In this episode, Jeff Malec sits down with Scott Phillips, the CIO of Lavaca Capital, to discuss the firm’s journey in the world of options trading. Scott shares his personal background, from his start as an auditor of energy derivatives at KPMG to founding Lavaca Capital and navigating the complexities of options strategies.
The conversation covers Lavaca Capital’s evolution, from their initial focus on simple option structures to the expansion into more complex portfolios and the eventual return to simpler expressions. Scott provides insights into the challenges of managing option books, the importance of discretionary overrides, and the impact of the growing options ETF space.
Scott and Jeff explore the misconceptions and pitfalls in the options market, the need for better education and simplification of concepts, and the potential for future market disruptions. They also discuss the firm’s customized solutions for clients, the current market environment, and the lessons learned from historical market events.
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From the episode:
The VIX Index and Muted Volatility in 2022
RCM: The Dummies Guide to Option Greeks
Check out the complete Transcript from this week’s podcast below:
Options give you Options with Scott Phillips of Lavaca Capital
Scott Phillips 00:06
I think that people get tripped up when they try to simplify them too much. I think that the options industry in general has not done a great job of bringing very complex products and simplifying those concepts to investors.
Jeff Malec 00:25
Welcome to The Derivative by RCM Alternatives, send it.
Scott Phillips 00:28
My name is Scott Phillips. I’m the CIO of Lavaca capital, and we believe options can give you options.
Jeff Malec 00:50
Where are you coming to us from? Today,
Scott Phillips 00:52
I am in Houston, Texas, here in our office in Houston, Texas. We’re in the Galleria area, for those that are familiar with the city. It’s also the options capital of the world. If you didn’t realize
Jeff Malec 01:07
you’re I was about to say you’re an equity options guy stuck in a oil trading town.
Scott Phillips 01:11
That’s right. That’s right. So I think some people get confused. They see Chicago on our website every once in a while, and they’re like, are you in Chicago? Are you in Houston?
Jeff Malec 01:21
What? Uh, what happens at party. Or people like options, what? What kind of options? Energy options, yeah, or people get it down there. Uh,
Scott Phillips 01:31
so I would say in Houston in general, there is more of a vague understanding of what we do versus, you know, you’re in Chicago, like everybody knows options up there, down here, it’s a little bit off the run, more off the run. And if they do have any familiarity, it’s through typically energy hedging, hedging programs that they’ve worked in in some, some distant past we even
Jeff Malec 01:55
have. It’s probably just the people I know and hang out with who were on the floor in the business. So they talk deltas all the time. Of like, what do you think the delta of the Cubs winning the pennant this year are? Like, like, oh, there’s only a 5% Delta. I make it to that. It’s gonna rain anyway. Blah, blah, blah, yeah. See,
Scott Phillips 02:12
we’re more you know, you’re all hat, no cattle. Yeah,
Jeff Malec 02:17
all had no cattle. So let’s dive in. Give us a little personal background. How you got into the world of options, and we’ll go from there.
Scott Phillips 02:25
Yeah, definitely. So I went to University of Texas at Austin. I’m a native Houstonian, and when I first got out into the workforce, I started my career at KPMG. I worked in energy derivatives, so I was part of the audit team here down in Houston, working on a wholesale powered company at the time that’s no longer, I think they were absorbed by NRG 1015, years ago now. So kind of got a hunger for derivatives there. I have a kind of a family background in it as well. And so I always knew I wanted to end up in investment management. I started off with more of a technical, you know, kind of career there in accounting, and then jump quickly over into investment management about two years after being in accounting, that’s
Jeff Malec 03:17
a rare path. I don’t think we’ve ever had anyone that went from auditor to trading, and that’s right, that’s right, yeah, it goes the other way. They were not so good traders, and ended up,
Scott Phillips 03:27
ended up at auditors, yeah. So, yeah. So call me a rare bird, and definitely not your typical career path. But started out managing some family capital, like I said, there’s some some background there in the family, and and then use that as kind of my initial capital base to to start the firm back in 2014 2014
Jeff Malec 03:51
Did you have any Enron overlap being down there? No,
Scott Phillips 03:54
not for me. Not for me. I did have a little bit with some people that I worked with, particularly at KPMG, but not a not personally, but
Jeff Malec 04:01
KPMG wasn’t the one auditing that Star Wars and
Scott Phillips 04:04
no, it was Arthur Anderson and a lot of those partners. A lot of those guys left and joined KPMG. When, when Anderson went down? Oh, really, yeah. So a lot of them, plenty of good war stories
Jeff Malec 04:15
there. Yeah, it’s got got any that are family friendly for the pod here,
04:23
nothing. PG, all right,
Jeff Malec 04:26
so then start of the vodka. Same idea from the start. What was the general genesis of it? Yeah, veteran options. You can do different in options. What was the Yeah?
