Volatility (LIVE IN VEGAS) panel discussion

We’re doubling down on the knowledge and taking you through the high-stakes world of Volatility with a special “Derivative Podcast” straight from the world’s entertainment capital, Las Vegas. Join host Jeff Malec and our panel industry heavyweights Cem Karsan @jam_croissant, Luke Rahbari @luke_rahbari, and Zed Francis as they delve into the intriguing market dynamics and risk management world.


From the role of Volatility as an asset class to the impact of retail platforms like Robinhood and TikTok, our panelists explore the ever-evolving trading landscape. Discover the power of probabilistic decisions in options trading, uncover the significance of liquidity, and gain insights into the art of positioning for success. These experts also shed light on the challenges of managing risk in an unbalanced options market, examine the role of market makers, and analyze the implications of the Federal Reserve’s actions. 


This episode provides a jackpot of insight surrounding the fascinating interplay between Volatility and macroeconomics, providing valuable perspectives on inflation, fiscal policy, and market trends — SEND IT!



Download our VIX and Volatility whitepaper!


Check out the complete Transcript from this week’s podcast below:

Volatility (LIVE IN VEGAS) panel discussion

Jeff Malec  00:07

Welcome to the Derivative by RCM Alternatives, where we dive into what makes alternative investments go analyze the strategies of unique hedge fund managers and chat with interesting guests from across the investment world. Hello there, and hello from Greece, which caused us to skip last week as my travel this lovely country threw a wrench in the works. Sorry about that. But we’re back with a banger of a con for you today. And then we’ll take next week off for the Fourth of July festivities before resuming the full schedule until the end of the year holidays. On this episode, which is recording of our recent volatility panel in Vegas, where I got to sit down with Cem Karsan of Kia Volatility. Luke Rahbari of Equity Armor and Zed Francis of Convexitas tries to talk through all that’s going on in the volatility space from zero DTE to the Fed to vol sellers returning and more. Send it This episode is brought to you by RCMs vix and volatility specialists and it’s managed futures group. We’ve been helping investors access volatility traders like the ones we’ve talked to in this episode for years, and can help you make sense of this volatile space. Check out our big and bold white paper at our cmos.com under the education menu, then White Papers link and now back to the show. First up, reintroduce everyone here. First up, we have Luke rebury CEO of equity armor investments with sub advises on the rational equity armor fund, as well as run managed accounts for investors blending long equity exposure with their own volatility index. Next up, but not in order here is that Francis CIO and co founder of convexity cost which runs a unique tail and convexity option overlay strategy in equity accounts as well as opera two programs in the futures based managed account space. And last but not least, the croissant Baker himself, Jim Carson, CIO and founder and senior managing partner of high volatility advisors. Welcome, guys.


Cem Karsan  02:09

Thanks for having us.


Jeff Malec  02:10

Thank you. Let’s dive right into it. Hear from each of you why you think it’s so important to have a piece of the portfolio that trades in around volatility, it spikes, its reversals. And everything in between sprinkling in some of what makes your approach different and special. As it approaches the 3d chess game that is volatility. Loop. Let’s start with you. All right.


Luke Rahbari  02:35

You have to have some volatility in your portfolio. And whether you know it or not, you’re all trading volatility, you own some volatility bought volatility. If you have a car, if you have a home, you’re buying puts, you’ve been sold those puts by some institutions, and you’ve bought some volatility, or you’re trying to hedge your risk using that volatility. Obviously, almost every asset class, to me anyway, has volatility embedded in it. And this is my line that I’ve phrased here, so no one else use it. But volatility from one asset class will always bleed into another asset class, always, the only question is how much and how fast. So you need to be aware of volatility. Volatility is not like other asset classes. It’s mean reverting stocks are not necessarily mean reverting or commodities, or currencies. So it’s something you’ve got to keep an eye on, it’s something that you can take advantage of. It’s something you can use as a hedge. And it’s something you definitely got to be aware of no matter what type of portfolio trading.


Jeff Malec  03:47

I’m gonna have a question on, it always bleeds in in a second, but we’ll leave that for now. Go over to us Edie.


Zed Francis  03:53

Algo, fastI, don’t forget your question. And how we really think about volatility is utilizing it as a portfolio tool to allow you to take more risk today and have liquidity during the drawdown events to potentially accumulate additional assets, accumulated additional things accumulate additional stuff, when the market is down, and potentially things are more attractive, so very much view it as a portfolio level tool that needs to be potentially constructed and right operational framework to make it easy to utilize and easy to access that capital during those drawdown events. But again, we have a portfolio construction theme, rather than relying upon correlations, something that allows you to go to work aggressively today and have access capital excess liquidity during those nasty events to be proactive rather than reactive.



All right. Jim wanted to


Jeff Malec  04:48

be a little bit more long winded as I proved to be not Yeah.


Cem Karsan  04:54

I think for both of these guys are talking about primarily long ball right and its role in the portfolio. I don’t really look at volatility. As an asset class, it’s the underlying distribution, right? It’s the options that underlie every asset class. The world has been managing, long or short every asset since time incarnate. And you’ve been seeing a secular move towards a more flexible and robust way to express direction and probability. I think that’s what underpins, ultimately, the increasing demand for options broadly and for volatility. Options are, in my view, the underlying they are the full distribution, both in terms of terms of muddiness and time of the probability distribution of every asset class, I think the market is heading towards that direction, because it’s a more again, flexible, robust way to express information, you can do that with long ball, you can do that with short flow, you can do that with put spreads call spreads all kinds of different, you know, probabilistic trades, but it more accurately expresses that direction. And so for me, that’s what ball is we have a long ball product, we have a ball neutral product, we have products that that take advantage of the positioning and the distribution, what that means for the distribution itself. But at the end of the day, vol is probability. It’s the shape of the distribution, not just the direction, I think that’s the important takeaway.


Jeff Malec  06:27

So would you say it’s kind of everyone has been trading in 2d and vault surfaces give you 3d or options? In particular?


Cem Karsan  06:36

Yeah, an asset is the expected value of the asset is the expected return on the distribution, I could give you two assets with exactly the same industry, same market cap, and two, if you didn’t put a label on them, you would think they were the same asset, unless you looked under the hood at the distribution, they can have the same exact expected value, one could be very fat flat, left tail would be very flat, right tail, the reality is their personalities, the actual underlying personality of that asset is expressed in the distribution, it is simply a summary when you’re looking at the asset value.


Jeff Malec  07:13

And so do you think like Robin Hood, all these retail platforms that growth and options, I’ll throw this out there? Like is that? Which cars which which is the chicken, which is the right? Are people getting pushed into options? And then saying, Okay, this is cool. I have more optionality for not very creative term. But


Cem Karsan  07:32

I think of options involved broadly as a technology, it’s a superior way to express the information that people get. And at the end of the day, that doesn’t mean it’s going to be adopted day one, you need network effects, right? You need more different types of options, like we’re getting micros and Nanos. And every day and every hour, you know, that is building out the assets, I mean, the actual product, you need more access. That’s the Robin Hood’s the TD Ameritrade. So why not you need more education, you need more volume, and the volume begets volume, because it brings money in brings different technologies to adopt it in. And at the end of the day, that’s what we’re seeing. And that’s why we’re not seeing this in a linear way. It’s really happening, kind of hockey stick, right? We’re really hitting that tipping point, which you hear about a lot with technology. And I really do believe 1020 years forward, this is going to be central finance, I don’t think people realize that people still talk about as an asset class, we’re still talking about oh, 2% 5% allocations. It’s not about an allocation. It’s not an asset class. It is a way to express every asset class. I think that’s what I


Zed Francis  08:46

think trading often begets more trading. And so it’s definitely seen that over the last handful years, I think what’s interesting from from our seats, is a lot of the folks that have come into this marketplace, let’s institutional in terms of product building individuals are really strike buyers and sellers and not necessarily volatility traders. And so because of that, they’re looking more so at payoff diagrams than necessarily fair value of any sort of options, which, you know, an RFC hopefully gives us a little bit of edge. We welcome those folks entering the space holistically. But I think a lot of its trading, because we’re creating a lot of people are buying and selling things based on, you know, at expiration payoff diagrams rather than a fair value. I agree with


Cem Karsan  09:31

that. But that doesn’t mean they’re not naturally thinking about probability. We all when we make a decision whether we put probabilities on it in our mind or not, are making probabilistic decisions, right? And so if somebody decides to bet on a outcome, right, it’s because oh, I don’t like this and I like this, because I don’t think this is worth what it should be. And this is what it’s, and I think that’s the important


