Vol Persistence, The Unholy Trinity of Risk, and the (100 yr) Dragon Portfolio for our 100th episode with Chris Cole

Picture this…Downtown Chicago…December 2019 B.C. (Before COVID)…The RCM crew is venturing out to a small studio ready to record the first episode of The Derivative, with no video or clue what we were doing! Who would have thought we would be crossing the 100th episode mark just two short years later!?

And, we couldn’t celebrate this special milestone without a one-of-kind guest. Chris Cole, founder and CIO of Artemis Capital Management, is taking it up 100%, as he tells us about his very own journey within the industry. From his days of convincing people that they need some long vol – to too many people trying to own long vol and bidding up the cost of that protection — and everything else in between.

But the fun doesn’t stop there! We’re talking about a change in the persistence of vol, risk’s unholy trinity, the ticking time bomb that’s corporate debt, and of course…Dragons. Plus, we’re bringing back a favorite fan closer from seasons 1 and 2. Stay tuned, sit back, and enjoy the show!

Follow along with Chris on Twitter @vol_christopher and check out the Artemis website

From the episode: What would you put in a 100 year portfolio?



Check out the complete Transcript from this weeks podcast below:

The Wide World of Vol with Chris Cole


Jeff Malec  00:07

Happy 100th Episode everyone. I remember episode one like it was yesterday sat down with Wayne Hamilton and small studio across my office in Chicago, December of 2019. We had an audio tech in the room me Wayne, our marketing head and our graphic designer. No video and really no idea what I was doing. Not sure I know any better now, but we’ve had such great guests on the show that they’ve made it pretty easy for me to play along and try and keep up. And somehow we’re here 100 episodes later. Thanks for listening and being part of the journey. We’ve got a great one for you this special 100th episode finally getting Chris Cole to come chat. In addition we Spurgeon got some new equipment to celebrate the milestone with a better mic and HD camera. Take us through the next 100 shows. So apologies for those watching on YouTube and not used to seeing me in HD. Onto the show. Chris Paul’s the founder and CIO of Artemis Capital Management, who focused on providing institutional investors volatility exposure, and he’s the author of some tremendous research pieces over the years. This is a great chat where we dig into Chris’s pet dragon. George Lucas Star Wars is a long vol metaphor. And his could have been should have been Pulitzer material paper on Dennis Rodman, and of course, all things Bob, send it. This episode is brought to you by RCM alternatives who’ve been great in supporting the show and helping us access all these great guests, many of whom are clients of our CM. So go check out what they do for managers@www.rcm.com. And while you’re there to go along with today’s show, go download the newly updated vix and volatility white papers. And now back to the show. Welcome, Chris haven’t spoke in a while, I think, since the Texas ice storm last year. So how are things? I it’s it’s great. How are you doing? I’m great. Thanks for being on. Thank you for having me. And you’re there in the office in Austin.


Chris Cole  02:19

I’m here in Austin, Texas. Beautiful Austin, which goes between 70 to 30 degrees. 70 to 30. Yeah, it’s like it’s like literally Yeah, it’s like it’s almost like volatility itself.


Jeff Malec  02:32

And how is it getting too crowded down there? All the Chicagoans moving to avoid their taxes?


Chris Cole  02:37

It’s a lot of a lot of people in California, actually. Yes. Tremendous. i I hope Austin Can Stay weird. That’s what I really hope because I think there’s more VCs now than there are musicians. But there’s plenty of room for people. So you know, to to embrace the the culture down here.


Jeff Malec  02:54

Didn’t they have a little out of campaign? Like Stay weird Austin or stay? Okay, so


Chris Cole  02:58

Austin weird is the the official slogan for for as long as long as anyone can remember.


Jeff Malec  03:05

Keep us and we love it. So let’s jump right in and talk what is happening in the wild world of vol trading. We had vix hitting 36. Today, we’re just talking offline here. Nickle was up 100% bonds sort of sold off. So what’s jumping off the page for you? What do you what are you thinking about today?


Chris Cole  03:23

Well, I mean, obviously the the big vol is in the commodity space. I’m asking that’s been absolutely incredible. And we’re seeing kind of a repeat of the 1970s. Now, I think which we spoke about and was talked about, you know, in my 2019 paper about how you can get that right tail risk. But what’s interesting about equity vol is that it’s been a very, a very measured downturn in the s&p. And I think that’s been what has been most striking. In fact, vol has kind of underperformed to the upside in s&p and and outperform to the downside. And to that extent, even though optically, VIX is over three and people would say that is high ball and it is high vol. But what we’ve seen very similar to January of 2016 s&p Ball has followed sticky strikers using almost to a tee. And that has occurred until this last week on all change this last week. So you know what does that mean for


Jeff Malec  04:23

push you tell us what sticky strike regime means sticky striker Jean? Well, that was like semi NEDA cream for something. Yeah, no, right. No. Right. So I mean, if you think about if you think about implied vol.


Chris Cole  04:35

Think about it like this for people who are more familiar with traditional equity analysis. If you’re a growth investor, what you’re seeking to do is you’re seeking to buy companies that are going to exceed the expectation of earnings and that are already embedded in the market. So to that extent, I think we all know that, you know, with a growth stock, sometimes it will report earnings and match what the With the earnings expectation of the street are and the stock will actually go down. So if you’re a growth stock investor, you are you are buying the stock expecting it to exceed the earnings expectations already embedded in the market. And volatility is no different if you’re owning long ball, if you’re a long ball shop like RMS is what you’re looking to do is buy volatility on and have that vol exceed the expectations that are already built in market. So in many ways, the skew of the s&p or the implied volatility by strike price represents that linear expectation, and the market will gradually move down or up the skew curve. And the VIX will track that skew curve. But when there is what I call the unholy trinity, of of risk, which is really the combination of illiquidity solvency risk, leading to volatility, you will see jumps in that skew curve, the seeker will jump up vertically. And that’s what happened in March of 2020. That’s what happened in August 2015. That’s what happened in October of 2008. Well, what’s interesting is that volatility throughout this year, from January to February, perfectly followed the expectations embedded in the skew in the perfect linear way. And that occurred, really, until last week, you know, starting March 1, we finally saw that jump in the skew curve. And it’s interesting, why did that happen? I think for the first time, people looked at this Ukraine crisis, and said, Wow, this, this could go nuclear. It could go nuclear. It was right at that point where, literally nuclear, yeah, Putin began to threaten that option. And it also coincided with a number of new sanctions by Western democracies targeting the Russian banking system Swift, which I think led to some liquidity stress. So I think, you know, you know, first and foremost, you know, the situation in Ukraine is very sad. It’s extremely sad. And I think John Steinbeck once said that, that, you know, in effect, it’s, you know, war is a failure of, of man’s intellect. That that is exactly what this is, it is, it is an unneeded war, and people are suffering. So I always want to hold that. And I always want to think about that when analyzing voluntas environments, you don’t want to be making money at the expensive peoples of people’s lives and their liberty. Um, but you know, that being said, you know, our, our goal, as fiduciaries is is to help our investors take risk responsibly. And you know, the best thing that we can do in this environment is analyze it and to perform and work within that context. So everything I talked about with Ukraine and Russia, you know, is with that in mind, but I think for the first time in the imagination of investors, we saw this risk come into play and tail risk began to get bid, really, for the first time this year, above the expectations that were already built in the market. And consequently, I think you have begun to see a rebound in many of the long volatile response as a result of that.


Jeff Malec  08:31

is another way to say all that, right? We’ve been talking in January and February up until those last days that yes, VIX is higher, but fixed strike ball has declined, right or the Vols come in on these fixed strikes, set another way to say your sticky strike strike regime.


Chris Cole  08:48

Yeah, that’s, that’s exactly right. That’s another way to kind of describe that. So you know, meaning 60 Strike, you know, the market has been following. And what we mean by sticky strike has been following that, that that strike regime, almost perfectly implied balls moving up the skew curve along by strike, but then they jumped, jumped up very recently. And that that that is very interesting. And that represents a real fundamental rebid of tail risk are a fundamental rebid of risk in the marketplace. And that and that, that’s really when long ball and and tail risk funds can begin to make more money. It’s really when the Vega component begins to pay off, rather than just the Delta component, or the negative delta or the gamma component,


Jeff Malec  09:33

which we should dig into that in a second. Because the right we’ve had some other guys on have looked the other way, like it’s too expensive. It’s too you have to wait too long for the Vega component to kick in. Why not have the Delta component and gamma hedge and flip back and forth? So let’s, let’s ask you your thoughts on that. Why why is that not a great idea, in your opinion?


Chris Cole  09:52

Well, it’s not a bad idea, but um, you know, I wouldn’t poopoo that idea but I think I think at the end of the day, I’m You know, at the end of the day, it’s it’s Vega that’s going to jump if there is a fundamental fundamental risk event and a geopolitical mishap or be more convex. So it will be more convex. That’s right. So, you know, to that extent, I think, I think that’s it depends. It depends on what your objective is, you know, there’s a lot of different ways to play volatility, a lot of different objectives. But if you’re, if you’re interested in that type of convexity within that framework, that’s why you’re buying that’s what you’re buying, right? In Vegas, you’re buying Bama? And, and, you know, and that’s, and that’s what will protect a portfolio to some degree. Of course, if there’s thermonuclear war, nothing will protect anyone.


