started, more and more being in overwriting say 10% or 20% of their equity portfolios starting in about 2012, 2013. Selling cash secured puts against their equity portfolios. And those programs have grown and grown and grown very steadily, say doubling every two years for the last six years or so. And now, I think you really look at some supply and demand in the option marketplace and it's completely flipped from the post-crisis hangover, where there's a very large amount, arguably too large for the capacity of the market to support it of short term, relatively near the money option selling by large institutional investors as an overlay within their portfolio.
MIKE GREEN: This is one of these interesting switches that occurs. So, if we come out of 2009, and we look at what I would, by and large, call the Black Swan market. The crisis hedging opportunities in that market on a pure size basis grew to about $60 billion worth of allocated capital that was dedicated to buying, all hell breaking loose puts, whether it was in fixed income, or it was an equity, it didn't really matter. So, there's this tremendous bid to actually buy that convexity and to buy that protection.
And most people tend to think about options as either buying protection or as a form of buying leverage to the tops. I think the stock is going to do great. And therefore, I buy a call option because I want to make a lot more money. But what you're highlighting is, is that the vast majority of the institutional exposures have now shifted to using options to generate what we would probably call yield enhancement. Why are they doing this?
BENN EIFERT: I think it's been a long process of evolution. There was academic research, obviously, on the volatility risk premium and the historical tendency of implied volatility to be above subsequent realized volatility on average. Has been around for a while. You started to see some of the pension fund consultants writing white papers based on that evidence, say even in the mid to late 2000s, early 2012, 2013. And the process of those consultants working with pension fund clients and educating them on what they saw as this opportunity took a period of time.
And then, as with anything, large institutional allocators move slowly but once they start moving, and something becomes accepted and popular and consensus so that as a pension fund allocator, your boss isn't going to say what the heck are you doing over there? That's some very unusual thing. Now, it's actually very common place and you wouldn't be questioned. So, the answer you had, this persistent growth.
If you were to look at a long term back test, and AQR has some nice papers on this. If you're going to take a 30-year perspective and say, is there a volatility risk premium? The answer is you get is, of course, absolutely. Where is it the greatest, if you look across the volatility surface, short term options, long term options, deep tail options? The long term evidence on average will say, well, it's highest for relatively short term options, let's call it one-month, and it's highest for around the money, slightly downside puts snapped too far downside. And, like anything, you can see a historical pattern for 30 years, that's true on average.
But then if there's a dramatic amount of behavior change in response to those prices, then that risk premium can change very dramatically. And I think that that's what we've seen over the last several years, if you look at the evidence. And you need statistical models, and you need to do the work. My view is there still a volatility risk premium at the short end of the curve, but maybe it's half of vol point. So, on average, if you sell 10, you expect a realized vol of 9.5 or something like that, maybe it's three quarters of the vol point. Whereas historically, over long periods of time, it was closer to say three vol points.
So, you've cut that risk premium, the large inflows into that, into very benchmark like strategies all selling the same thing, typically one-month range, typically within 25 delta, calling to put legs relatively close to the money has changed risk premium by an order of three or four times, so cut it by 70%. And those flows continue to grow at about the same pace.
When you raise the question with pension funds or pension fund consultants, you say, have you thought about the size of the market, the capacity of the market to absorb these flows? At what point risk premium start to change? Have you done some work on whether you see risk premia changing typically? The typical responses- the folks just haven't really thought about it that way. They think of this as a risk premium that's behavioral and will always be there and should be roughly constant over time. But I think that we just know that that isn't the case. That's not how markets work, when large amounts of capital move into doing something very, very similar and very visibly changed the prices.
So, if you look at the typical shape of the S&P, just at the money volatility term structure, look at a quiet volatility regime prior to the credit crisis, you might see something like at the money one-month implied vol of 13 and the one or two-year at 15, before the credit crisis in a quiet period. Now, during quiet periods, it's eight or nine at the one- month point and maybe 17 in the back. So, these flows have dramatically steepened the volatility term structure and make the front much, much lower. So, we're changing risk premium, we're changing prices. But I think the people involved aren't really asking that question.
MIKE GREEN: They aren't asking that question. That's one component of it, too. And this is something you've heard me talk about is, functionally, all of these assumptions are predicated on the work of Mark Watson Sharpe. And their ideas are very straightforward that we can model these is if they're games of chance, they're stochastic in nature. The frequency in the past is the same as the frequency in the future. And nobody stops to say, well, what's the capacity when you talk about these models? Nobody stops to say, what's the capacity of a blackjack table or a roulette wheel? Functionally unchanged by the players that are playing the game. But those are the tools that were built. So, stochastic model, we use Monte Carlo simulations, precisely because we think that we're simulating games of chance. But that's not really what happens.
BENN EIFERT: Now, That's exactly right.
MIKE GREEN: Yeah. So, explain to me what you're doing to think differently about these risks. How do you think about things like crowding? How do you think about