Jeff Malec  09:49

isn’t that where retail gets themselves a little bit of trouble of like, Oh, I think Tesla’s gonna go down to 400. I don’t even know what it’s trading at, but it’s gonna go down to this strike price. So they buy that but not realizing whatsoever that they’ve lost a lot of value in buying that put it needs more than just the price to get done. So


Cem Karsan  10:07

be clear, it’s early days, right? You know, you plug a cord into the wall, you don’t understand fully how the electricity gets there. But we’ve all gotten used to it, I think there will be a lot of infrastructure built to make it easier for people to express the information that they believe. Right. And as it relates to options, specifically. So I’m, I’m optimistic with time, right, that we are building out the infrastructure to make it more, you know, easier for retail, individual investors, asset managers, broad IRAs, everybody to do this, but to really express what’s in their head more specifically to what the distribution itself says. And


Zed Francis  10:47

I think Jeff probably bring it up as when you’re possibly trading things based on the payoff diagram at expiration, you’re kind of ignoring how much the risk changes between today and that point in time. So that person that bought the Tesla put from that view, they were originally short, $10,000 a Tesla, and now it’s 100,000. And now it’s a million. And, you know, they were in the correct view, but they didn’t adjust along the path. And now the random walk gets them on that random day at expiration, rather than having any sort of risk controls or we’re trading risk focused, rather than that payoff diagram.


Jeff Malec  11:22

A few newcomers in the audience, I forgot to use my joke before if you made it to this room, and it’s way more complicated than this volatility stuff. So congrats. You’re smart enough to get here and to figure out the volatility stuff. And quick, Luke Woodbury equity armor, Jim Carson, high volatility and Zed. Francis, of convexity us. Thank you. And we’re just Zed. Jim was just comparing options to electricity. So we’re getting into. Luke, you got any thoughts there?


Luke Rahbari  11:54

Yeah. I think I understand what these guys are saying as far as the retail goes. So just to bring it down a level, volatility is calculated, like volatility indices, like the spikes are calculated off prices of options of the spiders, right. So if there’s a lot of retail coming in, I think the retail paper coming in is using options for leverage. They’re saying, hey, if I put up $800, and the stock gets at this price, I’m going to make this type of return 300%, return 80% return whatever it is, in this short period of time. So that’s what they’re doing. Now, it doesn’t really matter to me what why they’re coming in or, or how or whatever, but they’re coming in. And this retail flow that tends to be in the front month, or the front week or whatever, right? It changes the calculation or changes your expectations of volatility for that week for that stock, for longer term volatility, etc. So knowing the flows, knowing how things are calculated, knowing how people are trading options is all is all a part of it, obviously.


Jeff Malec  13:09

I’m thinking of the Oakland A’s who are going to come to Las Vegas here and there, right? They have like 200 people in their stadium instead of the game. So where I’m going with this is, right, if if everyone’s trading the options, if that becomes the new thing. There’s nobody watching the actual game, you’re just trading, you’re like betting on the game and trading around the game. And there’s no one actually watching the game, does that matter? Do we still need to play the actual game to get the derivative of the game.


Cem Karsan  13:36

So I think I’m just gonna jump in here, the liquidity hasn’t been enough in the options market, because it is complicated, there’s only a few players who really get it and that dominate the market making in those products. But that means as volume increases, because these are a better technology, a better way to express that liquidity and the effects of it have to be pressured out into where the liquidity exists. Which event, generally speaking, is in the underlying, still distributed across products and the underlying or correlation trade. But that is why it is become so important now to the bigger picture is because the majority of the world is still playing this game over here. They don’t understand necessarily the effects of the distribution. But it’s increasingly the tail wagging the dog. And you’ve heard a lot of talking about that. But but it is just again, an expression of direction at the end of the day, whether it’s direction, up or down or direction and change in the distribution or the shape, but that has effects on either volatility or direction that ultimately has to find liquidity, liquidity to absorb it.


Jeff Malec  14:46

And so part of me is here thinking like okay, but what does this do for my portfolio? It’s complex, everyone’s complicated. It’s the new technology. I don’t want the new technology. I just want to own apple. I just want to own IBM. What what’s it do for me,


Luke Rahbari  15:01

well, couple of things about options. You can get a piece of software and it says what an option is worth and what you should do. But what’s what’s really important to understand the liquidity as champ said and the pricing and the flow of the options, when I used to be a market maker on the CBOE, if a call was at $2, and I was short it, right, I’ve sold a lot of it, and people were trying to buy it at two, I would offer out at 190. And then overall, four out of 180. And then I would continue to pound it. Because I was the biggest trader and I had the most money. And it didn’t matter if the calls were worth two and a quarter, or what the biggest player says the call is worth $1.90 or $1.80. And you for your software, right? It doesn’t matter what your software says, Some of this is happening in retail, now they’re just coming after options, it doesn’t matter. They’re looking at a binary event, or they’re just trying to get the leverage. So that’s starting to skew stuff a little bit. And how do you use it in a portfolio? It’s, it really depends. But I would think that the best way to use it in a portfolio is to find someone I know I’m talking my book, but are some of these guys that actually have traded it are watching it all day, because this is not a passive game. It’s not that type of thing. We marry volatility with our with being long assets, both on the long and short side, depending on what we’re doing. We’re long on our on our funds. We short when we’re doing structured products, and we look at it holistically, where does this asset class? Where does this strategy fit in my entire portfolio. So when we do our OCIO services, it’s a combination of being long volatility, short volatility, and depends on the kind of asset class and the type of volatility you’re short. But I think you need to own some. It’s a cornerstone, I would think of any portfolio, you own volatility now on your car, on your house, most people’s stock portfolio or the stock for an RA that they’re managing, is pretty big. You don’t need to have your entire portfolio in there. But a portion of that needs to be protected needs to have it in a non mean reverting asset in combination with risk assets. And then you get into the other stuff that you want to do, whether it’s fixed income, and other things


Zed Francis  17:32

that generally ultimately derivatives are a risk transfer tool, like at the heart of them. And so it’s important is to first understand what structural things are in place that create imbalances and the pricing of that risk transfer tool. And now you can utilize that knowledge base to create a absolute return relative value hedge fund type of allocation, or I can NRC, we basically are saying we want to use that tool. And what we see is edge within the pricing of the derivatives from the imbalances in those structural flows, to deliver something that is negatively correlated unfunded and liquid during drawdown events to allow folks to take that liquidity and redeploy capital, but likely the fundamental edge that we’re seeing within the instruments themselves is probably pretty similar, but you can utilize that many different formats.


Jeff Malec  18:25

I’m going to get another weird metaphor now. So it’s kind of like, okay, we’ve, we’ve discovered colored paints, is that a thing? Right? Ink? colored ink, right? And before we’re all drawing in black and white, and we’re up here, me and others on podcasting, okay, you should invest in color paints, in colored ink, or like, No, it’s not the thing. It’s not that their code is what you can do with, it’s what you can paint with.


Zed Francis  18:49

It’s just like, if you think something baby has a fair value of 10 bucks, and it’s like, not guaranteed or anything, but like Atlas, probably what it is, but there’s a decent amount of folks that are structurally selling that thing. So instead of trading at 10 bucks, it trades at nine and a half. So you’re like, there’s multiple things, you can do that you could go long short, and just say I want to capture that 50 cents, I think that is a reasonable way to express value is just capturing that mispricing due to the fact that there’s a significant amount of flows, altering what probably the fair price should be. Or you can say actually want to take a directional position. And it seems cheaper to me to just buy the nine and a half dollar thing because it should be 10 versus something else. So let’s see. There’s a little bit of edge driven by a decent amount of structural flows from various products and such that have been created. And you can utilize that edge in multiple different ways.