Jeff Malec  10:47

Let’s hope that’s not the case. Yeah. Let’s back up for a second. And on those. Do you believe we had too much protection in the near term like with JP Morgan hedged equity, these types of programs? buffered notes, knock ins, all this stuff? Is that was that compressing the small part of the curve there? And making those strikes sticky? What are your thoughts?


Chris Cole  11:10

You know, what’s interesting is that I would we see, at least in terms of net put delta is actually that there’s not that much there. The street is actually a little bit enraged. Yeah. Across the curb. Yeah. Yeah. And that’s, that’s one of the things that we’ve been seeing, and that if anything, people have been monetizing hedges that are exist, rather than adding on risk. And that that has been that way for the, for the majority of this year, until this last week. That’s, that’s, that’s what changed this fundamentally change this last week. And that’s what’s that’s what’s pretty interesting about that. Um,


Jeff Malec  11:43

and where do you see that getting bid all the way? Like, how far out of the money? Are you seeing it getting bad across the spectrum?


Chris Cole  11:50

So this, this really depends, I think, you know, I think in terms of how much this will get bid up, I think I think that really depends on how this, how this results. But the major, the major factor here, which is really interesting is that this ties in with a lot of the deal. This ties in with a lot of the monetary and fiscal policy risk, because at this point, so one of the things that it sort of made me a little bit upset, I thought it was a little bit sloppy analysis, because I’m sure you got this across the street where people have come in and said, well, war is a reason to buy stocks.


Jeff Malec  12:26

Yeah, definitely a few tweets of like, here’s the s&p performance on every armed conflict over the last 100 years. And it was it positive.


Chris Cole  12:34

Besides being poor taste, you know? Um, yeah, it’s right. I mean, I think I think Wall Street needs to kind of wake up and be like, hey, that’s people are suffering. Let’s like, I know, people are giving investment advice. But beyond that poor taste of that type of dialogue. I also think it’s sloppy analysis. Because if you go back and you know, looking at that framework, people are looking at the Gulf War, the War in Iraq, the war in Afghanistan, maybe even going back to Vietnam War, inflation is super low in all these environments. Right. In like, for the last 20 years, we’ve seen inflation be very, very low. Throughout the Gulf War, Afghanistan, there was room for monetary policy. Right. Even during, even during, even during the beginning part of Vietnam, there was a relatively benign and low interest rate, relatively low interest rates, but room to cut and relatively benign inflation during the first part of that war, not towards the latter part. But, you know, if you go back and you look at the beginning of World War Two, when Hitler invaded Poland, inflation was at a, I think over 8% At that point in time. So that’s more more of an interesting comp to some degree, not a fair comparison. not a fair comparison, by all means. But from an inflation standpoint, that was the last time we saw a major war, breakout with respect to that type of inflation, you know, where there’s a threat to Western democracies. And to this extent, you saw markets dropped tremendously. When that broke out. It was a tremendous decline in markets, and a lot of volatility at that point in time, and there was not an immediate rebound. So I think, I think some of this dialogue is a little bit myopic, with respect to the, to the regime that we’re in, and the fact that the Fed has its hands tied with where inflation with inflation, where it is, naturally, you know, naturally to like war. You know, war can be a war can be an inflation buffer, you know, when you’re using fiscal stimulus to say buy tanks, and then those tanks are blown up, and then that’s not inflationary. Well, We’re not fighting this war yet. So at this point, rather than being disinflationary with fiscal spending, the only thing we’re getting out of it so far is inflation, in addition to, in addition to the turmoil in Eastern Europe, so I think these are, these are really difficult factors. It’s you can’t compare it to the Gulf War. That’s not a fair comparison. When you’re trying to evaluate what this means for markets, and I’m speaking about markets here that’s only speaking about,


Jeff Malec  15:35

and I think it also ignores just the binary nature of it too, right. There’s a nonzero chance that there there’s nuclear warrior that any analysis that says, hey, you average x percent after each war ignores the threat of losing all your money, right. Yeah. So right, that’s, that’s the key, kind of the besides that, Mrs. Lincoln, how was how was the play?


Chris Cole  15:56

Yeah, exactly. So to this extent, I’m a little bit surprised, that we haven’t seen more of, of a of a jump, like a true jump involves, um, in that sense, but it also speaks a little bit to the liquidity regime and the dynamic with respect to the number of shortfall players and the way vol might change going forward. And I think that’s a really interesting thing to kind of evaluate and something that’s really greatly understated by people.


Jeff Malec  16:38

So your unholy trinity before was named the three again,


Chris Cole  16:43

it’s a illiquidity credit solvency and leading to volatility, and that’s the unholy trinity.



Jeff Malec  16:52

So where we add on on the first two, liquidity has been okay.


Chris Cole  16:57

But is getting worse much. Yeah, that is that is actually beginning to show signs of stress. Whether that whether that’s premium or premium discount discounts to net asset value in some major bond ETFs. Whether that’s interbank lending stress, we are beginning to see liquidity stress seep into the market just just now. And obviously, credit spreads have been rising as well. And that is something that’s pretty we can come back to that in a second. But, you know, you go back to my 2017 paper, the oroboros people thinking its own tail. And we talked about the, you know, over $3 trillion of implicit and explicit short volatility. And I wrote in 2017 in October 2017, that vix would touch all time highs, and all time lows and all time highs within two years. And that’s exactly what happened December, that December hit all time lows in December 2019. And obviously, we hit all time highs in March of 2020. Not not counting, you know, 1987 with the s&p 500 s&p 100 Vol is you know, I’m looking at vix but but so


Jeff Malec  18:05

you’re not even counting Feb. 18 When you almost nailed it there too. Right?


Chris Cole  18:09

Well, yeah, that’s correct to say that’s interesting, but didn’t hit all time highs. But so at this point, you had a shakeout of the irresponsible ballplayers, many of the the people irresponsibly shorting volatility, were shaking out and and utterly destroyed by that.


Jeff Malec  18:28

And you’re You’re not just saying retail there and the the Vixie short. But yeah, I mean, I


Chris Cole  18:34

think short sellers as well, yeah, that involves XIV, but it also involves a number of a number of you know, hedge funds that are no longer in existence, that were shorting convexity in various forms. You know, and I think so, if you look at if you look at vol model, right, you have all of these different vol vol ma models and ball surface models, you can fit in everyone thinks about the absolute level of all but one of the one of the major elements there is vulnerable correlation of all of all of all involved participants, right. So, while persistence is very interesting, in a regime where there is liquidity and there is none, you get the gaps up involve involve collapses back down. So in that regime, vol persistence is very, very low and vulnerable is very, very high. And that that’s due to the forced unwind of many of the shortfall players. So that is the ORA Boris eating its own tail until the dice got. Well,


Jeff Malec  19:43

now, that’s from others coming in and selling the ball when it spikes to or not. It’s going through them it’s eating there.


Chris Cole  19:50

That too. Yeah, that’s that’s a fear as well. And so consequently, what happens is everyone calibrates their role models to this high volleyball level persists. Since reality, and then, you know, in, you know, 2020, everyone’s talking about how quickly you have to sell your tail insurance. Oh, obviously, ball spikes, you have to sell it. Right? Right. You have to sell it. You’re an idiot if you keep it.


Jeff Malec  20:15

Let’s you sold it at 35 and went to 80. Right?


Chris Cole  20:18

Yes, yeah, whoops. Well, to this point, though, it’s very interesting. This high ball of ball, low vol. Persistence is a very modern phenomenon. It’s not something that we’ve seen historically, when you go back to 2008, and vol, stayed elevated over 30 for almost a year. If you go back to the late 1990s, you saw very high vol persistence, all the way between 1998 to 2002. Very high vol persistence meeting ball in a rising market from us in a rising and falling market. Yeah. Now, we don’t know what vault would have been like, what implied vol would have been like in the 1970s or 1930s. But, um, you know, it’s very, very interesting that you can look and see some of the mental during those periods by analyzing realized volatility. And there was exceptionally high vol persistence of realized wall across the 1970s. And across the 1930s, that realized volatility would have averaged about 37 to 39, over the entire decade of the 1930s. A long vol would have been a positive carry strategy, or arguably would have been possible to carry strategy 1930s for a decade. Um, so you know, this is very interesting. So there’s one element which is like you have all these shortfall players that get washed out. And as a result, they’re not shorting every ball spike. And, and or they’re not getting washed out and every fall spike, and that that reduces the the decline in vol. and reduces vol persistence and vulnerable. Or excuse me, it reduces vol persistence and increases vulnerable FOMO. Yeah, but there’s another factor that comes into play, which is the monetary reaction function. That’s another really interesting factor. So in this environment, we’ve had hyper reactive central banks. Yeah, every single time. Every single time there’s a crisis. They cut rates where they do QE, or they do whatever. Where they inventory corporate


Jeff Malec  22:28

debt. Right? Yes, Pan, they decide actual stocks and ETFs. Right,


Chris Cole  22:31

yeah, they buy stocks and ETFs? Well, I mean, hell, the Fed, and I would argue illegally, my friend, Daniel DiMartino, booth has said, it’s against their charter as well. I would agree with her, you know, spend some time with her and Lacey hunt in our offices here. But like, they sat back, and I mean, you think about that, the inventory, like they gave out loans to a special purpose vehicle funded by the Treasury to buy corporate debt.