Scott Phillips 04:37
So just started really with simple, kind of more simple structures and options, so utilizing, you know, more simple approach of just some simple cover call, writing some simple, you know, hedging around equity portfolios and then quickly, kind of got into more complex option portfolios. Is as the business grew in 2018 made first new team member additions. Those team members are still here to this day. And then 2019 made our move into the private fund space, the launch of our first fund. And then into 21 launched our second fund, and those those strategies, it’s kind of interesting to see the genesis of the business because we started with, or at least I started with, much more simple structures. We went to a much more complicated book, and it’s been interesting to see the Genesis business kind of shift back towards more simple expressions of options. And
Jeff Malec 05:46
we were talking offline right before we started of those simple expressions are gathered, like 140 billion and yeah, assets and simple covered call stuff. And yeah, I guess I wouldn’t say the buffered note stuff is so simple, super simple. But,
Scott Phillips 06:01
yeah, yeah, you know, I mean, but the, you know, at the end of the day, like a caller, or a footsburg Caller, so that they’re utilizing there on the buffer notes, or, you know, you got three legs there. And people generally these days are starting to pretty much understand cover calls. And a lot of them are starting to understand, you know, hedging or protection, I guess, is the is the buffered ETFs, call it. So I think it’s been interesting to see how options have been democratized, pretty, you know, pretty widespread since, really, since COVID. And if I mean, you know, we were talking about that chart, there you look at the the inflows into these ETFs that that utilize options, these actively managed ETFs that utilize options. This has grown tremendously over the past four or five years. I mean, um, when I first started in this ego, I was just kind of like to say the Christmas dinner barometer. Now I go to go to Christmas dinner, and people ask what I did, and, you know, I’d say, No, what’s an option? You know? Now everybody wants to talk about options at Christmas dinner. You know, it’s like people want to talk about Bitcoin back in 20, 2019 when it made its first 2017 2018 when it made its first peak, and then went into bear market after that.
Jeff Malec 07:13
The some of that is not right, the democratization is not always good. What we had a guy in here who’s his nephew was the one who killed himself, like, because he lost a bunch of money trading options on Robin Hood and all that. So, yeah, yes. But also, I think at some points it’s been too gamified on some of the apps and whatnot, yeah, you just like, oh, you can make YOLO buy all these options on Nvidia, and you could never have to work again, you know, like, well, you also have a 5% chance of actually making any money. Yeah.
Scott Phillips 07:46
You know, it’s interesting. You say that because I was on the so I was on the we used several, several custodians, several primes, one of it, which is Interactive Brokers. And I was on their, on their app this afternoon, just checking the market. And they have a whole gamified section on there now about how to use options to, you know, express a thesis, essentially, hey, I think, you know, Apple stock is going to go up, or the volatility is going to go up on Apple by four points, or something like that. And then it creates a pre made, you know, ready made structure for you. It’s like, you know, TV dinner to stick it in the oven, yeah? What
Jeff Malec 08:28
are the problems you see with that? I mean, the simple answer is, it’s not that simple, right? Like, yes, if you think it’s going to go up, you can’t just buy the call. Yeah, it’s never that easy, right? You need to think it’s going to go up more than it’s already expected to go up. Right,
Scott Phillips 08:43
right? Yeah, it’s never that easy. I think that, I think that people get tripped up when they try to simplify them too much. I think that, I think there’s two parts to it. I think one, I think the options industry in general, has not done a great job of bringing very complex products and simplifying those concepts to investors. You know, a lot of the talk, you know, still revolves around Greeks. And you know comp, you know second order Greeks and third order Greeks, and you know Volga and Vanna and charm, and you know the, not let alone, you know delta and gamma data and all that, right? And for most investors, even you know the the really institutional investors we come across like that, stuff goes over most people’s head, unless, you know, unless you’re in Chicago, you know, or you run an option fund, like people don’t, people don’t have time to understand, or really care to understand what the, you know, charm of a three, you know, three month put option on the SPX is,
Jeff Malec 09:53
and what, tell us what charm is real quick.
Scott Phillips 09:57
Yeah. So charms, the decay of. Of the Delta as time passes,
Jeff Malec 10:03
right? Instead of the strike or of the premium, yeah?