Jeff Malec  19:45

Here on the lifetime we have a butterfly in the room. Go ahead. Yeah,


Cem Karsan  19:51

so I just want to add to that. So if you have any piece of information about a stock You know, everybody has their own edge, they have some piece of information maybe that they know better than somebody else. But just expressing based on that information whether a stock’s value should be higher or lower, is incredibly inefficient, because you’re dealing with all these other participants and all the other information that they have, which you may not have, why try and bet on whether a stock should go up and down based on some piece of information you have, what you should bet on is the probabilistic reality, the effect on the distribution that that that has, right, that is a much easier, more precise way to, to express the information that you have. And I think that’s where its truest, best value is there are other things here, right, understanding that distribution, understanding the positioning, as Luke mentioned, is critical. Because it’s a part of market microstructure. It’s just like understanding short interest, but much more detailed understanding of if the price goes to here, it’s likely to face supply or demand. So there’s a place for that. It also is incredibly valuable, because most of us are long in our lives, lose sleep, eat, sleep, breathe, right. And the reality is the tail, right is, is the part of the distribution that is the least linear, that is the most convex. And so having something that improves your geometric returns, and allows you to take those other bets and do other things, is incredibly valuable in the portfolio. But I think that’s part of a broader conversation. I think it’s part of that this bigger picture, which is, you know, you’re expressing a part of the distribution, which is just


Luke Rahbari  21:43

so if I can, I’ll try to that was very eloquent, but I’m going to dumb it down to it took me six and a half years to get my undergrad degree. So I’ll dumb it down for people out there, right. So the way we look at volatility is the s&p is going to have the same volatility, whether it’s 10,000 points higher, or 10,000 points lower on a normalized day. So average volatility, if you say to yourself is, I don’t know somewhere between 18 and 22. Okay. That’s going to stay constant. So how do you take advantage that you say to yourself that’s in P normally moves this much at around these levels? What’s its volatility? How much is it expected to move? Given that expected move, you look at a price of an option, and you say, wait a minute, the s&p is expected move over the next month is supposed to be 100 points. And this call is trading $30? Lower I’m using extremes $30 lower than its normalized volatility, what should I do? Well, you should buy that call. Because it’s probably going to realize that volatility, or if it’s trading at 140, well wait, what’s going on. So the best way to do that is looking at a stock that you follow, or you trade options on the week of earnings, you’ll see that it’s not trading at its normalized volatility, long term volatility, it might be trading at its normalized volatility for earnings, which is much higher, because you don’t know what’s going to happen. Right? And then that’s where you get into the building the position and what you want to do, and what you expect. And I think that’s where the public gets in and says, you know, in videos got earnings this week, I think it’s gonna be a 40 bucks to 330 Call is $3 man that looks like a buy. And they buy it and they come in and they rush in. And then that changes some of the front front month Curve edge and what it does, I think that’s what you were saying.


Jeff Malec  23:45

That was simply or should


Luke Rahbari  23:47

I go? Or should I go sit in the audience? And listen, it’s part of


Cem Karsan  23:51

like, at the end of the day, if let’s keep ticket to the kind of YOLO call crowd, right? Why they are not thinking necessarily about explicit probabilities or implied volatility, but what they are thinking about is two things, which we’ve mentioned one, that the probability the payout is significant, relative right, there definitely look at that is, is higher, and it is a very fat tail. They also related and this is kind of reflexive is, is that the more they buy it, right, the more they control liquidity there, the more they can force, a fat tail. And so, yes, at the end of the day, they are they aren’t thinking explicitly about what I’m saying. But that is the reality of, of what’s happening and and more and more options are wagging the tail, particularly on the parts of the distribution that are liquid and fat, right. I think the banks recently is a great example. It’s not just, you know, all these regional banks. It’s reflexive not only in that they’re squeezing the market. down, you then force a tail that forces liquidation in the bank itself, right and pulling, pulling out of deposits. So it’s so important to market structure right now. Because the liquidity is weakest on the tail. You can dominate liquidity in these illiquid places in the market, and really force major outcomes that can have macro effects.


Jeff Malec  25:26

What do we think about that? Like the, as you’re saying, the MEAN stack guys were like, Hey, we can make these things go up. Have they figured out we can make these things go down? Or was it so


Cem Karsan  25:36

two years ago, I, or a year and a half ago, during the meme craze? I, one of the things that was very, you know, that was talking very vocally about is just wait till they figure out the puts? Yeah, nobody, everybody’s fine with the call side, right? Call side like, yeah, you can have a couple congressional meetings. We were like, what’s going on? Nobody really cares. But when you start forcing liquidation, and all regional banks, yeah, that’s a big deal. That’s a little bit different, right? And it’s the same thing. And it’s actually much more dangerous, because liquidity on the left tail is worse than the liquidity on the right tail.


Jeff Malec  26:12

And then not to go too far down the rabbit hole, do you think hedge funds and others are like, the first step in that to push it into the retail crowd? And then the retail crowd takes it? And then they finish it out?


Cem Karsan  26:22

I think it’s the other way. Other way? I think. So this whole idea of like diamond hands, right? This idea that retail comes in, and does the same thing, and we’ll hold on and we’ll do it regardless, is an incredibly powerful thing. Because what it does is it signals to a citadel, or to high volatility or to whoever that these guys are going to be in buying tomorrow morning to you better not be short, it actually you better be long it because they’re gonna buy it from you tomorrow. And the more and more you have a consistent buyer, the more and more it forces. The whole it’s a signal, right? It’s a cascade, it forces essentially, speculators, the infrastructure, the market makers to start pushing the whole thing in that direction, which begets victories for the retail, which makes them more consistent, which drives a whole,


Luke Rahbari  27:10

it’s supply and demand, not not math, not options, pricing, supply and demand will drive, drive that up or down. That has nothing to do with where you think volatility is or where it should be or what it’s worth. So they’ll really learn that from me in the 90s. They should be should be calling that the Luke trade. Pan that too.


Jeff Malec  27:38

So while we’re on the meme stock craziness, let’s move on to the next bit of craziness, which is zero DTE options, which have rocketed up and growth. I can’t remember what I said here, we’re going to just have a quick, one word answer or one phrase answer for EG, zero d T E, is it a irrelevant noise, be a big deal really affecting bond markets or see somewhere in between? Look?


Luke Rahbari  28:10

Somewhere in between? Because it depends on the stock and the index or in or whatever. But it’s a it’s a big deal. No, that’d be that’d be so so. It’s a big deal. Right? Come back to me, then.


Zed Francis  28:28

I’m more on the a camp. I think it’s pretty irrelevant of a


Jeff Malec  28:31

noise. All right, Jim. I think it’s a big deal. Big deal. Alright, we got two big deals one irrelevant, let’s get into it. Well, let Zedd go first, why it’s relevant. Man, these guys can come over the top.


Zed Francis  28:42

I mean, I anybody trading one day options, as a market maker understands that it’s essentially a binary option. It’s one day risk, it’s, you know, yes or no. And so the only way you hedge your portfolio is to trade another binary option. And those types of folks are essentially, you know, posting on both sides, creating a portfolio of all these binary options, obviously have risk controls, if they get too imbalanced when say other turn off the machine. Once you have a bunch of binary options, it kind of turns into something that’s pretty benign and linear and easy to hedge. So, ultimately, and I think it’s the folks that are mostly providing liquidity in those zero duty options are pretty darn good risk managers. And it’s not a linear instrument that you utilize to hedge that risk. It’s another binary option, right? Another zero DT option.


Jeff Malec  29:51

How does that work without them losing money? So if I’m red ESPYS at 4000 Bunch of Onselen 4010. Call All to retail. So, what are they using to hedge that? That I get that right? Yeah, retails buying 4010 Zero dde calls saying they think it’s going to close there today? Well,


Zed Francis  30:12

they’re likely getting decent to a flow. And they’re building out an entire book or various different strikes. And if they get a little unbalanced it probably clean it up by actually not just sitting on bid ask and utilizing the one day option and just hedge some of that risk because you’re utilizing a linear instrument is not very effective. Something something that is has


Jeff Malec  30:33

zero, right, but I’m saying the only one to really use would be the exact one you sold. And then you’re just buying it tonight. So you go another strike out or another five or 10 strikes,


Zed Francis  30:43

that’s reasonably inconsequential. You’re just you know, five handle differential in the s&p 500. Okay.