Jeff Malec  22:56

Right? It’s a little weird. Why didn’t they invest in Artemis? Or why? Right, like, how come those companies got the benefit?


Chris Cole  23:02

Right, I guess I’m not politically corrected. Not exactly. Neck connected enough. But um, so we look at this though, they are constrained in their ability to respond. You can’t flood the market with liquidity. Or maybe you can. I never say never with with them. Yeah, they can’t flood the market with liquidity when inflation is at seven and a half percent and wholesale prices are at nine 9%. So this is this is very similar to what was happening in the 1970s. And it has a fundamental effect on the behavior of volatility.


Jeff Malec  23:39

So this point dampening,


Chris Cole  23:41

I would say not dampening, it doesn’t dampen it. What it means is vault can still rise. In fact, it has a higher average. What it does is it is it extends out the distribution, you have less peak, but you have less extreme tails, and more persistent vol. We have these situations where vol stays over 30 For a long time.


Jeff Malec  24:08

But how doesn’t that hurt? Guys like you harder? Is that a harder game to play when it’s over? When it’s long for a long time? Instead of you’d rather have the spikes?


Chris Cole  24:17

There’s different ways to play that. Yeah, there’s different ways to play that dynamic. So yes, yeah. I mean, you know, it presents interesting opportunities, because when the when the like, definitely when absolute level of all is higher, we only think about it linearly that way, right? Then that definitely you’re buying expensive ball. But when the market is wrong about vole persistence that produces interesting opportunities to play forward for.


Jeff Malec  24:45

Got it right. So people are expecting six months out nine months out 12 months out for it to have been coming in already. When it doesn’t stays up.


Chris Cole  24:54

Yeah. So and that’s, that’s, that’s quite, that’s quite interesting. And um, so it’s, it’s not just it’s not just a. So I mean, I, there’s a lot of people that have kind of talked about, you know, the I mean, I talked about the impact of short volunteerism, Teen People have talked a lot about that institutional shortfall selling. There’s a lot of talk about dealer, gamma dealer vana charm. And I think all of this is very relevant. It’s all very relevant. And I don’t poopoo the people who talk about these things, but


Jeff Malec  25:25

that makes a good podcast. Oh, come on, does make


Chris Cole  25:27

a good podcast. And I mean, that that analysis is extremely important, as part of the mosaic of understanding markets. Do you guys lose? Yes, absolutely. We do. Yes, it is extremely important in the mosaic of understanding markets. But, Mike, my problem sometimes comes when my problem sometimes comes when, you know, if you’re a hammer, everything’s a nail. Yeah. And there’s sometimes a view that that is the only thing that matters, the only thing that matters. And to that extent, we somewhat forget that maybe maybe looking at a different monetary and fiscal regime, then that has changed radically with a very different inflationary regime. That vole fundamentally is not going to behave the way that it’s behaved the last 10 years. And that is something I think that that kind of laser focus only on things like flows, misses.


Jeff Malec  26:32

Yeah. And what does what does that do for those market makers? Right, because they still have to cover those strikes your So are you saying that’s gonna still exist? Yeah,


Chris Cole  26:40

it’ll be new, slow, relevant, it’s a new flow


Jeff Malec  26:43

will come in to meet the new regime that will dwarf that. That dealer hedging flow.


Chris Cole  26:48

It’s still relevant. But but in effect, in effect, the the, it’s still a relevant part of the mosaic of understanding the markets. But it’s, you can’t it becomes less dominant as a factor. Then some other factors, other fundamental factors. So let me give an example on this. Right. Love it. In 2020. We reached all time lows in autocorrelation. On on all time lows in autocorrelation of equity prices. So what that means is that buy the dip, never paid off more ever post post pandemic, post pandemic. That’s right. Yeah. And that represented a 20 year trend downward in autocorrelation. So what does that mean in English, it simply means that buying the dip pays off, if yesterday was down today is likely to be up. Well, that was not always the case of markets. In fact, that strategy of buying the dip, which is a part of a synthetic replication of a variant swap, would have gone bankrupt if you had done it between 1919 and 1970. But something fundamentally changed in the early 70s. And take a wild guess what fundamentally change?


Jeff Malec  28:12

I was born, but that’s probably not it. Wasn’t Star Wars. Star Wars coming? Close second. Something to do with gold perhaps?


Chris Cole  28:22

Yeah, it was a dealing exactly with a D linking the Nixon shock, the D linking of gold. Right. And at that point, at that point, began the regime of central bank reactionary function, were central banks suddenly, and of course, interest rates peaked out. And then what what began was a dynamic where every single market crisis, you could rely on a central bank to save the day, introduce the Fed put essentially reintroduce the Fed put exactly over over 40 years. So here we are all the way down. And now the real question at the end of the day, and it’s worth asking, is, is that fed put valid? Or is it capable, in the event that inflation remains a seven and a half percent, or the event event that continued supply chain disruptions happen? With oil prices expanding in Russia? And you know, you have to imagine it’s a matter of time before China? China tries to take Taiwan. And what does this mean for the global for change the change in the post world war two global order of trade, but what it means at the end of the day is it will fundamentally change the whole regime. The idea that you don’t have a central bank is able to quickly respond to every market crisis because inflation is raging fundamentally changes the way that prices behave. It accentuates the right tail on commodities, and it tremendously ruins the mean reversion airy characteristics of equity markets, which by proxy proxy fundamentally changes the bowl regime and suddenly your your dynamic of extremely high ball that comes back just as fast. As with high ball ball and low ball persistence, goes out the door. So one of the things that I’ve really enjoyed to do is you can plot the the magnitude of equity involved price movements on a power law distribution. So it’s fun to do this with realized volatility or the VIX. It’s really fun to do this with this. And if you plot this on a power law distribution,


Jeff Malec  30:33

fun for some, maybe the listeners probably included Yeah, yeah.


Chris Cole  30:37

So So what does it mean like a lot of things, a lot of natural systems can be plotted on a power law distribution, which is, you know, exponential in nature. And what that means is that these natural, natural natural systems will follow kind of an exponential growth curve. And this one example is wars, the death count in wars. The average skirmish will perfectly follow along this power law distribution. But World War Two, or the Chinese Japanese war, where there’s millions upon millions of deaths suddenly exceeds the power law distribution. So when something exceeds the power law distribution, it represents a reflexivity that pushes something even more extreme than an exponential growth curve.


Jeff Malec  31:32

Right so it’s like more exponential exponential.


Chris Cole  31:35

Yeah, exactly. Yeah. So if we look at this, you know, obviously wars follow this a proxy earthquakes follow this proxy. You know, the average tremors and then you have your massive earthquakes, the San Francisco quake in in the in the early 20th century. City sizes will follow this this power law distribution, and in some cities like Tokyo violate it. And of course, you know, your favorite thing movies, follow power law distributions, your average movie comes out it fits the power law line, but Star Wars and Avatar and Titanic exceed the power law distribution in terms of their in the revenue they generate. So vix moves will neatly follow a power law distribution, except some of the VIX moves will exceed the power law distribution, both on the upside and the downside, over 70% of the top moves violations and power law distributions in vix have occurred in the last three years alone. Whoa, whoa, up and down. It’s not just up. It’s also down.


Jeff Malec  32:46

And what do we mean by that daily moves or the print these daily? Okay, so we so if it lost 16% in a day, or whatever we’re saying that might violate the power move on the downside?


Chris Cole  32:58

Yeah, exactly. Yeah. Huge moves up and down. Huge moves up and down. And the majority of the top rank ones have occurred in the last three years alone. I mean, so to put that in perspective, for a second, like who just think about that perspective, that’s like, you take the last three years, that is like Titanic, Harry Potter, Star Wars, Avengers, endgame, all coming out in the last three years, in the last three years and simultaneously, every major box office bomb, you know, right, our Heaven’s Gate, you know, John Carter of Mars, you know, all those bombs also coming out in the last three years. To me, that is that is


Jeff Malec  33:50

anomalous, something smells right. Yeah.


Chris Cole  33:53

Yeah. And you see the same thing and statistical bowl. It’s not, you know, it’s implied they’re just following realize here. So you see the same thing. So that fundamentally, whoa, when you look at that it pops out to you saying This is bizarre. This is really bizarre. And why is that happening? It’s because of the dominance of flows. flows are a big part of that. The dominance of short vol implicit and explicit strategies and the hyper reactivity of central banks that that force people into these risk premia strategies that all blow up at the same time. And then the Fed comes in and rescues and creating more moral hazard so it can rinse and repeat over and over and over again. Well, what has fundamentally changed many of those, many of those short vol risk premia strategies have been blown out and people are less inclined to put on that risk. Whether that’s a whether that’s a day trader sitting in Houston or whether that’s a Canadian Pension


Jeff Malec  35:00

System. And you mean they’re forced into those by the central banks by the rates being zero and they have to search for yield elsewhere, they have to


Chris Cole  35:07

search for yield. Yeah. And so on one factor, you’ve seen the, you’ve seen a lot of those implicit and explicit shortfall trades go away. Because of what has occurred. The second factor is you can’t have the reactivity of central banks. The reactivity of central banks is constrained greatly by what is occurring with inflation. And what is occurring in the commodity markets right now. And how, how the average American is going to be paying more in gas prices and food prices. You know, for God’s sakes, you know, my parents couldn’t find cat food the other day. They went to four stores looking for cat food


Jeff Malec  35:51

in Austin. No, no, in Michigan, got it.


