Comments
Transcript
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AJGreat interview and comments Having traded both listed and OTC Asian vol before and during the GFC there are a couple of points I feel are worth making. - The short vol products sold to retail investors were predominately offered by the French and German banks. The main market was Korea but we saw them sold all across the region. The most popular one was called an "Accumulator" which consisted of a ladder of OTM puts. - These products were so popular that the long vega position of the issuance banks became too large to hedge in the interbank long dated vol markets. They hedged their vega exposure via LT vol swaps and selling short term gamma in the Kospi 200 option market. After they had crushed Kospi vol they continued selling both short and long term vol in Nikkei, Hang Seng and S&P. This massively distorted the risk reversals, calendars and intramarket basis into the GFC - As the GFC kicked off volatility initially moved higher and all the market and duration mismatches came undone. We saw vol markets like the Hang Seng bid-no offer for days across the curve. - When risk management teams took over the forced vol buybacks across the whole universe. If Andy's thesis is correct things could get very interesting again
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dmWhat is the total notional of these structured notes out there? In a scenario where vol spikes beyond risk parameters, do the banks close the buyback window, ie, choose to not buy the products back? Since the issuer is essentially the sole market maker, this would suck. In a typical prospectus for these things, it is mentioned dozens of times that the buyback window is entirely at the discretion of the issuer. They mention this over and over again. I saw that these products are intended to be held to maturity, but doesn't that assume a reasonable/low amount of tracking error relative to formula value/underlying and maybe even some expectation of liquidity in a worst-case scenario. What happens when CDS spread's blow out thereby potentially impairing the mark-to-market of these products and possibly causing some folks to decide they want out? Isn't the biggest component of these products a zero coupon bond (presumably properly accounted for on the BS and not an off-BS item)? Do the 99% holders become 99% sellers? If demand for these notes drop, how impactful would that be to bank revenue's? I understand that the product is domiciled in an SPV so I guess the debt is accounted for in the SPV? and not the parents' BS? But then technically its still an off-BS item. Apologies for my incoherent ramblings. Just trying to get a better understanding. Any insight would be very much appreciated.
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NROne of the best interviews in RV. Nice job lads.
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MCOverall very good interview (as usual with MG). Just one point to balance the scary tone of it: these products are not new at all, they have been there in very large volumes in the Japanese and Korean retail markets for 15 years or so, well before Central Banks actions depressing yield curves. And they went through the Knock-In events back in Q4 2008. It didnt kill these products popularity at all. Their issuance size just came back quickly post GFC. What is new (and impacting investors in the US) is the massive diversification to non Asian underlyings, impacting the SP500 vol dynamics: SP500 vol players just need to get used to the Nikkei and Kospi vol dynamics of this product => SPX vol is being "asianised" if I may say.
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JHGreat interview, thank you RV!
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WMHad a great laugh reading the transcript on this one! Some good clangers.... Terra Incognito is "Tara" Incognito. The Japanese Prime Minister whose economic vision is called Abenomics was translated as Abbanomics (perhaps because he is thought by some to be a "Super Trooper".......sorry). The famous Japanese average housewife investor known as Mrs Watanabi is written as "Mrs Watson Obby". But other than that lightheartedness it was an interesting discussion
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ROGreat interview, one of the best out there. As a professional.investment manager looking in this day in day out, I still learnt quite a lot. It is very different from Chris Cole because Andy's view is from.different prospective. I think is rightly so and easier to argue vol is too low and should be higher. But what this video adds value is the market structure and the supply/demand dynamic. Due to these dynamics, market could deviate from fair value for long time. Therefore it is as important to understand these dynamics as to know what is the fair value. Again great interview thanks Mr Green.
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JASolid technical content. Market structure conversations really are the most interesting.
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PPWe need more excellent technical conversations like this on Real Vision. Deep and well done.