Cem Karsan  30:53

So, the problem with options is when things become very unbalanced, right, this is what happened again with AMC, GME, if you can’t hedge it out well enough, because the market is not liquid enough. If it’s in a point of the distribution and asset kind of on the tail, that’s where the risk happens. And when you push something, either to the furthest part of the distribution on the tail, or to the most forward shortest time, the impact of that because of the gamma effects is that much more dramatic, you can have per dollar spent per positioning that much more impact. So moving 45% of the liquidity from 30 days to zero days to expiration has much more impact, not just because of the amount of gamma that can be expressed, if it’s unbalanced. Does that point, if it’s balanced, it doesn’t matter if the market makers are taking both sides, no big deal. But every sort of it starts going in the same direction, which will invariably happen. That’s what we do, we crowd into trades crowd out, it will have more impact, and it’s on the part of the distribution is very hard to hedge. It is very hard to get enough gala in the portfolio with anything other than 00 d t than was the odt. And that’s why it matters. Same reason that, you know, bank stocks crash because they can have an outsized impact, same reason that the AMC and Gamestop names kind of do with it, going to zero DT just has a greater impact. It has more convexity. And it’s less liquid ultimately, to the market maker. That’s what matters.


Jeff Malec  32:35

You are somewhere in between what do you got to say on both those?


Luke Rahbari  32:40

I think it’s really difficult to risk manage, first of all, you know, something that’s got a one Delta trying to Delta hedge it when it goes to 100 is within an hour is a bit difficult, right? Because you’re not the only one trying to hedge, you’re not the only player in the market. I think it you know, when we’ve done it, we’ve been buyers, because the least you can lose is your premium. And sometimes what happens is, if you’re in early enough, some of the strikes that are further out, you can spread off very, I mean, puts it becomes a great trade. But who knows, I think they are important, I think sooner or later someone will blow out as it’s bound to happen. They won’t be able to manage their deltas, they won’t, they won’t be able to manage the exposure, whether it’s on the shorts or alongside. There’s a whole bunch of other stuff that goes with it, whether you can find a borrow on these stocks, but someone wants to do after hours trading all sorts of things. So I think I think it does matter depending on the instrument. And it’s not it’s not something that we we play in a lot at all. Although you say you traded some we bought we bought we would never trade


Zed Francis  33:58

to positions inside of a day.


Cem Karsan  34:01

We’ll do it more reflexively. If they’re we feel like Yeah, exactly. But more in the long run. Yeah. And so


Jeff Malec  34:07

who blows up in that scenario, though? The market maker? Yeah. who’s at risk of the of it all, unwinding will always the


Luke Rahbari  34:15

seller the option, especially obviously on the call side, on the put side, too if something happens, because something that was one delta or five Delta five minutes ago can go to 100. It’s a binary option, right? It goes through your strikes. The


Jeff Malec  34:31

flow is basically one day covered call writing.


Cem Karsan  34:34

I mean, the dealer would write this is but the question is, who’s the dealer? Let’s talk let’s go to Gamestop who blew out Melvin did why did Melvin blowout because they were not the sophisticated dealer. They were warehousing risk. They didn’t understand why. So who blows out not citadel? They’re the ones buying because they know it’s coming. They’re getting in front of it. They’re pushing it. It’s going to be the warehouser Probably a bank or a fund that has an opinion about something that doesn’t understand.


Zed Francis  35:06

I definitely my comments focus very much at index, you know, sure a $5 billion sub single name can have more interesting things happen. But at the index level, I think it’s pretty benign, ultimately. And, you know, I think similarly good SIBO revenue per contract, it’s down. Why is that? Well, it’s because it’s mostly market makers participating and getting paid to sit on, you know, bid asked to participate in this market. So like, a pension comes in and trades 10,000, contracts, XYZ, my guess is there’s a follow through of 3040 50,000 contracts is essentially market makers Lane risk off onto each other. So it’s showing a little bit of an outsized influence and how big the market really is.


Jeff Malec  35:54

To edge the one zero d t, they might have to do five further strikes. So it’s like, it’s


Zed Francis  35:59

not even the ratio. It’s more just laying off rescue cross.


Jeff Malec  36:03

But you’re saying they go to another zero dt at greater size?


Zed Francis  36:07

Or even the same strike? Yeah, like they’re laying off the rest to each other. If somebody gets imbalanced and they’re willing to pay each other for it, to get the book right sized. But take one trade looks probably causes a much bigger number in terms of volumes, and it’s kind of realistic risk sitting in the market.


Cem Karsan  36:26

Jimmy we’re so a couple of interesting things just to like every talks about CRDT like just generally like what’s actually happening. The play by play is last year, the Vega any vol in the equity world did not work. Right? So you had a massive exodus from anything that was implied vol related, the market went down ball got compressed, it didn’t work. So people, but what did work for some entities was buying realized vol equivalents, like zero dt. So there was a lot of volume that started moving to that because it was working, it was an alternative hedge, most of the volume was buying zero DT early. That is in line with the general kind of non vol specific trader being like betting on a direction betting on puts, okay, we’re gonna go down today I’m worried about it or call. But guess what, once 45% of volume goes there, what happens? That doesn’t work anymore, either. So ball has gotten massively compressed on a Realized basis, as well. And a lot of that is because there was so much volume in that zero dt, gamma stuff. But now, not only are people not hedging in Vega, people aren’t hedging and gamma either. And it’s a lot more sellers. Now, it’s actually unbalanced, much more sellers of zero dt, because that’s what’s been working. That’s what people do. So I think the big takeaway here is not just what’s happening in zero dt, why is there so much volume? It’s where are we in this dealer positioning progression? And what does that likely to mean, for the next outcome?



Loop? You’re gonna say something? No,


Luke Rahbari  38:07



Jeff Malec  38:08

the witch. But interesting, you know, I’ve noticed it seems to coincide roughly with the saving of SBB, the bank of the debt floor that’s been in place involved since COVID. Really, finally, we broke through that and got, I don’t know, you guys,


Cem Karsan  38:23

bottoms up the right kind of ball effect. But then you have the top down fed coming in underpinning selling puts. Right, right. So those two things together, that can be pretty powerful for a while, but then that encourages excess risk taking all kinds of other but do


Jeff Malec  38:38

you think is for your strategies? In particular? Is that a good thing? Or a bad thing? Is it more of a two way market now than it was through most of 21 and 22? Like that you have upside and downside?


Cem Karsan  38:48

These guys can jump in I’ll


Luke Rahbari  38:51

I don’t think it’s a real two way market until the Fed completely gets out of the way. Right? They shouldn’t have come in and saved Silicon Valley Bank, I don’t care if someone was going to lose $15 million. And that was all they ever had. Maybe they should have been a little more careful and spread their money around. And the Fed should have allowed people like myself and some others that are more discipline to come in and buy the assets of people that take unreasonable risk, or they’re blind to the kind of risks they have in whatever institution they’re in. Instead of coming in and saving them with my set tax dollars.



How do you really feel? Well, that’s


Jeff Malec  39:29

how I feel. So we’ve got a couple of California guys here, they might have been had been at risk.


Luke Rahbari  39:34

Well, maybe I should have owned one of their homes. The Fed has been in the market and the Fed has been the Fed put saying everything’s gonna be okay. We’re not going to let the market float away. It really should be for the last 10 years has been a huge mistake.


Jeff Malec  39:52

When it seemed to me that that part was sort of gone and then they came up with a new


Luke Rahbari  39:55

right the minute something goes wrong. Yeah, they they they Give more methadone to the addict. So a


Zed Francis  40:05

little bit different course, I would say the, you should be wary of purely systematized strategies and the derivative space. Because as you think you’re kind of alluding to Jeff, things change quite rapidly and dramatically, and often kind of, obviously, and a systematized strategy is not going to have the ability to do that transfer and how they operate when those inflection points happen. So I think it’s more so, you know, is their edge better or worse? You know, I think we have certain edge and certain things at all points in time and other things is changing. Often you got to monitor it and adjust with it. But I think the main takeaway is just purely systematized implementation of derivative strategies is problematic because things change rapidly.


Luke Rahbari  40:55

I’ll just add one thing to what Jim was saying, as the market went down last year, vol got crushed, because people are thinking, well, the Feds gonna stop raising, which means it’ll be good for the market. Right? It’s not, it didn’t make sense. But that’s what people thought. So I think the Fed has been fully in there, it hasn’t let the markets flow the way they have capital has gone to a lot of wrong places. And now that’s starting to be problematic, like, hold the maturity securities. Right? If you bought the tenure, when it was a two and a half, it’s a problem right now. But why not? The Fed is going to be there, two and a half, whatever. Right? So it’s the Fed has put people at risk by its behavior. It’s encouraged bad behavior.