Chris Cole  35:56

When they found a store that had cat food,


Jeff Malec  35:58

they bought it off.


Chris Cole  36:00

Right? Off the cat like a fine.


Jeff Malec  36:03

I think of it as like, the little kid comes up to his dad, he’s like, Dad, my ice cream fell. And the dad’s like, not now, kid, the house is on fire, right? Like the so as it prices are the the kid with the ice cream, like the Fed has this dual mandate, which they in theory only have the single mandate. So now, right, we’re putting rubber to the road here now is the test. What do they care more about asset prices or inflation?


Chris Cole  36:28

And so so that, I think is very, very important distinction. And I don’t think you can just isolate that. Because if that changes, fundamental, it does want to have fundamental changes to the way the equity bowl behaves. absolute fundamental changes to the way equity of all behaves,


Jeff Malec  36:47

and you think it’s just mentally with traitors, or that’s also actually physically there’s not people coming in and selling the wings and selling all this ball,


Chris Cole  36:54

it’ll be forced, you know, it will absolutely force because A, they because there will be more of all persistence. So you know what, what happens in that, like, much like we saw in the 70s, ball goes to 30. And it just stays there. For a long time. There’s vault persistence,


Jeff Malec  37:12

and it stays there on average, right to say that, yeah, you


Chris Cole  37:15

have an absolute higher vol regime?


Jeff Malec  37:17

Got it? Yeah, no higher vault, higher, lower vault persistence, there are no higher vault, Vault persistence. But you’re also hireable


Chris Cole  37:26

Yeah, hireable persistence and a higher ball regime. So I mean, that’s that’s um, it’s it’s it’s a it’s a fascinating dynamic, and that is a fundamental shift about the way vol will behave, that will fundamentally change the way that people will need to look at a different strategies if that is if that is the case. So part of that’s just a washout a short ball traders, um, you know, in that framework, and part of that is part of that is the part of that will be the the actual reaction function of central banks and how that impacts the realized volatility of equity prices. I mean, equity centric, obviously, commodity balls a different thing. There’ll be more realizable on the right tail of commodities in this framework. But I think you can kind of see how that all comes in, comes into play.


Jeff Malec  38:13

But part of my theory is the risk departments are infinitely better at their jobs. And they were five years ago, 10 years ago, 25 years ago, right? So used to have these big hidden risks inside a bank, and they blew up and it caused ball. Now, that’s, Hey, Chris, three strikes and you’re out. Right? You didn’t close out that position, you went over your bar limit today. We’re liquidating, you’re right, the computer systems and all that have kind of tightened up the ship on an institutional level a little bit.


Chris Cole  38:43

Let’s think about it for a second. Is it the risk departments? Or is it the quant models themselves? Because there’s, if there’s persistently higher wall across asset classes, as there was in the 1970s, back when inflation were where it is, today, we have the highest inflation since early 80s 70s. As was in the 1930s if there’s persistently higher vol. Many of these strategies, the lever with vol. So in many ways, the strategies will be forced to deliver simply by the fact that ball persistence will be higher, right they’ll


Jeff Malec  39:21

still give their investors $17 whatever but by delivering to meet the new version,


Chris Cole  39:27

yeah. If you know if you’re targeting 15 Vol and vol is at 30 You’re going to have to run is persistently at 30 and commodity vols that gazillion. You’re gonna have to pull back your, your positions, right commodity and risk parity, we’ll have to do it too. Um, and all of these quant strategies we’ll be doing it. So in many ways, it might not even be the risk department doing anything. The natural order of the markets will We’ll deliver.


Jeff Malec  40:04

But that can also lead to more volatility right as they’re delivering into a sell off.


Chris Cole  40:09

And naturally leads to more persistent wall as well, it would speak once again becomes, so it’s vol persistence. Everyone thinks in terms of gold level.


Jeff Malec  40:20

No one there is Greek for a fancy Greek for that or no.


Chris Cole  40:25

I guess no, right. Right. They should. Yeah. So but you can you can fit it. It’s one of the fit parameters for many of these ball surface models. So that’s kind of fun. You know, maybe maybe those balls surface models become a little less academic. And you can actually pull something out of that, you know, you can pull that ball persistence out.


Jeff Malec  40:45

How do you guys think about it in your programs, you’re also looking at proxies, as I call them, right? Like, hey, if index falls too expensive, may we go into rates ball or gold or whatnot. Um, explain to us how you think about that, how that works. And what you’re seeing right now, with rates ball going through the roof, I think I saw it’s been at its highest in a few years.


Chris Cole  41:07

You know, I’m a believer at the end of the day that that it’s, it’s a combination of different conditions, because what appears to be high, what appears to be high, may only be high by looking in the rearview mirror. Hmm. So, of course, that can be that can lead you to trouble too. But, um, yeah, let me give an example. Like, I’m not saying we’re going to go into hyperinflation. Please don’t infer that from this. But, but like, if you looked at the German hyperinflation, you know, bankers would come out and they’d be like, Okay, we’re gonna lend you lend you money to buy this thing at 2%? And they’re like, Okay, now rates are higher, we’re gonna lend it to you at 5%. And people were like, oh, rates or rates are high. And well, what is your at 8%? It’s like, okay, well, that well, rates are high, we’ll let it to you at let it to you at 20%. And oh, my god rates are really, really and then and then they just stopped lending and any interest was at, you know, 1,000%. So, um, to the same fashion?


Jeff Malec  42:14

Um, that exceeded the power law there as well.


Chris Cole  42:18

So, you know, for a long time, people would say that 27 wall is high. But 20 sevens, exactly where vol averaged in the late 90s. That was average wall in the late 90s. And someone might go back and say 30 Balls expensive. But vol averaged 3037 to 39 on a Realized basis in the 1930s. So, you know, I don’t think you can necessarily divorce, volatility from the, of any asset from the macro environment. You know, the the vol of oil is fundamentally different today, given what’s happening geopolitically than it was six months ago. Um, so in that sense, you know, it’s an analysis of all whether it’s quantitative or qualitative, you know, requires not only an understanding of dealer flows, I’m never gonna, I think that I think that work is incredibly important. And I respect the people who do that work. But it’s, it’s not only a basis of looking at flows, but it’s also a basis of looking at things like everything from, you know, monetary, fiscal policy, geopolitics, and trying to quantify each of those factors in some sort of a way that that can be repeatable and unusable. Definitely flow is one of the things that’s most data driven and some some of the easy, one of the easiest things to kind of look at. But, you know, to this extent, you know, liquidity and credit, stress, I think, are paramount equity, Vol. And I would argue, just as important in many conditions, and there’s a lot of good data that one can observe to those effects to understand ball persistence. So what is what is high or low vol, is really dependent on the specifics of a cross section of data analysis across these factors.


Jeff Malec  44:16

And as we spoke about earlier on, it depends what people are expecting and what actually happens is even more important, right? Yeah, that’s you. That’s exactly right. So but as you guys are using those tools, how do you think about that you’re it’s a Vega play in rates and in gold as well, or more of a Delta play in those.


Chris Cole  44:33

I mean, you can you could be a Vega play or you can, you could tilt it as well, in a direction. So, but I think to some extent, to some extent, clients may have a preference in one way. Clients may have an objective to that set. And and so you’re seeking to meet that objective. So it depends. Are you looking at it on an overlay basis as a means to protect a particular portfolio? Um, you know, what, what type of what type of pain points does the client have? And, you know, how can how can you address that pain, those pain points by your exposure to you know, they get gamma deltas and you know, in higher order Greeks like like Bama for example


Jeff Malec  45:22

let’s change the subject here for a minute. So you’re known as the bald guy, but your newest pet, so to speak, is the dragon portfolio. So I first got to ask you what’s with all the animal names? You’ve got the Aurora Borealis, the dragon, the serpent, the hawk? Does that come out of your brain? Or what’s with all the animal names?


Chris Cole  45:42

I guess it just comes out of my brain? I don’t know.


Jeff Malec  45:44

Right, Artemis itself, right? Or


Chris Cole  45:48

the dragon came out of I’m just kind of an accident because I wrote that paper allegory, the Hawkins serpent. And I looked, I looked back over 100 years back testing all these different quantitative strategies. And you know, they’re all out there. And the thing about the the allegory of the horned serpent paper is that the the the appendix is actually longer than the paper.


Jeff Malec  46:07

It’s not easy to do, especially with volatility, right? Yeah, exactly.