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SAAs a vol trader was very disappointed with this interview. Yes, vol selling is an income augmentation strategy that everybody is now doing - whoop die doo - everybody knows that. It's not 2012 and vol selling is not a new strategy. Chris Cole of Artemis Capital is infinitely more insightful. What he is correct though is that we don't have complete data on vol selling returns since we have not gone through a real recession since vol strategies have came to market.
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MBAs a vol trader myself (buyer not seller) I found this a great conversation on a topic that is still largely overlooked, with Feb 2018’s spotlight on vol aside. Certainly most regular savers and investors are completely unaware. However, this should scare the hell out of them if they only knew. The distortions in markets now from near desperate yield chasing are mind boggling. The vol selling discussed is just 1 of many desperate approaches scattered through really every asset class. It also is so strange, almost eerie, that almost everyone in finance thinks things now are nuts, everyone expects a blow up, a reset, a new regime etc etc but everyone wants to just get what they can and get out of the market before the you-know-what-hits the fan. I guess if you are on salary or bonus you just ride that years income, take your money, ideally with a performance bonus, and not look back or worry, For anyone trusting their life savings to this though, my god. Either the eventual blowup consensus is wrong and we carry on safely with no massive drama after-all, or the day when everyone wants the exits is going to be written in very big writing in the history books. I’m all for questioning any consensus, but it’s hard to see how this won’t one day be the latter.
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WYPlease do more of this type of discussions.
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PCI think we are going to soon seem some more major volatility moves, disasters / opportunities,.... My dream is an interview of Nancy Davis & Chris Cole with Grant, who can put context & simplicity into this stuff for all.
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CNThis was easily one of the most fascinating conversations I've seen on Real Vision. Bravo! Please keep producing such in-depth content from brilliant interviewers like Mike and interviewees like Andy. Going to watch this again now to try and absorb even more
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JWThis is in the very best tradition of Real Vision - very educational.
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TWReally good stuff. As always Mike is very conscience about how he asks a question and if needed breaks down the response to help those of us who are not around this stuff everyday.
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TPThis is high level content. Great stuff. Thanks for sharing.
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SLSimply fascinating!
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RAVolatility Tuesdays!! Love the new Tuesday concentration on a a RV curated topic. I’m a huge Mike Green fan and he delivered an excellent Guest to us (wow—only 29 and a level of sophistication in an esoteric product that is off the charts). I’m talking my book having been in Chris Cole’s Artemis Capital Vega Fund for a few years, but Chris Cole would be a wonderful adjunct to these Volatility discussions, IMO. Chris has been on a couple of times, but not recently....any chance Milton?
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lDERrrrrrr can you repeat that please
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DSIt is interesting that the Fed said today that if there is a problem the will help support the market and the market was up 400 points. The Fed cannot push on a string. Cutting the interest rates will not turn the economy around. DLS
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HJOk brain freeze! BG as always great!
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AMAwesome interview. If this actually gets to the point where it blows up, I highly doubt anyone is going to realize the blow up is an unintended consequence of central banks manipulating short-term rates to zero for such a long period of time? Instead, some sort of regulation will be put in place as central banks keep rates at (or move rates towards) zero to fight the problem. Sigh.
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HCGreat interview, look forward to seeing this smart gent next year. Hope RV G650 corporate jet will ferry Mike to Austin, TX to interview Chris Cole in this series, "how to get long vol in this environment." The mechanics: options, swaptions, straddles, this is deep subject matter for some of us so thanks to Mike for trying to fill in what are gaps for some of us.
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JHThis is excellent - just having a hard time following the degree of technical detail and language. Many thanks to Mike Green and to Andy Scott - great interview. And MG excellent as usual - my daily dose of brain training is just trying to keep up with his intellect, lol.
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PSGood interview These products destroy people who have no idea what they are buying Asia is still a happy hunting ground for this investor In 2017/18 I saw $TSLA 8% notes sold by Bulge Brackets with 40% downside bail-ins - they are now 60% underwater History will hopefully look down on this garbage - but history in finance obviously doesn't exist 10 years after the last disaster Vale Asian muppets
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SSGreat interview and great to see the interviewer GOAT Mike Green back. @RV. Someone please interview Mike Green again rather than him being the interviewer.