Scott Phillips 10:07
Okay, of the Delta, the delta, right? Yeah, it’s helped out the changes through time.
Jeff Malec 10:11
And so do you, I guess that’s an interesting point. Do they care? Do they not care? Because they don’t have to care, right? Like so the institutional guys, they just have a specific, specific idea of what they want to do, most of which involves hedging. They probably don’t need to care that much about the decay of delta over time. Yeah,
Scott Phillips 10:31
that’s the thing. I don’t Well, I mean, I think maybe, I think, if I was an institutional investor, I would care about the, you know, decay of delta over time, because that’s going to impact the effectiveness of your hedge. Yeah, right. But just simplifying that, right? You don’t need to talk about it in terms of of charm, necessarily, right? You need to talk about it in terms of the effectiveness of your hedge, right? That’s a much more simple concept.
Jeff Malec 10:53
Hedge loses its effectiveness this raise over
Scott Phillips 10:56
time. Yeah, exactly, exactly. So when you started,
Jeff Malec 11:00
when you started, when you said you went from simple to complex, back to simple, or was that because you got taken to the wood chip like, where most option programs have this kind of historical progression right of they start out great, mostly all are kind of selling, naively Selling ball. And then they get whacked in some event, like a Feb 18 or something, bomb again. And then, like, oh, I need to have some filters. I need to have this and that. So did you ever have one of those events, or you just started to see, I
Scott Phillips 11:34
didn’t, I, you know, I really didn’t. What I did get to was, you know, when you’re running, you know, a complex book, multi line item, option book. There’s ways that you get surprised, all right, not because you don’t understand it, but because, when it gets that complex, and there’s that and there’s that level of, you know, I mean, let’s say you got what, 789, Greeks, right, per line item. Now, those all interact. You’re just, you’re not, your expectations are not going to be met like you think they’re going to,
Jeff Malec 12:15
which is the idea of those Greeks right? To sum that all across that book, and be like, here’s my yeah exposure,
Scott Phillips 12:22
yeah, yeah, certainly, certainly. But I still think that that things can move outside of the realm of your expectations more than you, more often than you expect it to. And so, you know, you know, if you’re trying to come up with, you know, I think that things become far too complex when it comes time to say, offer a portfolio hedge. A lot of times like the simplest hedge is the best, right? A lot of people want to try to use, you know, maybe they’ll try to use a fix call, right? To hedge a portfolio. Well, I mean, that didn’t work out great in 2022 right? But just delta, you know, just owning a put delta, especially if it was longer term, didn’t matter that they could then expand on you. You got 100% of that short Delta and that and that decline.
Jeff Malec 13:14
What would you say to then just do, right? If that’s kind of just taking down your overall delta. So instead of being 100% long stocks with a this hedge, why not just go to 80% long stocks or something, right? Yeah, just adjust your delta on that side as well. Yeah,
Scott Phillips 13:30
just trim your equity portfolio. That’s certainly another way you can express that.
Jeff Malec 13:34
Yeah. That’s always a confusing part of the hedging. Like, well, you that’s the simplest of all. Just do less.
Scott Phillips 13:40
Yeah, yeah, yeah. And, you know, in a cash environment where you’re earning four plus percent, yeah, not, you know, it’s not nothing,
Jeff Malec 13:48
um, so you have any examples of some of those. I get caught you by surprise, so to speak, just like skew movements or what,
Scott Phillips 13:59
um, I would say the level of volatility that we started at coming into 2022 you really didn’t have, like, a spot vol beta kick up until June and September. Of those years, you had a little bit in January. It was January 24 I only know that because it’s my daughter’s birthday, and things always tend to and we’re at Disney World, and things always tend to happen when you’re out of the office, right? Yeah, and then you have this massive ball crush in May of 22 if you don’t remember that picture I call got just taken to the woodshed and then picked back up in June, when, you know, S and P was down nine that month. So that lack of spot ball beta, which is somewhat returned, though, meaning that we now have spot ball beta coming back into the market, was a little bit surprising.
Jeff Malec 14:54
Just the amount and magnitude of how it magnitude and velocity of the crush you’re saying.