Chris Cole  46:11

There are a lot of interesting assumptions, I think valid assumptions, but that, but you know, Saxon, I always looked at that that analogy, you know, the serpent represents a regime of secular growth, and moral hazard and reflexivity. And, you know, in the Iliad, a hawk comes down and kills the serpent and the hawk in this case represents secular change. It represents either inflation or deflation, you know, the right wing of the Hawk represents inflation, and the left wing of the Hawk represents deflation. So you end up having a hawk come over, and and disrupt the corrupt oroboros of the snake eating its own tail. And of course, what the dragon represents is the combination of a hawk and serpent. And that’s you get a dragon. And the dragon portfolio, the 100 year portfolio diversifies, it’s really meant to be a competitor to a 6040 portfolio competitor to a risk parity portfolio, because the vision of the Dragon portfolio is to diversify based on thematic regimes of markets, and not by asset classes. And so to this extent, the dragon portfolio combines assets that perform during periods of inflation and stagflation. Of course, that would be Fiat alternatives like gold, silver, and commodities. And, and, and then commodity trend advisors, commodity trend advisors are a big component. Obviously, then you have assets that perform and deflation. That would be volatility and fixed income. And then you have assets that perform in periods of secular growth. And that would be that would be assets like stocks, equity. And so you combine all of these assets together, not predicting what regime you’re going to be in. And you apply some degree of leverage to reach your volatility target. And, you know, when tested over 100 years, I think quite credibly, as outlined in that paper. That is a portfolio that outperforms and more importantly, outperforms almost every single systematic trading strategy, and importantly, performs in every single regime, it performed, you know, during the Great Depression, you would have gotten huge returns in long vol. and commodity commodity trend and fixed income during the stagflation of the 70s You got it, you would have gotten huge returns from CTAs and field alternatives like gold during periods during the last second boom in the last 30 years, you get a big performance out of both fixed income and obviously stocks and real estate, you know, the sector growth. So the dragon portfolio diversifies based on thematic exposure, not by not by not by asset class, and it does not rebalance it assuming it does it rebalances but it maintains a constant weighting of these thematic asset classes not trying to predict and not using volatility as a as a metric to rebalance correlations, we risk parity those so different


Jeff Malec  49:17

from risk parity, and that it’s not levering up bonds, forex to equal equity, VO It’s just everything


Chris Cole  49:23

all of these asset classes are held in about 1/5 exposure and they are all leveraged linked together to the extent to hit the rich to hit the ball target and so you know why the animal names and that particular product well because it combines the hawk and the serpent that is the dragon and the dragon is a is a universal symbol of of prosperity and strength.


Jeff Malec  49:45

And was it was it that paper another one that had the news clipping of was in a Montana where there was a forest fire and that they found the hawk crisp stuff that was holding the snake?


Chris Cole  49:56

Oh, yeah, that wasn’t that paper. Yeah. But that was in the appendix. Yeah,


Jeff Malec  50:01

I read the


Chris Cole  50:03

you really read it? Yeah.


Jeff Malec  50:06

Like what? That was a great fun what you must have been digging deep for that one.


Chris Cole  50:10

Yeah, you know, you’re like, you know, you spent a lot of time looking at hawks and serpents. Oh, look at this,


Jeff Malec  50:14

maybe the the powerline fried it, it went down, but then a dragon launched, there’s a dragon flying out there. So


Chris Cole  50:21

it was reborn as a phoenix. Exactly.


Jeff Malec  50:25

But just to put a finer point on that. So risk parity would say, Hey, I made 20% in s&p, I made 5% in fixed income. I’m gonna lever the fixed income up for x. So I made 20%. And both in that same scenario, if you make 20% in stocks, 5% bonds, that’s all you get, you’re getting the 20 and the five, adding them together. And


Chris Cole  50:46

that’s right. Generally, what happens is that one or two of the asset classes are outperforming by a large margin. And that’s what we’ve seen this month, you know, that, you know, in Dragon we actually have seen, you know, this particular month, equities are hurting but Fiat alternatives gold and Fiat alternatives. CTAs obviously, are ripping it and the ball vols returns have been good but muted, you know, you know, I think we were talking a little bit at about that before coming on is what we talked about with the fix strike, and in some of dynamics there, but overall like that, you know, so this month, fixed income has not been doing well, or that well, it’s kind of been flattish, and, and stocks obviously not been doing well. But these other asset classes move so well, that, um, that, that has led to lead to positive returns. So I think that’s what you see, but take that same idea and extend it over a decade. Right, I


Jeff Malec  51:41

was gonna ask that. Do you think like the CTA returns, it feels like a decade compressed than the last three weeks? Um, but that’s the idea. If you usually wouldn’t see inflation or have you in your testing? Do you see it in like, such a short period of time?


Chris Cole  51:55

Oh, yeah, definitely. Yeah, absolutely. So, um, uh, you know, 1970 saw a huge ramp up inflation very similarly. So this is the thing, you know, when when they say all inflation is transitory, and I, you know, okay, maybe, maybe it is, I don’t know, I’m not an economist. But, you know, I am a student of financial history and inflation is clearly here as close as it gets, I guess, in the adult science, but inflation is rarely transitory. You know, when inflation gets moving, it’s rarely transitory. Um, and, and


Jeff Malec  52:27

I think that’s a made up word. I don’t think they had that word back, right? In the 70s. They like


Chris Cole  52:31

to make up words don’t say, quantitative easing. Quantity.


Jeff Malec  52:35

And then how do you think, and I gonna know the answer, but how do you think about the bonds? Like who in their right mind would want to own bonds right now? At the zero bound? And like, why not just time it? And say, Hey, I’m gonna get back in bonds when rates are good when I don’t have the duration risk or whatever.


Chris Cole  52:53

Now, I mean, it’s a good point. You know, I think certainly you might move around where you on the yield curve, but um, you know, one of the things I always say is, you know, don’t don’t predict prepare. Why would you want to own bonds? Well, let me give a shocking idea here. What might actually cause us to tip back into a massive deflationary crisis? Well, I presented a chart at this event in Austin, I was very gracious of Steve dropping to invite me to speak at it. And it generated a good degree of a good degree of debate among the participants of this particular conference. But a paper I wrote in 2012, I had this visual image and the image was like, just imagine the global economy as a global economy as an armada of ships. And the ships are sailing through a narrow street on one end of that street is is the waterfall of deflation. So no one wants no one wants any of the economies and their ships to follow this waterfall of deflation. But on the other side of that straight of water is the Hellfire inflation. So if you get too far close to that you’re going to burn up. If you try to try to swing from one to the other, you can run the big problems. Well, there is a narrow street right now. There is a narrow street and it’s directly related to my unholy trinity of volatility. And that that straight represents the amount that interest rates can rise before we have massive corporate defaults.


Jeff Malec  54:36

So this was the chart. Yeah, this was the chart. So


Chris Cole  54:39

I’m right now corporate debt. Now why is this related to derivatives well. Credit solvency is volatility. If you take a chart of OAS Sprint’s and overlay it on top of the VIX, you will see what I’m talking about. So define is for the listeners, option adjusted spread, so we’re the credit spread. So this the spread the spread of high yield bonds over investment grade bonds adjusted for optionality Got it? Got it. It’s a credit worthiness and how much how much people how much investors are willing to accept in terms of credit risk. So if you take if you take that that chart of of the investor appetite for credit and overlay it on top of the VIX, they are one in the same. So right now we have the highest corporate debt to GDP in American history. It’s about 47%. So huge. It’s a very scary chart. extremely scary chart. Never before has there been more corporate debt, but not really a big deal, because interest coverage is fine. Right? Right. Corporations have no problem servicing that debt. Because what they’ve done is they’ve went out and they they reified, or they’ve rolled all that debt on at super low levels as rates came down. And they extended their duration to the maximum duration. Now it’s about five years. Okay, great. So no big deal. Well, at some point, those corporations are going to have to roll that debt. And there’s the largest tranche of corporate corporate debt at the lowest grade of investment, investment grade. I think it’s over 2 trillion right now in the junk bond market is only 800 billion. I think those numbers might be dated, but it’s approximately


Jeff Malec  56:35

that level. But out of the 47% of GDP, we’re saying like, the biggest chunk of that 47% is in junk bonds, or




Chris Cole  56:43

is in the is in the investment grade, but just above junk. Got it? So those bonds get downgraded who there will overwhelm the junk bond market.


Jeff Malec  56:56

Right, right, right for Wilmotte. Like quadruple, it says, yeah,


Chris Cole  56:59

yeah. And so what’s going to happen, then what’s going to happen to junk bond yields, they’re going to explode. And then a lot of companies that could get financing are not going to build to get financing, and they’re going to go under? Well, it’s fine, as long as rates stay low. Right. Well, so what this chart shows is it shows um, how much can rates rise, before corporations are going to be forced to spend anywhere between 33 to 50% of their profits on debt service? And the answer is, if corporate debt yields rise up to where they were in oh seven, all it has to do is for them to go back to where they were in 2007. US corporations will be forced to pay are anywhere between 25 to 50% of their profits to servicing that debt. If rates raise back to where they were in the 1970s 100% of corporate profits, will go back to servicing the interest on that debt. So you can look at this like an arm, you know how the arms that caused the housing crisis back in the day? This is a big, yeah, our adjustable rate mortgage, adjustable rate mortgages. So, so it’s fine as long as we see low, but this is this is a massive volatility trigger. It is a deflationary time bomb. And as my friend Mike Green, told me, when I when I sat down and talk to him about this, he’s like, Chris, you’re, you’re an optimist. And I’m like, like, What do you mean by like, my dress like he’s like, you’re assuming these companies will be able to roll their debt. Many of them won’t be able to roll them in. So to this point, the Fed can’t raise rates that high, but they can’t let corporate yields go that high, because it will be a collapse of corporate profits. Which, of course, will be a massive collapse in the s&p and a massive collapse or massive increase in volatility. So the inflation could lead to a deflationary crisis of epic proportions.