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TBGreat interview by Mike Green, yet again! Getting into the detail of market structure change (the Brian Reynolds interview was another) is not something I've seen outside of RV. And volatility as a topic needs to be explored more.... on which note it has been a while since we have heard from Chris Cole :)
ANDY SCOTT: We've never seen any Asian retail investor impact North American vol markets as much as they do today.
And it's that rapid shift that's encouraged increasing amounts of vol monetization, of vol selling, whatever you want to call- it in these retail structure product notes.
And it's entirely because we didn't get through that breaking point that which bands would have to become very aggressive buyers the volatility.
We did, however, get through a lot of those points for select single stops.
MIKE GREEN: Mike Green. I'm here in Las Vegas at the Equity Derivatives Conference again. This time, I'm getting to sit down with Andrew Scott of SocGen. Andrew is a fantastic strategist in the equity derivatives space. He's worked across multiple regions and is a key contact for me as I try to understand who is actually selling volatility, who is buying volatility, what are the forces that are playing out in the evolution of this market. Hopefully, you can handle this really technical discussion. But we're going to really try to dig in and understand both the evolution of the volatility selling market as well as the capacity constraints that ultimately may begin to influence the underlying markets themselves.
Mike Green, I'm here for Real Vision. I'm sitting down with Andrew Scott. Andrew, one of my favorite dapper, proper Englishman. But you and I have met through the years primarily in your involvement in the equity derivatives space, which some of the Real Vision viewers have heard me talk an awful lot about. We're here at the Equity Derivatives Conference in Las Vegas, the EQDT Conference, where both you and I have presented a number of times. And you have spent a ton of time in particular talking about a subject that's near and dear to my heart, which is the idea of short vol. All right? And volatility suppression, I think is what you are spending a lot of time talking about in your presentation.
How did you get here? What brought you into the equity derivatives world? And then let's talk about how that market evolved alongside your career.
ANDY SCOTT: Yeah. Sure. We take it going back to school, you read the FT every day onto being a dapper English gentleman. You just know you're exposed to equities until you have a mortgage, it's very difficult to have a conceptual understanding of bonds and fixed income. So, I think you're just naturally brought into that environment. Everybody goes to a supermarket, everybody goes to a bank, it's just more tangible. So, that was really it. As simple as that was why I started out in equities, obviously, to broaden out over the years. And I just loved trading.
And in a pre-Volcker environment, when you could still do fun things, it was a wonderful job. I traded for still the better part of my career, and then transitioned into more of sales roles, which I very much enjoyed as well, the more advisory type jobs, speaking to people like yourself. Essentially, I've tried to just spend my career speaking to people smarter than myself every day, and that makes me good at my job. And then naturally, because I was so bad at trading and sales, I now run a strategy team.
So, on my side now, I have spent the last three years- part of that in Asia, now, in New York- talking about structural dynamics in equity derivatives, because now, I feel like there's an awful lot of data that's available that wasn't necessarily there a decade ago to truly under understand and explain some of those structural anomalies in why the markets move the way they do. So, that's about it. And that got me here today.
MIKE GREEN: And just you're being a little bit humble, because you actually started at 19 as an intern at [inaudible]. And you're now 29. Right?
ANDY SCOTT: Yes, very fast.
MIKE GREEN: Yes. So, you have been doing this for a very long time and have a lot more experience than your few gray hairs might suggest. That's actually a fascinating segue. You talked about the emergence of data. And so, you've seen some of my data sets where I've attempted to replicate stuff much further back than most though. But we're still operating in a regime in which the data sets are relatively parse in terms of volatility- both equity and other markets and respond to that.
ANDY SCOTT: I think on my side, I took that as part of my responsibility in the role I have, which is to- in a more friendly fashion, communicate what that data means. You can get access to various data dumps from websites these days. There's various vendors that provide some of that public data. But I think the nice thing I like about the seat I have today at SG is that I get a lot of that private data too. Increasingly, we take historically, the largest retail structure product market in the world, something like Japan. Half of that market now is private auction. So, if you're not very close to that, you'll miss a lot of the subtleties and a lot of the structural dynamics and the flows that are coming increasingly to North America.