Scott Phillips 14:59
Yeah, Yeah, correct. Like, I mean, you just, I mean, market down, ball down, yeah, big strike ball was, I mean, I think, you know, SIBO asked me to write a blog on this. It was, you know, at this point, it’s three years old, but you look it up, it’s June of 2022, I think it was, wrote a whole white paper on it. Just how anomalous that period was. And, you know, the funny thing is, is that, you know, when we looked at things, we identified that as a period that can be challenging for some types of auction strategies. It was very similar to, like, 2000 2001 and yet, when you live it, right? You know, 20 something years later, you’re like, Whoa, one second.
Jeff Malec 15:45
So how, what? And then you went super complex. So talk, talk to me a little bit of when you went super complex, you just had all these major items, yeah.
Scott Phillips 15:54
So that was, you know, that was kind of mid, mid life of the firm, I would say, and we really started to focus our business kind of more on a fund business. But as we went to the market and we started talking with investors, what became clear to us was that, and I think you would probably agree as to this, investors these days are much more interested in what’s specific to their portfolio, right? So, like, in order to invest in, you know, an off the shelf strategy, an investor has to raise cash, right? They got to deliver cash to you. Yeah, you know, any manager of a fund or SMA or whatever, like, they have to deliver cash. But you can use options without having to do that right and work with an existing investor portfolio to provide maybe you’re providing alpha, maybe you’re providing a hedge, maybe you’re expressing a thesis, and do much more creative things, which is what I love about this business. That’s the part of options. Like I said, we kicked it off with options. Give you options. That’s what I like about it. It’s kind of like a canvas, you know, investors looking for something specific, and you can utilize, you know, a vast array of these instruments to create what they’re looking for. And what’s
Jeff Malec 17:12
an example of like the Boeing execs come and say, Hey, I’ve got 50 million in Boeing stock. Can you help me hedge it, or earn a yield off it, something like that. That’s
Scott Phillips 17:24
a great, you know, that’s a that’s a great example, generate alpha on that position, hedging that position. I think some of the ones that I kind of find interesting your private assets. So how would you hedge a private asset with a public instrument? Obviously, it’s a dirty hedge, but there’s no direct, you know, can’t buy an option on private company. But that’s that’s been pretty interesting to me. Some of the mandates that we worked on, there proposals that we
Jeff Malec 17:50
were and those are like venture investments or things that have an iPod yet,
Scott Phillips 17:56
it doesn’t necessarily have to be a company. It could be a real asset, right? It could be a commodity, something like that, that’s not hegible directly.
Jeff Malec 18:07
And how do you do that? Do you how do you start with that? You look at what’s correlated.
Scott Phillips 18:12
Yeah, yeah. So you look at correlated instruments, you find either individual equities that are correlated sectors, ETFs, you know, even if it’s just a broad beta, and really dial up to what the client’s trying to achieve for it. So if the impairment or the decline in value of some assets going to impair cash flow to that entity, you know, what can you what can you construct on the public portfolio side. You know on the liquid portfolio side that that gives an offset to that decline in cash flow.
Jeff Malec 18:53
What do you find that a lot those are rare, like those investors and privates or realizes that are actually looking to hedge. It seems to me, a lot of those guys are just, hey, this is how I’ve made all this money. No need to hedge it. I’ll just keep that risk going. You
Scott Phillips 19:06
know? It’s funny, they don’t care. It’s not so much the hedging. It’s they definitely don’t want to cap the upside, and it doesn’t go down. Yeah, yeah. So, you know, even in a mature asset, all right? Or even in a public asset, right? If you have somebody that is very, you know, has owned a public asset, for our liquid asset, for a very long time, they are very generated material wealth off of that asset. They’re very hesitant to, you know, to do an override on that, even if it’s, you know, an opportunistic override. Nothing that we do systematic here, everything’s much more discretionary. And so I think that’s the best way to express, to express options, because you have to find, you know, there’s, there is. There’s always a time to sell a cop call option. There’s always a time to buy a call options. What’s the pressure paying for it? And. So, yeah, we,
Jeff Malec 20:01
we used to have a Investment Advisor We worked with. He’d call those, uh, positions financial furniture, and be like, oh, and Jenny’s got this Coca Cola stock that her grand is just sitting over there in the corner. You can’t touch it, can’t sit on it, can’t do anything with it. Financial, yeah, admiring,
20:20
yeah, that’s awesome.