Jeff Malec  59:44

And that just looks like I can’t roll that debt. I can’t service the debt. I’m suing to stop taking on the debt and stop building my business. Right. Yeah, deflationary.


Chris Cole  59:53

And you may see this rapid rise in commodity prices craziness until at Some point 50% of corporate earnings now have to go to servicing debt. And the junk bond market is now $2 trillion. And we are thrust back into a violent deflationary reality. And, you know, I’m just not smart enough to know when that might happen, how it might happen. So to that extent, it’s a matter of just not predicting and holding that. Because, and, you know, it’s interesting, one of the things people don’t realize is that, um, you know, even something like a bear flattener has actually performed really well. Yeah, I mean, the long end of the curve is going up, but it’s not going up as much as the short end has. So you could actually put on a long duration trade and make money.





Jeff Malec  1:00:47

Right? Yeah, for the target dragon. Right? If you’re thinking in 100 year terms, or even 10 year terms, like, if you can hold out the duration, you’re going to get your money back with whatever interest right, so yeah, but


Chris Cole  1:01:00

but to this to this point, you you hold, like, we’re not trying to predict what regime we’re going to go into. We just we just want to hold an asset class that will perform in whatever regime we need it to be. And so if, if you take if you take your fixed income down to zero, you’re naturally making a huge prediction on the thematic regime. And, and we actually see that as a violation of, of the ethos of what the dragon represents, and is intended to do,


Jeff Malec  1:01:26

and how they like CTAs. And I’m a card carrying member of the CTA fan club, but it seems like there’s the most basis risk bear, right, like they’ll perform in inflation, they’re performing deflation, they’ll perform in a crisis period. Right? They’re not necessarily structurally set up to do so. What you could argue me on that, but just how do you think about that, that risk of the CTA, the commodity trend in the portfolio, right, like their mandates not to capture inflation.


Chris Cole  1:01:55

I’m a huge fan of CTS. And I credibly have, I mean, I guess it’s trendy to now but I mean, credibly look at my writing back in 2019. Before all this started, and, you know, I think I made that case. So but I believe CGH should be the same as as longwall funds, there’s basis risks and longwall funds, you know, you can be in a tail risk fund that bleeds and bleeds and bleeds and bleeds. And that makes money, but it’s not an alpha, you know, it’s not an alpha product. Um, but so that’s the only basis certainty you can get as a tail risk from that bleeds and bleeds and bleeds. You know, there’s those guys who’s naive put by essentially, yeah, and I’ve put Brian, like, the guys who sit back and say they made 1,000%. Yeah, in March of 2020. And they’re they’re quoting, they’re quoting on their, their option premium, and they’ve lost 100% For the last 10 years prior. Right. I mean, it’s, it’s comical in that sense. But, um, and I would say even unethical to call


Jeff Malec  1:02:49

Yeah, we’ve covered that on here before, like, yeah, you lost on a made 6,000% You lost 6,000%, the last five years before that.


Chris Cole  1:02:57

Yeah, exactly. Like, you know, it’s but to the basis risk concept. You know, if you are, if you’re a long ball trader, you’re trying to find it in smart ways to carry long ball affordably, and some bleed is expected to that said, if you can carry neutrally or positive, you’re a hero, if you’re performing in those in those down periods. Similarly, CTAs, you know, you’re gonna have basis risks, because there’s some CTAs that are gonna be holding for two weeks, some CTA is gonna be holding for two months, some CPAs that are intraday, as you know, and probably know, much better than I do. So, you know, my view on all this is that you do not want to silver bullet, you don’t want to invest in one CTA, you don’t want to invest in one blombo fund, you want a mosaic approach, and I think that’s incredibly important to to, to building that aggregated portfolio. And so, you know, to that extent, it’s almost a commercial for what you do.


Jeff Malec  1:03:57

A great leading question, but


Chris Cole  1:04:02

not intended to be, but I really believe that, and I think that’s, that’s how a lot of our smart clients look at


Jeff Malec  1:04:08

  1. Right? Right. My worries. And when even when we’re putting clients in CDs, and I’m like, okay, there could be some inflation environment, where it’s all driven by oil, and everything else is going down. And the CTS flat, right. There could be some environment where it doesn’t catch it. Just so everyone’s aware of that. unlikely but it could happen. That’s right. Yeah, that’s absolutely right. And then gold. We talked a little bit about I’ve had a love hate relationship with gold over the years like I was proven right up until the last 20 years, I guess, or 10 years, right. It’s gone on a tear. But how do you think about gold is that for the dollar debasement? Right? Is it is it a Fiat hedge, so to speak? Yeah, it’s a Fiat hedge. That’s the way I look at it, in which which environment that’s the inflationary environment or not. So it’s a


Chris Cole  1:04:58

very simple environment on gold. Well, when when real rates are trending negative, it’s the most misunderstood asset. Right? Not inflating, it’s not necessarily an inflation hedge. It’s a hedge against negative real interest rates. And so that’s that’s when gold is performing when the when real rates are trending lower, or when the expectation of real rates are trending lower gold as well. And, um, and, you know, that’s, that’s naturally what’s happening here. You know, why is gold doing? Well, it’s no mystery, right? inflation’s at eight and a half percent. And you know, bonds are, our yield bond yields are going up, but not enough to match the inflation rate.


Jeff Malec  1:05:34

And the real rates still negative to


Chris Cole  1:05:37

negative real rates are getting more negative and guess what’s going to perform gold goes down. It’s that simple.


Jeff Malec  1:05:43

And what about crypto?


Chris Cole  1:05:46

You know, it’s I, I spent a lot of time at this conference target some interesting crypto people. And I, I own personally, some crypto and, um, and I said in the paper, you know, I even said in the paper, it’s, it’s valid to kind of put, you know, anywhere from 25 basis points to 1% of your portfolio in crypto, because it’s either going to go to 100, or it’s going to go to zero, right? And I’m not smart enough to know. Um, ah, so it’s very controversial. Dynamic, um, I think crypto has shown elements of being a hedge like gold. So sometimes it behaves that way. And then sometimes it just behaves like a tech stock,


Jeff Malec  1:06:34

right, a risk, total risk on risk of, yeah, so


Chris Cole  1:06:37

I am open minded to it. I personally own it. Um, I do think that there is a asteroid coming for the crypto space in the form of regulation. Um, I look at some of these device shops, and they look like bucket shops from the 1920s. I’ve had interesting conversations, some very smart, I’m not very smart people in that space. They were doing very interesting things. I think there’s a lot of opportunity. So I’m not I’m not some, I’m not bashing crypto, but I think there is a regulatory KYC asteroid coming. And some crypto firms will be mammals and some crypto firms will be dinosaurs. And I’m just not smart enough to know who’s who’s who. So, um, but there’s


Jeff Malec  1:07:23

a lot of people out there who would design dragon and say, forget the gold. We’re gonna use crypto instead, right? We’re gonna use that as the Fiat hedge. Yeah, and I, you know, I, you’d prefer the thing that’s been around for 10,000 years. Yeah,


Chris Cole  1:07:36

yeah, gold’s got a 2000 2000 year history. Right. Yeah.


Jeff Malec  1:07:41

Um, prices are like literally they were right, right.


Chris Cole  1:07:44

Yeah, literally, I mean, literally, you can get gold prices going back to 1200. So I, I’m not against the inclusion of gold, or of excuse me of crypto in in a dragon style portfolio. I think if you’re putting 10 or 15 or 20%. I just don’t know if that I would not think that’s responsible.


Jeff Malec  1:08:10

Right? Well, you that if you started in a year ago, you’d have some bruises to prove it


Chris Cole  1:08:16

now. So I love momentum trading crypto, crypto, crypto kind of looks like commodity markets in the 80s. or Now you can momentum trading. And that’s kind of fun. I do that in my fun. I do that personally.


Jeff Malec  1:08:30

And that’s my new favorite line like commodities in the 80s or now.




Chris Cole  1:08:33

Yeah. It’s but it’s super it’s super fun to kind of kind of trend Trend Trade crypto. But I’m definitely not the right person to be talking about it other than those those those feeds. So


Jeff Malec  1:08:52

before we let you go and big Star Wars fan is no so you had a great piece all the way back in 2016. Explaining how George Lucas his real brilliance wasn’t Yoda or Han Solo but his optionality so people can go read the piece I’m just gonna ask you because happened after the piece where he sold out to Disney for 2 billion, right? Yeah. Did he become did he shift off his optionality brilliance to cashing in it did he go short bonds and a long ball.