We've never seen any Asian retail investor impact North American vol markets as much as they do today. And so, I've really spent a lot of time trying to aggregate this, understand what it means, look at all the structural participants and think about what their goals are, what their ambitions are, and then trying to deliver a message back to clients rather than just saying, I think you should buy S&P calls. We're trying to explain with an awful lot of powerful data why we want you to own this exact strength for these structural reasons. And I think that's something I've really tried to do- spend a lot of time doing a better job on.
MIKE GREEN: Well, and so when we talk about data, and I think it's important for people to understand what data means in the context of derivatives, right? So, data helps us in a couple of different ways. One, it helps us to try to understand the distribution of possible outcomes, right? Because when you're pricing a derivative, you're pricing the probability of all potential outcomes and some embedded distribution, right? And unfortunately, we very rarely have the history that allows us to create that entire distribution. We certainly can't observe everything that's ever going to happen, right? And so, that's part of the data set that you're talking about.
The other data set, and this is where the private ones become important in particular, where the access to that type of information is, where individual strategies or players i.e. Asian retailers, structured product, which you referred to- what their strategies and tell them doing systematically, right, or where pressure might emerge in the market that may lead to a shape in a distribution that is different. Is that a fair assessment?
ANDY SCOTT: It's a very good and very good overall understanding of how I think about it, too. I would say, the other thing to think about, as well as the qualitative lens of that, and something you and I have had lots of discussions on in the past is that does a back test on a country like Japan's asset classes mean anything post Abbanomics? Because the macro lens has changed so dramatically that even if we do have 100 years of data in Japan, doesn't really matter if we have anything before 2013 anyway. So, I think that's a very important point we need to make clear as well. But in terms of more broadly, how we're thinking about how they're impacting those distributions, I think that's key to everything.
And understanding as well the psyche and the emotion around why they're doing things around investment banks, buy side firms, we love to deconstruct the grids into as many orders as possible. We make ourselves think we're very intelligent, dang it. But at the end of the day, the most powerful driver in the room is a retail investor sitting in Asia, who has most of their property, sorry, has most of their wealth and property and their allocation to retail. We need to understand better why it comes, why they're doing it, why it's evolved. And so, we are spending a lot of time looking at monthly data sets of how that in entirety that flow is coming to market, but also what's the decomposition of that flow?
And that's where we started to realize it was impacting the US economy dramatically in the last couple of years. And I'd argue there's several reasons for that. But if you go to the root reason why an Asian retail investor would ever trade a retail structured product, all they're doing is deciding first of all, is this market going up? So, generally, am I constructive? The S&P was the most different trade on the planet 12 months ago, and might be again, so they were very constructive US equities, they were less constructive domestic equities. So, that's answer one. Correct.
And then the second reason why you do it is the pickup above the risk-free. That interesting to me. If it's five, 10 bips, I'm just going to trade my KTV bond. Clearly in Japan, is a different argument because there's no yield whatsoever. But I would say this is why Kore has become the biggest retail structure product market in the world. It's a very simple thing. But in 2016, Korean bond yields cratered. The 10-Year went to about 1.4%. And we think about that from a US context, let's call it 4%, 5% to 1.4 doesn't seem so extreme. But Korea was double digits, it was considered by most metrics an emerging market country not so long ago.
And it's that rapid shift that's encouraged increasing amounts of vol monetization, of vol selling, whatever you want to call it in these retail structure, product notes. So, it's less that they're thinking so much about the vol argument, it's a pure coupon, yield enhancing argument for them. And what is the differentiation that I'm getting versus the risk-free rate? That is it.