Cem Karsan  41:42

Jim. The reason the market didn’t go down last year, in my opinion, is because in the short term, referencing kind of what you were saying, the thing that matters most is positioning, because it is the ultimate, biggest driver, arguably, to supply and demand. Skew was at record levels. And hedging was at record levels in early 2002. Because everybody knew the Fed was going to be raising rates. So when the market did decline, which was partially because the Fed raised rates, but also because the Russia Ukraine thing happened. It became vol compression, drove realized vol compression drove, you know, everybody’s long, 110% stocks and has a 10 Delta put as a hedge, guess what, if you drop down to that 10 Delta put, everybody’s gotta monetize that put. And if it starts losing money for them, they’re not only down 110%, now they’re losing on the both sides. That’s what happened. That’s what happened. So plain as day underneath the surface SKU there, you collapsed, the all the put buyers liquidated. And and the reality is that doesn’t change the macro realities. The reality is that interest rate hike doesn’t hit the economy for 18 months, right. And now we’re in a very different position. The market is structured differently. So you really got to look top down and understand what’s happening underneath the surface to liquidity into flows, but to also understand what’s happening from the bottom up. And what’s that positioning, like? What does that mean? This is why often we get a first move where it is slow, where it is managed when people do expect it. And the markets rally back. Everybody’s like, oh, crisis is over, we’ve averted things bad, right? It’s a matter of shaking, shorts, shaking that structure involved positioning. And ultimately, those two things are generally squeezed, that positioning is squeezed either by a counter trend move, which changes the narrative or time, which bleeds out to K. Anybody who’s trying to hedge


Zed Francis  43:52

is that the only they want to chime in there as I agree that the most interesting thing for 2022 in the fall arena was skew. And like skew, which I think you’re trying to lead to this just Yeah. Puts relative to calls, if you will. So steep skew means put some more expensive calls for implied volatility. Flat skew means calls and puts volatility about the same. And pre 2008. Skew was reasonably flat, especially comparison post 2008. Because essentially, banks could warehouse that downside risk without really any capital charges associated with it. 2008 happens rule change. Now it’s pretty difficult to warehouse a lot of out of the money risk on the put side, thus, right. Thus, skew has now been pretty habitually steeper since 2008. And that was, you know, even excessively so into the case leading into 2022. Because not only do you have that regulatory regime that’s kind of forcing steep skew, but you also had a decent amount of folks with an opinion that we’re shifting things even more so. And so the extreme flattening of skew, not only through the extreme steep levels, Like normal ice deep levels, but like truly flat skew surface. And 2022 is probably the most interesting piece and the ball surface, which again, I think is related to positioning that, you know, people are still always long the market, but they’re probably less long from their benchmark, thus their ultimate risk once the market started moving lower was actually a snap recovery, not a continued fall.


Jeff Malec  45:31

And then I want to pull on a thread there that you were mentioned, it’s tough to systematize this stuff. But that seems clear to me, like this is a new technology, it’s super complex, you need three D ball surfaces, you need all this stuff, right? You need super complex models just to understand it. But then you’re also kind of saying, well, it’s more art than science. So help me understand that of what which is in control art or science.


Zed Francis  45:56

I think the science is we’ll call it imputing fair value of something. But the arts more important for any sort of thematic moves. So if you’re purely the quote, unquote, scientists, they put you in the category of a really strong market maker, which involves a likely pretty extensive technology budget to make sure that you’re, you’re quote, unquote, science is at the pinnacle of the industry. But if you’re having something that’s a little bit more, you know, not just straight up market making, then you got to move out of that pure science, you get to understand the fair value of things and have the correct tools in place. But it’s more important to be able to adjust that thematic changes than being a pure market maker.


Cem Karsan  46:40

I think the way to systematize it is not to just fit a volatility surface and say this is high, or this is low, or this is high relative to this or this is low. It is to understand that this is not tornado insurance, contracts themselves have a reflexive effect on the underlying so to systematize a strategy, you have to genuinely understand where the positioning is in the market that can drive a real edge in a systematic way. Understanding what that means for the probabilities. Yes, understanding what’s high and what’s low, those are absolute, and they matter. But if you think that because something is high, it’s less likely to happen, you’re missing the whole part about actually modeling the distribution itself. And I think that’s an important piece that a lot of market makers didn’t do for the longest time. But more and more, they’re using the information embedded, you know, in in the distribution in the market to understand supply and demand.


Jeff Malec  47:39

I’m going to use your tornado insurance there, right? Drove the whole concept of gamma and everything happening with the market makers is, as the tornado is getting closer to that house, it doesn’t have the insurance, the tornado is getting stronger. And the more houses it knocks down, the stronger and stronger it gets, right, which doesn’t happen in real world phenomena.


Cem Karsan  47:56

But Correct, correct? No, it’s the contracts themselves are reinforcing reflects reflexively affecting the distribution. So that is a really unique thing about market insurance. And it’s important to understand that that liquidity that’s being put into the market, and that part of the distribution ultimately needs to be driven out. And that itself reflexively affects the distribution.


Jeff Malec  48:26

So we can’t just throw fixed prices into chat GP, and say, Make me a great model on this.


Zed Francis  48:32

Thought, ya know, what I’m saying is, it’s really a tool to focus on distribution, rather than necessarily direct price movement. And that distribution tool might influence price movement in certain scenarios. But I think it’s simple one is, especially you know, the conference happening through the wall is a bunch of allocators that really want mailbox money. So you know, a lot of people that would love to just earn their, you know, Sofer plus 150 basis points like clockwork, and the only way to get something that looks like that kind of return is you got to ignore the extreme left tail, because that’s too expensive. So you build a bunch of products that look like, Hey, we’re just gonna give you that mailbox money. And then when everybody’s like, Well, what happens if this happens, like, oh, well, that’s gonna be the end of the world and guns and gold and whatever. So just ignore that, because that’s too expensive. And then you wouldn’t like the yield that I’m going to give you in the mailbox money. So it’s affecting the pricing of the distribution within options. And that allows you to potentially take the other side of some of that positioning on a pretty habitual basis. But then when the market moves, you probably have to move with it because people are starting to enter a different piece of the distribution of those actual products that they own.


Luke Rahbari  49:47

I just want to add one thing when we’re talking about market volatility, there’s different there’s different markets, right? There’s the Dow, the s&p, and the NASDAQ, and there’s so many NASDAQ friends here. So Oh, in 2018, I did hit with the NASDAQ. And we were looking at where the market returns are coming from. So keep talking about market volatility. And this is what the s&p is doing whatever. I think right now, in our calculation estimation, SNPs, over 55%, NASDAQ. And so far this year, I think roughly 50% of the market gains have come from three stocks. So when you’re talking about and what are those Microsoft apple and video, I think, so when you’re talking about the market, and you’re talking about indices, and you’re talking about which big indicee? You have to know what’s making up that indicee? What’s driving the moves? Apple right now, again, I read this, I haven’t done the calculation, I think is worth more than the stocks in the Russell 2000.



I saw that I think so. It’s great, right?


Luke Rahbari  50:53

So even if a stock is, let’s say, 18%, or something of any index, does it really drive? What’s the beta of the index to the stock and vice versa? You know, is it really driving it more and more? What’s making up the volatility of that particular index? So it’s gotten to a point where I mean, I’m old enough to remember when there was a real difference between s&p and NASDAQ, and the Russell. Now I’m, you know, is there a difference between s&p and NASDAQ? Maybe yes, maybe no. So I’m gonna


Cem Karsan  51:26

take this thread blood a little bit and talk about something that probably happens. Some people here may have heard me talk about this, but I think it’s important that everybody understands the reflexive effects here are not just directional, or you know, affecting distribution, if the hedging or the majority of all supply is in something like the index, right. And yet, you’re having a macro effect of where the majority of the market is getting hit, because the single stock that’s not those aren’t ball centers that are actually experiencing it is idiosyncratic risk. By definition, because that, because the index itself has pinned, some things have to go up. And what we’re seeing and often what you see when Brett gets out of whack, like this is exactly that. That’s part of why it’s a poor indicator for future performance. That’s why breath is such a good signal is because usually it means something is happening in market market microstructure that’s holding the market in place. And it’s generally vol in the s&p, or other kinds of centers that are not in step with what’s actually happening underneath the hood. And so right now, that’s what we’re seeing. Right now, there’s lots of sellers in less liquid non ball centers, because those are places of risk. And they’re expressing macro liquidity concerns. And the index is pin, because volatility is very well supplied. And that has to be expressed somewhere else in the market to balance that out. And that’s why we’re seeing it. And guess what, where the ball is not pinned in the video, where people are massively buying calls, right. And other names that are big enough to counterbalance.