Chris Cole  1:09:22

Hey, Toby, sell something for a billion dollars. I think, you know,


Jeff Malec  1:09:27

he got a million stock and a billion in cash.


Chris Cole  1:09:29

I think he definitely sold it cheap. I was interesting, you know, um,


Jeff Malec  1:09:35

because Disney had they were flipped, right? The rolls. They had huge optionality on that and it’s paid off in spades.


Chris Cole  1:09:41

Huge optionality on it, like they were able to unlock things. You know, maybe George Lucas is looking at a different type of life optionality right now. You know, at his dynamic you reach a point, maybe, maybe George Lucas’s optionality is spending more time with his grandkids or something like that. I can’t I can’t theorize but I But the original paper, the original Star Wars paper, which was super fun, and, you know, that was all about like finding like Lucas way back in the 1970s he was coming hot off American Graffiti. He was a big, big time young director. And he was offered a I think it was a million dollars to direct Star Wars. And he said, Hey, why don’t you only pay me $500,000 And I want to buy the licensing and sequel rights to this movie. And um, you know, the fox executives laughed at him. They laughed at him. Um, and the reason being is because at that point, they had tried merchandising, with a movie called Dr. Doolittle. Not the one with a nine. Right? Yeah, not the Eddie Murphy one or the Robert Downey Jr. One this is way back at sorry, I don’t think Eddie Murphy did when it was a disaster critically and commercially. Um, they actually bribed people to get it into the Oscars. So I think it did get nominated for an Oscar based on bribes alone. But they were they were left Fox was left with like $2 million in the 1960s of like, worthless llama merchandise from from their doctor,


Jeff Malec  1:11:19

do you got a picture of it in the paper then?




Chris Cole  1:11:21

Yeah, that’s right. So they’re like, they’re like, We don’t like this George Lucas fool. What’s he going to do with the merchandising and sequel rights? Of course, what Lucas did from an optionality standpoint, is that he sold the middle of the return distribution. So he was getting he had a carry he had carry, but he sold off some of that carry in order to buy left and right tail optionality. Right, that paid off tremendously, so that that $500,000 option he bought, actually became a multi billion dollar payout huge. Um, you know, analogous today, like, you know, people will sell the middle of the return distribution by tails, they might sell term structure roll down, but by tails, you know, Star Wars, if Star Wars was a modest hit, that would not have paid off. But because Star Wars was a power law distribution hit it, it was a massive convex payout. So to this extent, you know, you can look, you look at that and, and as a proxy for both wall trading and life, but I think I think, you know, maybe, hopefully I’m at a point in my life, one day, where you trade in the optionality you get from trading for a different type of life optionality. Yeah. And we have no idea what type of life optionality George Lucas might have gotten.


Jeff Malec  1:12:53

Well, I was I was upset when they they screwed up Chicago screwed up, they were gonna have the museum here. And the Friends of the park pushed it away because it was going to turn on turn everyone’s tailgating spot outside Soldier Field into a museum God forbid.


Chris Cole  1:13:09

So you’re gonna have a Star Wars resume.


Jeff Malec  1:13:11

We lost it. I was gonna go knocking on a


Chris Cole  1:13:14

park with that with that mural of all I really want to Star Wars character.


Jeff Malec  1:13:19

I know that posters are coming we’re sending you some posters. Now were you upset we made you Anna kin were you upset because he he turns to the dark said I wasn’t trying to say turn


Chris Cole  1:13:27

though. I loved I loved it. I love Danica I love being young Darth Vader I love it. I think it was I think it was Carl Jung who said you know your roots have to reach to hell. So your branches can go to heaven. Oh, I like it. And so I like I like Anokhin I’m definitely on you know when you’re whenever you’re playing left tail vol you’re definitely on the dark side. So but but but you know he comes around in the end he becomes one of those ghosts


Jeff Malec  1:14:03

right he was a force ghost when they did the RE redistributed or whatever.


Chris Cole  1:14:09

Hopefully I can become one of those ghost people one day and


Jeff Malec  1:14:13

guess what you’re going to be on this art because usually when we do our part there’s like a little glow around the head. So you’ll be a force ghost on this potter. Oh, yeah,


Chris Cole  1:14:25

I love it. So I absolutely love it.


Jeff Malec  1:14:27

And then I got to mention my second favorite paper because you have two papers on my two favorite things Star Wars in the 90s bowls. So you tried to explain why people need this negatively performing long ball thing by saying Rodman was a great fit on the bowls.


Chris Cole  1:14:42

Yeah, no, I mean that’s that’s that’s, that says it all right there. It’s so simple that the robin thing because you know Robin So Dennis Robin, lowest scoring inductee in the Basketball Hall of Fame guide really didn’t have never average only average over 10 points one time on his entire career. And in fact, he was so bad at scoring, you would put them on the court and you wouldn’t have to garden you know, he was that bad over there. But Robin was so good at one thing. And he was in fact, he was so good at it. He was six standard deviations above the norm in rebounding the basketball. So, you know, what does that what does that mean exactly? Well, what happened is when you put Robin on the court, and they only knew this by doing advanced statistics later on today, you put rod on the court the offensive efficiency of his teams went through the roof so even though the guy couldn’t score every single time he was on the court his team didn’t massively better at scoring right


Jeff Malec  1:15:49

the guys who could score got second third fourth chances they got second third fourth


Chris Cole  1:15:53

chances exactly right. So um, that you know, you get Michael Jordan misses a shot Dennis Rodman gets the rebound, you’re not going to miss the shot again. You know, Isaiah Thomas, Joe do Mars they miss the shot, Robin gets the rebound. He’s going to be able to get they’re going to score again.


Jeff Malec  1:16:08

So we don’t talk about him on the Detroit teams just just the bolts. I was I wasn’t a trick guy. So


Chris Cole  1:16:13

we were like enemies back then with that guy. All right. Yeah. But, um, but so in that sense, Robin is like long ball is like CTAs in that sense. So when, when the rest of your portfolio is missing. Volatility gives you the opportunity to take a second shot,


Jeff Malec  1:16:35

rip theory bouncing take those profits put it back into the the offense.


Chris Cole  1:16:40

So Rodman’s wins above replacement value, which means like, how many extra wins did Rodman get his team was one of the highest in NBA history. The guy was truly represents maybe a top 20 player in the NBA across time. This is something that’s really interesting because we came out with a paper last year, which looked at a metric called wins above replacement portfolio. It’s wins above replacement player for the investment portfolio. It’s it’s a metric that allows people to substitute in it’s a better metric than Sharpe ratios. So what’s fascinating is like Dennis Rodman got overlooked he was a second round draft pick people he I think the bulls got him by trading will Purdue will expect a will Purdue was the backup center. So people didn’t respect Robbie’s a


Jeff Malec  1:17:34

better announcer these days, yeah, yeah, that’s right.


Chris Cole  1:17:38

With respect to well, Purdue, I’m Robin was not his value was not seen. It’s the same way for long bowl. It’s the same way for CTAs. People sit back and they say, Why do I want this thing that bleeds? And what does it do? You know? And the reality is, the question is, does it help your team win? And you can measure that quantitatively using this metric we develop called C warp. And what C word does is, you assume you borrow capital, and you invest in a hedge fund strategy, and you layer that strategy on top of equities, or whatever your portfolio is. And then the question is, does that asset layered on top of your portfolio, increase your Sortino ratio and return to drawdown ratio? And if it does, it has a positive seawork. It’s like it saying that asset it’s your portfolio extra wins, adding wins now, and as it turns out, 70% of hedge funds have negative see worse, even if they have so they negatively impact your portfolio simply because they’re replicating the same exposures you have in stocks or bonds. Only 30% of hedge funds have positive wins above replacement portfolios. And guess what is the number one right above? Mambo? Yeah, long ball relative valuable and CTAs are right at the top. So, you know, it speaks to this idea about their value in the portfolio, to hedge against inflation, to hedge against stagflation to hedge against deflation. And I think a lot of the institutions haven’t woken up to that fact, go on our website, if you’re interested in this, if you’re seeing if you’re interested in seeing the sea org metric, we have the paper the calculations either and we even have a GitHub repository, where you can download code to implement that. And I think that’s an effect There’s a website called allocator that is a hedge fund database that actually is now using C sharp as part of their process. So um, and I will say this much if you use C work in an iterative process, you get better results than a Markowitz portfolio optimizer.


Jeff Malec  1:19:49

Do you think? Over time, have you? Are you still trying to explain this to people like it’s right over since 2008? You’re still trying to explain even to institutional investors like that still? don’t get it. Why don’t why don’t they get it? Yeah. Are they new? Have they turned over? And these are the new guys you have to convince?