MIKE GREEN: Well, so you hit on a number of important trends that have played out, all right? One is the rapid aging of Asia. So, the Korean investor equities are far less appropriate for them than they would have been 10 to 15 years ago, because the population has aged dramatically. The second is that the availability of yield in the form of risk-free both domestic and international has fallen sharply. Right? So, interest rates feels like a lifetime ago, but as recently as 2007, where six plus percent and Korea, I believe that they were almost eight at that point. Now, as you point out there, there are low ones occasionally pressing towards less than 1%-
ANDY SCOTT: They're better than Japan I guess.
MIKE GREEN: Still significantly better than Japan, which is another market, obviously, that has been pushed into this. And so, faced with relative inappropriateness of equities as a direct exposure with the relatively high variability, many of these individuals retail, broadly speaking, have chosen to engage in yield enhancement strategies, which involves some form of selling options on equities. Who developed that because it clearly wasn't the classic phrase of Mrs. Watson Obby, right? She didn't figure out that she could go out and write calls or write puts, who built these structured products, who created them?
ANDY SCOTT: Sure. I'm not going to claim our firm was the first. There were multiple people involved in these markets. But to know the data of the first retail structure product, there's several people that might know the answer, I don't know. It was before my career started. But it wasn't necessarily a big part of the market, it was still very, very small. The evolution of that was clearly from the financial engineering department that came to that exact conclusion in another cycle in another time, what can we give to the client that make them feel comfortable with the trade? And then thinking through those basic steps and those questions I'm asking them, do I think the S&P is going to half, which is often the risk embedded in a lot of these products?
Generally, people don't believe indices, maybe single stocks, but indices are going to half overnight, over a month, over two months. So, that is the embedded simplicity and the safety. But by monetizing something shown far out of the money because of where skews exist that far down on spots, that created some interesting yield that was appealing to an investor, a retail investor. And so, I assume that is how the logic played out, that it was as simply just asking ourselves several questions, once the risk-free rate was no longer that appealing, what can we do to other asset classes?
Wasn't necessarily even a volatility argument from the origination, it was just more what can we monetize that we feel comfortable with, that they feel comfortable with? And actually, unlike most derivative markets, where there's generally a winner and a loser, you can have two winners out of this outcome. And I think that's why they've been such appealing products.
MIKE GREEN: That's a great insight- that you can have two winners out of this type of product, right? Because part of what has emerged, and particularly through post-GFC is a change in the regulatory environment that has forced banks and insurance companies to seek that type of protection against that type of catastrophic outcome. Ironically, insurance companies, for regulatory reasons need to seek protection against 50% drawdowns, 40% drawdowns as a typical attachment point if I understand it correctly, right?
So, they need to actually buy insurance. And they turn back to the retail community to purchase that. And they require- they don't necessarily think that this is insurance that they want, but they're required by regulators to buy it. Right? And so, this is a cost that they must bear in order to do business. And retail isn't taking that. Is that fair assumption?
ANDY SCOTT: Yeah. I would say from a North American argument, that's very clear. And that's why you probably have not had the scale of vol distortions that you've had in Asian vol surfaces. Perpetually, HSCI, the Nikkei. They've always had flat smiles. And they've had a very depressed long dated vol, because the offset of that which in North America is an insurer isn't necessarily present in the same scale out there. But what has changed in the last two, three years, is a huge evolution and a huge redesign of the insurance market, and specifically in the variable annuity market. And this big transition towards vol control vol managed funds.
So, if you think about around 2008, we were about a trillion dollars on the variable annuity market fast forward into today, that market has doubled, and 70% to 80% of their new issuance has come in what we would call vol managed funds. So, that's actually reducing the exposure of the insurer to that negative convexity that they've historically had, at a time when the Asian retail investor, as I said earlier, has never been more powerful in North American markets. And that offset that incremental buyer and seller where vol is reading starting to shift in North America. And that's something we've been very close to as a topic because we think it's not that well understood.
MIKE GREEN: Well, so let's push on this for a second because a lot of this, as you talk about developed in the vicinity, and I would argue, contributed significantly to the global financial crisis, right? So, in the United States, you have a natural buyer