Jeff Malec  53:14

And this was the dispersion trade that was taught.


Cem Karsan  53:18

And last year, it’s all about equity, you know, yeah, globally QD, and it continues to work. Because the hedging is happening in the structure products are broadly in the s&p. Now, the reverse side of that is when things become unbalanced, like we’re talking about. Now, that starts to go the opposite way. And that’s what happened in Feb March 2020. That’s why the s&p started to decline the day after the Fed bought x. That’s why the market ended the day after March optex. And that’s why the majority of the pain in the performance was in the s&p, not in the constituents is because when it starts to reverse, that goes exactly the opposite way. And guess what correlation goes to one.


Jeff Malec  53:59

And now I’m going to bring it back to my question of your first thing involved, always bleeds through, but we didn’t see the bond ball bleed through to the s&p and 22. Or did we? You can correct me


Luke Rahbari  54:10

if I think I think we did. I think we did. And we saw it and we saw it and some of the stocks that are related to that are some of the products right? mortgage backed securities agencies, the dollar, the movement, the dollar, the move in currencies? I think I think you’re starting to see it now. Is it fully done? Is it as violent as it was in the fixed income market? Not yet, but I think, you know, you saw the first tier which are banks that bought hold to maturity securities and all of a sudden they’re looking they’re going from saying, I as a treasurer, I have zero risk because I own hold them maturity, securities to duty, you’re down like, you know 180% Because you bought the stuff on leverage as well. Right. So you saw that into banks that’s happening. It’s it’s happening now. If The Fed hadn’t stepped in, it would have it would have been much, much worse. But the Fed stepped in. So I mean, that’s the way that’s you can’t cry about it. That’s, that’s how the market works. But the Fed has been keeping volatility dampened, especially if they let these banks go, you know, it would have been, it would have been a mess. And to what Jim was saying earlier about what the market structure was talking about, to translate it, he totally agreed with me.


Zed Francis  55:32

Jeff, the, you know, spread between Treasury volatility and, you know, equity volatility makes a lot of sense, because equities are kind of floating instruments, right, like, their revenues are probably somewhat tied to inflation, which was what was driving rates and thus, their, you know, free cash flows are probably going up, somewhat aligned with that inflation number. So it’s a, you know, a floating instrument, and, you know, yes, you know, you should discount things, possibly more aggressively with higher rates, especially with a tech heavy indicee. But ultimately, it’s a floating rate instrument, versus a fixed rate instrument. And when interest rates move that much, they’re gonna ding you know, and have more violent moves with the fix. But


Luke Rahbari  56:21

you also have to agree with that. But you also have to remember 20 years ago, if you were a commodities trader, or FX Trader, you didn’t know an equity trader, you only knew equity traders, and you were in your own little cycle. Now with structure products with ETFs that give you access to all sorts of different things, to REITs. You know, it’s, it’s getting more and more because big funds and managers are all owning different things. So when they get in trouble or when things go, well, correlations go to one. Right because their entire book, they’re starting to get hit on other stuff, too. So you know, and another, Blackstone or whatever, Blackstone, BlackRock, whatever that $65 billion REIT, yeah, right. Everything’s can’t get your flag, right. Everything’s fine. But we just put up gates, everything’s right, other you can’t get your money out, then Starwood did the same thing. And then the banks, you know, that really started it was that and then people started looking at commercial real estate. And I like, man, these, you know, hold the maturity, security, and then boom, boom, boom, boom, boom, it bled down.


Jeff Malec  57:32

There’s a Wilson Phillips on, just hold on.


Luke Rahbari  57:36

I said it blood down, not hold on.


Cem Karsan  57:38

So I have a couple of thoughts, one 100% In the short term, when there’s a liquidity event, that there’s not enough liquidity in the tail, to absorb the amount of people trying to get out. So that’s part of why, again, correlation goes to one and it does eventually in those scenarios bleed through almost every asset class. But that’s often short term. It’s a function of liquidity. I think a common theme here that we’ve been talking about is the importance of liquidity importance of, of how the positioning is, and what that means for structured liquidity in different products and different parts of the distribution. Want a different type, the part of it, you know, the frustration on your end I hear is the is the Fed has been selling puts, and they’ve been selling it not just for 10 years loop, they’ve been selling for 40 years. And they are the bully in the room. And they always can can underpin the market is the psychology and has been for 40 years. This is a bit of a macro turn. But the reality is they could do that because we had two mandates price stability and maximum employment. And those two things were in line because we were in a secular deflationary period. The reality is, for the first time in 40 years, we have a more inflationary period. Now, the big question on everybody’s mind, is that going to continue or is that not? We go into a whole nother hour here talking about why we see that being the case


Jeff Malec  59:09

$20 avocado toast this morning, I think it’s going up.


Cem Karsan  59:13

But there are there are secular themes under you know, populism D, D, globalization, all these things are connected, I want again, I’d love to give the whole thing but we don’t have the time for all that. But if we are truly in a secular inflationary period, which I believe we are, that really puts the Fed in a box. And that’s a very different thing than we’ve seen the last 40 years the Fed has a very difficult decision to make in a stagflation airy environment. That means they have a loss of power or loss of strength. They are no longer the bully necessarily in the room. They are they’re vulnerable, and they’re not just vulnerable. Within the US. They’re the cross. The cross national forces come into play. The last time we saw this 68 to 82 right The last inflationary time we go look at that data. And what you begin to see is, is not volatility increasing across assets, you see it increasing in certain types of assets and dramatically so and actually, ironically, being dampened and other assets, we see an increase in FX, and interest rates and currencies, right. All this makes sense. We’re dealing with cross national kind of rotations. You see in precious metals, which are also kind of a currency type situation. But ironically, in commodities, particularly industrial commodities, energy, precious industrial metals, you actually see massive ball dampening. Why is that? Because now there’s a new source of power. Now, OPEC, or, you know, name your country with Reese, you know, Chile with copper, whoever right, has their own put, they can underpin the market, like we’ve seen with OPEC recently, they can really drive a four because they have more power. And during inflationary periods, that’s what we see. So it’s kind of an interesting little side note, not everything always moves secularly together involved during short periods. Yes, the tail goes to one. But we’re, you know, if we are truly entering a different regime, and the Fed put is weakening, which I believe it is, that changes the calculus for equity law, change the calculus for rates and FX and anything tied to that. But it also changes Oppositely, the, the calculus for vol and other products.


Luke Rahbari  1:01:32

So there’s a really


Jeff Malec  1:01:34

want to open it up to questions. One minute, go ahead. Alright.


Luke Rahbari  1:01:37

So the important point for me is that for the last 12 years, 1012 years, the Fed has been lowering rates while the markets have been going up. Which is just I don’t understand it. I mean, you know, Janet Yellen,


Jeff Malec  1:01:49

or did the market go up because they were lowering rates, as the


Luke Rahbari  1:01:53

market was going up, and economies are strengthening, they refuse to increase rates. And I have some of I tweet every once in a while, I’m, you know, I’m hugely popular. I’ve got like, 17 followers, I think. But the good thing about Twitter is, is that there’s a timestamp of what you said, and when when you said it, Janet Yellen said that inflation is the great equalizer, you know, and then all this stuff with oh, it’s going to be gone in a couple of months, etc, etc. So that’s one big mistake the Fed made. And the other thing is I agree with you, the Fed is going to be in trouble. And they’re not they’re not going to have the power they used to. But from the fixed income markets, I truly believe that the strength of a fixed income market for any country is the power of the military. Okay. Because if you remember, if, when Iraq went into Kuwait, Kuwait had the number one credit ranking of any country, two and a half million people like number four and oil reserves, right, credit rating, currency, the strongest, Iraq, totally bankrupt and broke, but they had a couple more tanks. Right, two days later, credit rating of Kuwait, Kuwait wasn’t even a country, they started to try to start printing new money. So as long as the military power is there, the Fed has more power than just what it really should, as far as supply, demand, macro, etc. Right. But this is what you’re seeing with China trying to change that China trying to say, our currencies, the one, etc, etc. So I do, but I do think the Fed is going to be in trouble. I do think we’re going to see inflation. And I do think that there’s a lot of legacy assets that people have bought, and there’s been a lot of capital in the wrong places, and they have to come down. That’s all there is to it.