Chris Cole  1:20:06

I think there’s I think there’s a I mean, I think I think most institutions don’t get it. Sadly, I think there’s I think there is there. Look, there’s there’s a number of very smart institutions out there that are massive, right? So if your $200 billion, um, you just you have no ability to adequately Yeah, to do this. And that’s understandable. And you’re the Norway


Jeff Malec  1:20:31

sovereign wealth fund, you own everything, you own every asset. And whatever happens happens. And if


Chris Cole  1:20:36

exactly, and if a drawdown happens, it’s going to happen. And so that that’s pretty valid. And I understand that. But if you’re a $3 billion endowment, or a $1 billion family office or a $500 million family office this is this is very important to understand. Yeah. And I think there’s a number of different institutions that do get it, the ones that get it really get it. Um, but sadly, I think most don’t, and I think you see people chasing performance, you know, a long ball fund is super popular after a spike. Yeah, but it’s sorry. That’s, you know, that’s not the best time, and they’re super unpopular after a long period of low performance, so, and bleed. Um, so I think it’s, it’s kind of the equivalent of saying that, like, Hey, we’re on a, we’re on a scoring streak. We haven’t missed a shot. Let’s pull Rodman out. Right. Yeah, maybe that we’re left? Well, you know, we’re up three, three goals to nothing on the soccer field. Let’s pull our goalie


Jeff Malec  1:21:49

what could go wrong? What could go wrong?


Chris Cole  1:21:50

And then yeah, so I think, you know, and then it’s like, oh, no, the other team has scored five goals. Let’s put our goalie back in, or for what they do. Is that like, okay, let’s, oh, no, we’re now down. 30 points. Let’s, let’s put in three Robins. Right. Right. So


Jeff Malec  1:22:10

I think it’s also a line item problems, right? Like, they just see it as a line item and get sick of it. If it was combined from the start. Right, then they never see the bad, they just see the good. They just see the blended performance that works out better


Chris Cole  1:22:23

blended performance. I think this is something that this is why it quite credibly, it’s most effective to do this as an overlay framework, you know, to like, that’s the beauty of derivatives is that you can, you can overlay derivatives on top of different equity exposures, or whatever exposures, credit or whatever, and not have a massive outlay of additional capital. That’s the most efficient way to run these strategies. That’s how most of our strategies are run. I imagine that’s how most of your strategies are run. Sadly, it’s difficult for smaller investors to access that I think people smart people like Mike Greene and Paul Kim at simplify are trying to solve that problem. But you know, it’s it’s a it’s the overlay and it has to be blended. But people have a lot of problems. A lot of problems. Just buying the asset by itself. Just like someone will look at Dennis Robbins, it’s got a score. Why


Jeff Malec  1:23:13

aren’t why do we want them on the team? Yeah, well. Last segment here, probably Let’s go. Your hottest take what nobody’s talking about what everyone’s talking about, but gets wrong. Get get yourself in some trouble. Oh, man.


Chris Cole  1:23:33

Look, I’m gonna go back because I think that’s so powerful. So powerful. That idea. if rates go back to where they were in 2007,


Jeff Malec  1:23:44

corporate America will go insolvent, which is what that number.


Chris Cole  1:23:49

That’s that number is like, if we if we have a renormalization of rates to 5%. And corporate credit yields go up to seven to 8%.


Jeff Malec  1:23:59

It’s over. Yeah, not to mention, like mortgage consumers and everyone who can afford that also. Yeah,


Chris Cole  1:24:06

it’s over. Yeah. So So in that sense. I mean, like, let’s think about what the Fed did in March of 2020. They backstop the entire corporate credit market, specifically fallen angels. They had this plan in advance. They knew that if all of those if that lowest tranche of investment grade got downgraded investment, regret debt got downgraded that it would be game over.


Jeff Malec  1:24:30

Which brings up an interesting point, like they’re smarter than they look right. So they they’re sitting there thinking of ways to not let these things happen.


Chris Cole  1:24:37

Yes, yeah. So the question we have to pose and I actually posed this to some very smart people, including one of the individuals who was profiled in The Big Short, um, you know, how, what could they do?


Jeff Malec  1:24:49

What’s the name Ryan with with furry? Yeah,


Chris Cole  1:24:52

actually, not not him. But like, what could they do? You know, do they have this I posed that question to Lacey hunt and Daniel DiMartino booth? Um, because you know at that, I mean,


Jeff Malec  1:25:03

one of the things they could do is do the same thing again, but then yeah, but


Chris Cole  1:25:07

then, you know, under a democratic. So keep in mind, the Fed did not buy the corporate bonds, they didn’t buy the ETFs. They were giving loans to a special purpose vehicle that was owned by the Treasury to buy those. So that means you and I were buying them, right. Using loans from the Fed.


Jeff Malec  1:25:24

I didn’t get my check. Did you get your check? Yeah,


Chris Cole  1:25:27

yeah. Didn’t so what like, it’s interesting, like in a polarized world where there’s massive income disparity and people suffering. Will the government, the US Treasury meeting, you mean, every other taxpayer be able to inventory? trillions of dollars of corporate debt? Will people be okay with that, especially when that debt was used for share buybacks,


Jeff Malec  1:25:50

but especially if they just add some zeros in the system and buy those right like MMT? And say, well, it doesn’t really matter. They’re just fictitious digital zeros that we bought this stuff


Chris Cole  1:25:59

with? Yeah, this is where I’m not smart enough to know. But but here’s the thing. That’s interesting, right? If you can get 5% inflation a year, steady, then you lower your debt problem by third in five years, you can inflate it away. So if that’s the straight, right, right, if you can keep inflation at 5%. You’re in the middle of the straight. If inflation goes to 10%? Yeah, yeah, you are in trouble.


Jeff Malec  1:26:28

You’re on fire. And if you go off the waterfall on the other side, you’re in the depths of despair.


Chris Cole  1:26:33

That’s right. Yeah. So it’s, it’s a, it’s a difficult, it is a conundrum. And the point being is that that will impact the ball environment, you are likely to have stagflation, airy, high persistent ball. Until May, maybe that happens. And then we’re back into deflationary sucker punch. You know, this is fourth turning stuff. Um, so, and the other way out of a debt crisis is a global war,


Jeff Malec  1:27:05

or a global reset, have been pushing for the global reset, right? Why don’t? Why doesn’t the g7 just get together and be like, hey, all of our bonds between each other are gone? Well, we’ll make we’ll make all the like, investor class, but


Chris Cole  1:27:20

I mean, that’d be not smart enough. No, I think it would be very, very inflationary. So. But I mean, you know, in the past, we got out of these crises by a global war. And I’m not advocating that of course, but, um, you know, I think that’s, that’s how the Great Depression was really resolved. Um, so I don’t know if that’s possible, or even that I mean, you know, without destroying everything. So, so it is, it is interesting sticks at this juncture. So I do like this. I do like this moody Kjar squirrel lighting here. It’s awesome. It goes well with my Darth Vader mannequin.


Jeff Malec  1:27:59

So that’s my last question on our 100th episode here. We got away from it this season, but we used to ask every guest their favorite Star Wars character. So you’ve got an admiral app bar. Admiral Ackbar. Love it. Yeah, I could have bought my T shirt. I got a nice t shirt with him with the Chinese finger trap. Right? That’s a trap. So you have to know you have to get the humor and the line to know the t shirt. And generally, it’s my favorite 100% A brilliant and he didn’t have that much screentime but


Chris Cole  1:28:27

no, no, they should have flushed him out a little bit more. I think maybe maybe Disney will do like a mini animal Akhbar miniseries and


Jeff Malec  1:28:34

Akhbar series I’d watch the in the books, so I read all those that have since been disowned. Right when Disney rebooted, but um, and all those books the extended universe they call it expanded universe he has whole books about them he was he was a character.


Chris Cole  1:28:50

Oh, wow. I didn’t realize they did flesh so there isn’t there is material out there. They can grab and go by have hope for an animal app or miniseries. I’m pretty excited about it. The alright I’ll write into Disney.


Jeff Malec  1:29:03

I’ll be like, Guys, you watch the Mandalorian and the book of Boba Fett Nolan.


Chris Cole  1:29:07

I watched Mandalorian Sunday episodes of it, I really, it’s super cool, because they’ve done this thing where you have an ability to they have a framework where the virtual set will move with the camera. So I have a background in cinematography. I was always very upset about how cinematography has died, because they just flatly like everything. I am not flatly lit right now. But if I was in front of a green screen, you’re layering so many elements on top of it, they just lay everything flat. So like any interesting lighting has just died. But, um, but what has what this tool allows you to do is allows you to put a character in a virtual set, but actually liked them the way that people used to be lit and as they’re turning and whatnot. Yeah, exactly. And if you ever see them, they They have some behind the scenes video on this. It’s super cool. And it’s so exciting because you’re like wow, cinematography is back. That’s awesome. But super fun, super fun series to and to do


Jeff Malec  1:30:14

this so do i dune they had great cinematography and that new dune movie. I have not watched that yet, just for the cinematography I’d recommend. Yeah, I


Chris Cole  1:30:24

was done by the same guy. I think he did the Blade Runner, the new Blade Runner, which I didn’t like that much, but I love the cinematography.


Jeff Malec  1:30:32

Yeah, this is brighter than that one, but he has good. All right, Chris. It’s been fun. Thanks so much for joining us. We’ll see you next time down there in Austin.


Chris Cole  1:30:43

Super fun dropping by some time. Awesome. Thanks, everyone.

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