Zed Francis  1:03:48

Finish their 30 seconds on inflation is you know, I think should think about things is there’s fixed costs and variable costs and variable costs will say a cost of financing and labor and fixed costs are generally assets are things that associate with assets. And it’s easier for the Fed to attempt to reduce the variable costs by increasing cost of financing and hopefully slowing down labor. But they’re failing at that, obviously, thus far. And the question is, do they actually care about inflation? Are they going to do something that could break the fixed cost side or you bring assets down? Or do they not actually care about inflation?


Cem Karsan  1:04:25

They won’t have a choice, unfortunately. Because the the problem for the fed the biggest problem is if long term inflation expectations go higher, because reflexively, that creates a pool of demand forward. As we all kind of know, and and importantly, it also allows if real rates are negative people to borrow for cheap, and buy assets that ultimately go up, which creates more inflation as well. So there’s like a reflexive effect there. They won’t have a choice, you’ll get runaway inflation unless they respond. And that’s what puts The fucking box


Jeff Malec  1:05:06

All right, let’s have it. John,



how should we be thinking about the actual constraints on the Federal Reserve, though? I mean, do we think of them as a unit with the Treasury? And it’s about how much debt you can take on as the United States? I mean, how do you actually translate? You know, inflation is something in on particular into policy that’s made? Specifically way I just want to understand this better?


Cem Karsan  1:05:38

It’s a big question. And I don’t, there’s a couple things one, the Fed has, was created with a legal mandate to use one tool, right? Monetary policy to address two specific things. Right? maximum employment, and price stability. Now, those two things were aligned forever, they could just print money all day long, send money to capital, create a deflationary environment. And at the end of the day, that created maximum limit to so that it’s easy way to keep going. The problem here is they weren’t in charge of the distribution of income. And we went from 30.32 Gini coefficient to point four, five in the last 40 years. That distribution eventually makes people angry at the bottom. People say to generations, my dad did better than I did. I did, you know, and he did worse than his father. That’s the type of thing that creates a loss of status and political upheaval. And what we’re seeing in all of this is a score that we see whether it’s right or left and the moving of populism, whether it’s rusted out cities in middle America, or, you know, Bernie and AOC, on the left, it’s all a function of that, at the end of the day. And that political swell that desire by the populace for a more fair injustice, let’s say the populace, primarily Millennials on down the world labor, the bottom of the jump into distribution is what is driving secular inflation. The Fed can’t fix that. The Fed can’t come in and raise interest rates. They can affect cyclical inflation, but they can’t affect secular inflation, and the Treasury can affect it. But the more they do that, trying to fix inequality, the more inflation


Zed Francis  1:07:39

was only gonna just chime in that the fiscal and monetary side were on the same team for a long time. That’s probably unlikely to be the case going forward even even the last three months, the fiscal side, obviously is not overly happy. And the Fed probably is high fiving themselves. They’re like, look, this inflation is coming down unemployment still at three handle, like they’re very much on different teams for the first time. The problem


Cem Karsan  1:08:01

is once this cycle gets started to populism, you drive inflation and as you mentioned, to flat tax, who does it hurt? Most of all, it hurts the poor. And ultimately, that then drives more populism discord like the system’s broken, it’s not working for me excetera, which leads to a new form of fiscal which tends to be price controls, or tax, gas, gas tax holidays or first time homebuyer tax. But things that are still fiscal students are more directed towards the inflation itself. This is the cycle that we’re when we’re just beginning.


Jeff Malec  1:08:32

And for Karen, does anyone listen to Smartlist? Podcast? No, all right, for Karen, can fiscal verse monetary, wins, I’m going to explain that in 10 Seconds or Less


Cem Karsan  1:08:43

fiscal verse, monetary, monetary is using interest rates or QE Qt to affect the flow of capital to those who borrow the quantity of capital out there. And fiscal is sending it to the people, like we saw in code while you’re taking it or sending it to them adjusting, essentially, the distribution of income where the money goes, the power of the purse string belongs exclusively to the Treasury, the fist the Fed cannot control that. All it can do is flush money into capital, called a planet Palo Alto sending money to corporations, or wealthy individuals, people who borrow to stimulate or


Luke Rahbari  1:09:23

stocks policy versus interest rates. SBB was the Treasury guarantee


Cem Karsan  1:09:28

that was the Treasury under that was a little there’s no there’s but the point here is not whether it’s fed, or Treasury. Yeah, the point here is, where is the money going? And the money’s been going to the top for 40 years. And people are saying enough is enough. We want to fix this unfair, they believe is an unjust situation. That’s a political problem. If we decide as a populace by our votes, that that is the case that is inflationary. And that’s a problem that puts the Fed in the box, and they can no longer come sell the put anymore


Jeff Malec  1:10:08

yeah, Darren Darren, so we’re gonna break that I’ve memorized everyone in the crowd.



So talking about like the path dependency of all right, and the history of ball and you know, where we’ve seen the cycles go with, you know, skew being really high and then coming down now, and then you’re talking about this structural, you know, pull, pull forward with the ball coming to zero DTE. So, you know, just going forward, do you think that the trajectory, the path dependency that fall has been on currently lends itself to a situation where we would want to protect those fat tails? On the downside?


Cem Karsan  1:10:57

My opinion is, yes, we’re we’re getting there, right. Dealer positioning is a function of trend of some kind. So the more something is profitable, people crowd in, people who are on either side, get out. And eventually it gets heavy 85% of scenarios in our models show deal positioning quite strong. And they also tend to be some type of trend doesn’t mean trend up or down necessarily can be trend down a ball, like we saw in 2017. It could be a massive rotation, growth of value and people getting crowded, right. But those trends situations create heavy positioning, and those ultimately tend to be more dangerous situation for situations for what the opposite of that positioning is now, imbalance. And we are heading to a point of a bigger imbalance, particularly from the short side. Whereas we were on the other side last year.


Zed Francis  1:11:51

I mean, they were like vulgar mean very different things, too. So it’s like, you know, one day one week, one month option that’s basically implied versus realized, or we’re gonna move more over the next, you know, one, one day, one week, one month, than the distributions currently implying, we’re, you know, two year options is kind of more of illiquidity. You know, stance, the marketplace, it’s less dependent on the realize movement, and much more when there’s an event where people need to reach for some sort of liquidity mechanism.


Cem Karsan  1:12:26

The dangerous part is when that position aligns with macro flows. And I think that’s the thing that worries me most is like, Nick, we’re getting that lag on the Quiddity. All those things right, as people are getting a fumble,


Jeff Malec  1:12:38

is the exciting part a little bit that it’s getting cheaper. Right, so just when it might be crowding on the short side, it’s getting cheaper to play the other side of it.


Cem Karsan  1:12:48

Yeah, I mean, it’s not that it’s cheap. That excites me. It’s that the positioning is getting offsides. Yeah.


Jeff Malec  1:12:58

Anyone else? Say you were an allocator that allocated to some of the people up here? Would you have any questions for them at all?



I guess I’ll shoot. You mentioned before, particularly about the fact that it seems like a beta is just, you know, across all different asset classes, there’s just no everything. Eventually, the beta goes to one and everything like that, if we get into that, like, initially with COVID SPP. And a lot of it has to do with these larger funds, as Jonathan said, and just had their hands essentially into everything. Do you see like that changing going forward, this thing is going to become a game and bigger issue a problem that, you know, just affect continues to affect volatility, and you see where you’re wasted and you take advantage of that. You’re kind of being like a smaller, more nimble animal type of finally, like warriors strategy. Sorry,


Jeff Malec  1:13:56

I’m just going to repeat the question for the recording of if I can remember that the betas as Luke mentioned before, are all seemingly as one in bonds and stocks at some point, and a lot of that, because these large funds are doing a lot of different things in different asset classes. Is that a good thing? Is that a bad thing? Will it change is that



NGC opportunities to kind of take advantage of that, you know, being if you’re ready to exceed like a, like a smaller, more nimble? And we’ll find your strategy or if you see a strategy is able to go and take advantage of that.


Jeff Malec  1:14:31

Right. And do you see opportunities in in that that you can take advantage of as not going to call anyone up here small but as mid size managers?


Luke Rahbari  1:14:41

Well, I guess you can, I guess you can look at it from the good side is if something big happens in commodities or something since it’s going to bleed down. If you have some volatility. You’ll get a little bit of you’ll get some benefit from that. I don’t think the funds are going to unless they have you have some blowout have some of the funds or whatever, I don’t think they’re getting any smaller. I think they want to attract more money. So what do you do you have to come up with a new strategy, you have to come up with something new, which means the entire fund is now got six different risk managers that report to one guy, right? Commodities, fixed income, whatever. Obviously, there are some specialist funds, but I don’t think that’s going to change. And I think as far as volatility is concerned, you know, it’s for us, we look at it as our we have a long exposure to volatility at all times, because we have we run it with long risk assets. So we’re always net long Vega. But what we try to do is try to buy cheap volatility relative to what we think is expensive volatility. Right? And also depends on what kind of regime you’re in. For example, if if I told you volatility is at 50, today, right, or the spikes index, or the vix index is at 50. Today, I think most people would say that’s high. But is that in relation to yesterday when it was at 100? Or yesterday when it was at 20. So today, matters the least. Tomorrow matters, obviously, and yesterday was important. But today, we’re volatility is matters, the least to us. So we’re always trying to look forward, say, what’s it coming out of where is it? Where is it been? What are the expected moves mathematically, what you’re paying for volatility Are you going to realize that move, and then we always try to marry it with a risk asset, having no choice but believing that over the long term, the market is going to go up. But there is going to be some downturns. And it’s more important to control the downturns. Because if you start at 100, let’s say $100, and you lose 10%, you’re at 90. If you gain 10%, you’re at 99. Right? So to us, it’s more important to control the downturns rather than be always fully invested in try to get in every penny on the upside. And again, that’s just a small part of the portfolio. Having some volatility, having some volatility management, taking advantage of advantage of volatility, whether you’re selling it, whether you’re trading it, whether you’re marrying it with risk assets, I think it needs to be a part of your portfolio.


Zed Francis  1:17:19

As I said, our strategy in isolation is meant to do well during bouts of illiquidity, when correlations are likely drifting towards one across the portfolio. And in that specific event, there’s likely larger disconnects, due to the fact that the market is less efficient than it was at other points in time, which hopefully, continues to drive the ability to take advantage of that specific opportunity, even though we’re in a position to do well, to go into that, I think it’s almost more important is the portfolio construction, on the, you know, allocator acid holder side of the fence, which is my opinion, don’t rely upon correlations, because they are likely what’s going to drive you to into some problems when they all kind of go towards one. And if you’re not relying upon those correlations, think about your asset allocation process of what you actually believe, is going to deliver returns rather than be a quote unquote, hedging asset that does rely upon correlations. So I think, you know, our strategies are probably meant to do well in that environment, and probably provide additional opportunities during that environment. But I think it’s even more of a portfolio construction question at the end of the day, is beware of relying upon correlations and those asset classes that you’re assuming are going to do well during those environments.


Cem Karsan  1:18:38

So we have like, two engines, I agree with you, is it we have an RV? Like our relative value market maker framework, right? Where we see what’s high, what’s low, not just within each product across asset, the other one is positioning, right, looking at where the positions are, what that’s likely mean to mean as a function of liquidity, right? Those are two sources of edge. When does each one matter? The RV piece, generally speaking, things come back to correlating to one on the tail. So when you get into a tail situation, what you want to own is what was cheap, ultimately. But in the majority of other scenarios, which is the overwhelming majority, you want to be where the positioning is on your side, as a function of how much liquidity there is. And those are the two things you have to put together. When you’re modeling. What’s, you know, what type of position do I want to have? What’s the best, most probable win versus risk scenario? But that’s kind of the way we look at it. It’s really kind of putting those two sources of


Jeff Malec  1:19:37

I got an answer for that you see, not with what these guys do, but more on the trend following space, that the last year and a half has really seen. More bets become active right? In the past when the Fed was doing all this stuff. It was really just one big bet. All these different assets were moving together. Now that rates are going now that different countries have different views on whether they should be cutting or raising Have you really seen a lot more? Dispersion is not the right word. But you’ve seen things split a lot more in trend followers love that because they’re placing 75 different bets, right? So the more long or short so the more each of those 75 bets moves independently, the better it is for them.



Yeah, so I have a follow up question on the trend following, right.



So we’ve we’ve jumped the shark. Sorry, guys. Yeah. So



March, right. You see the six sigma event in Treasury options on the futures? Basically, kneecap in all these trend followers? In the span of a week? Right. Two days, two days? Yeah. So I haven’t seen that bleed anywhere else. Right. Haven’t seen that event. Essentially, work itself out through other parts in the market. Yeah. And if I, you know, and looking at some of these strategies, and the relative value and you know, different index or products that are traded, is that just like, a one off esoteric event that, you know, has no volatility bleed throughs later, or, you know, are we going to see convergence between, you know, the big bet that rates are going to be cut? And the fact that rates haven’t been cut yet?


Luke Rahbari  1:21:29

I don’t know if, yeah, I would give a quick answer, which is, sometimes when things get really wild, like the metals exchange in London, it just closed down for three or four days, I would argue that putting up gates on $100 billion worth of REITs is closing down exchange. So you haven’t seen it follow through? Because they haven’t let it follow through. Right. But it did, then that kind of has watered found its way to people that are holding legacy assets and the banks and etc. And you saw, Will, people starting to look at that, and their commercial loans, etc. So I think you’ve seen it, it’s, it has bled down, but then the Fed came in, right. So obviously, they came in for a reason, they save that bank for a reason, they didn’t save it, because they didn’t have anything else to do, or they weren’t worried about what was going to happen. Right, they came in for a reason, because they saw what could happen, the dam could break.


Cem Karsan  1:22:28

Ultimately, I agree. But ultimately, the way these things break, to see everything come into line, right to go correlation, one really see a massive ball of that. Two things have to happen. I mean, we’re talking about like an OA type thing, right, or a 2001. You know, you have to Feb March 2020, you have to have some major liquidity issue, it has to be something that comes from the top from a macro perspective. But you also have to have weak positioning. And that can be happening several different ways can be a part of the distribution that’s so heavy and so big, that can have ripple effects that blow everything up, or can be at the center, or at the core of the positioning, like it was during Feb March 2020, the macro was big enough, the positioning in the center was that, you know, bounce enough, on balance enough to cause a bigger issue. So the answer is, yes, eventually, if the positioning continues to go off sides, which tends to gravitate towards because people are greedy, right? You know, that’s part of it, they have an incentive to beat. And then you pair that with what we believe is a macro liquidity issue, that eventually we will get there. And, you know, my view is that it’s, we’re well, on our way, now, a year and a half or so into this. But it always takes a bit longer than you think, because of the reflexive effects. Because people are positioning board, they have to give up, they have to be shaken of their conviction. Or the move, the move is counter trend, you get some type of blow up, right, that forces that position as well. But the positioning needs to weaken. And you need to have that macro thing. And we believe the macro issue is in place. It’s just this kind of reflexive positioning issue that is has yet to unpin kind of the rest of the Yeah, yeah.


Zed Francis  1:24:30

It’s definitely wasn’t healthy, but mostly assets, the owner long duration assets, so like 10 year plus stuff, and that part of the curve on surprisingly, was not nearly as violent. So it’s like you weren’t moving asset based on discount from treasuries moving around, much. And then the other side of the coin is financing, outside of fixed financing, which, you know, takes longer to have problems is floating, which is going to be fed funds or Sofer or something along those lines plus, and that obviously didn’t change either. You know, spot rates didn’t move. So it’s like your snap problem vehicles have either duration moved rather dramatically and guess who I’m all my assets have a lot of duration, or my financing costs changed overnight. While that didn’t change either because it was spot it was kind of you know, that is front end is kind of two year driven, but it was isolated for now to that spot. I’m the Treasury curve, but it’s probably not healthy. But that’s probably why it didn’t cause a decent amount of ripple effects and other things immediately. Alright,


Jeff Malec  1:25:30

we’re gonna leave it there. Unless someone has a really burning question. All right, we’ll leave it there futures.


Cem Karsan  1:25:37

A couple more on the screen. I’ve been watching. I can’t help myself. I’ve been like watching a little bit.


Jeff Malec  1:25:45

Thank you, everyone. There’s drinks and some food next door. Enough for 50 people. So go up yourself and eat it all. And thank you all. Thanks, guys. Thank you. Okay, that’s it for the past. Thanks to Jim. Thanks, Zed. Thanks to Luke. Thanks to RCM for supporting thanks to Jeff Burger for producing. We’ll see you the second week in July. Have a fun fourth don’t want any fingers or eat too many hot dogs. PEACE


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