Jeff Malec 20:27
Let’s move into kind of the current strategies, what you guys are doing across the firm,
Scott Phillips 20:34
and how all that works. Yeah, so we currently manage about four 50 million in AUM, and we do primarily sub advisory work. We do manage some commingled structures, I’d say about three quarters of our business, though, and the and the side that’s really growing is providing kind of bespoke solutions to end investors, either through intermediaries, such an advisor or so, or directly to, you know, an entity like a family office or so, the uptake of option strategies we talked about, the democratization, you know, one benefit of that is that people are much more interested in the use and utilization of these types of instruments in their portfolios, and they’re eager to see, you know, how you can provide value. I think that’s the main thing that we focus on, is focusing very, very closely on, are we able to add value to the end client. If we can’t, we’ll tell you, hey, this, this isn’t, this isn’t something that we can work with, which
Jeff Malec 21:47
would be what I’m trying to hedge this
Scott Phillips 21:51
palm oil stock, yeah? Or if it’s a liquid, or, you know, the last thing that we want to do is to not have expectations be met, right? And you can’t, obviously, you can’t guarantee that. And people, you know, there’s always that possibility out there, but as close as possible as we can of meeting expectations with investors. You know what is really important from a business perspective and a client relationship perspective,
Jeff Malec 22:24
most of those clients are trying to protect downside or amplify upside.
Scott Phillips 22:32
I would say currently we have received more inbound, probably for downside protection, yeah, yeah.
Jeff Malec 22:45
And then what’s a typical structure? How are you structuring your trades or your strategy to kind of meet that mandate?
Scott Phillips 22:53
Well, it depends on what the mandate is, yeah. And depends on the client. And it does vary. I um, typically we’ll look for either direct hedge, but put spread depending on what ski looks like and what pricing looks like. You can replicate OTC type structures and list the listed space. So, you know, maybe it’s a digital or something like that, a digital replicated in the in the in the in the liquid space, or maybe it’s just a straight put spread, maybe it’s one by two, you know, something like that. All depends on, on that specific asset.
Jeff Malec 23:34
But and then in your funds, would you say there is, like a flagship strategy?
Scott Phillips 23:41
We do run a specific strategy, although we are limited on what we can speak about from the from the private side, right?
Jeff Malec 23:51
Yeah. Well, give me as much as you can speak about.
Scott Phillips 23:56
Yeah. So yeah. So we’re so we just trying to generate alpha. Our goal is to generate alpha to the s, p
Jeff Malec 24:03
and so tracking is so if S and P is alpha to the SME, so SP is up, you expect to be up. S and P is down, you expect to be down, less.
Scott Phillips 24:15
Generally speaking, generally
Jeff Malec 24:16
speaking, right? So it’s not pure absolute return. It’s more of a what I would call tracking plus, s, p plus, you know the downside. I think
Scott Phillips 24:25
it depends, anything depends on if you pair something with equity or not, right as a standalone, then maybe more absolute return if it’s paired with an equity like looking at the total portfolio, right? If you have an absolute return bucket and you have an equity bucket, and you pair those two together, equity is down 30. But you’re, you know, your absolute returns up 10, well, your total portfolio is still down 20. Yeah. So you know where we judge, you know the value of our basis on is what that incremental return to the portfolio is. Yeah.
Jeff Malec 25:01
And what? What do you think most either we could go back to the retail guys or institutional guys like, what do you think most people get wrong? Or maybe that’s too harsh of a word, but what are they overlooking in the option space?
Scott Phillips 25:13
If any, I think, right, what? No, I think, I think one thing though, that’s currently being overlooked is this systematic nature of these ETFs and the explosion of AUM in them. I think the next time we get a, you know, a COVID like decline, or a layman like declined, or, you know, maybe even a December 2018 kind of style market, which we haven’t had, and, you know, we had a little bit in 22
Jeff Malec 25:41
but you know, yeah, a lot of those August 5, we started to have one whenever that, Nico, yeah, yeah,
Scott Phillips 25:46
that, that’s right, August 5. But I think the cadence of it has to line up with when these systematic portfolios rebalance, right? So, like, let’s say you had all this AUM today in those funds. Well, March, 20, 2020, you know, markets down, what 30% from its eyes. You know, XYZ. You know, $500 billion of XYZ ETFs that sell, you know, call options. You know, monthly call options, maybe at the money, maybe slightly out of the money go and rip a bunch of calls. You know, at down 30 market rips back up into April OpEx. And you know, investors are now, you know, capped, and so their return profile, expectation, there something like that is going to happen in the future, at some point when those two things line up, and I think that’s where, where people are going to see that, that the systematic approach to option strategies does not produce the, what do they call it, sec yield, that they’re, yeah, they’re getting right because, you know, you think
Jeff Malec 26:56
that’s kind of a right. They’re calling them alternative income funds. They’re just selling premium, and I don’t know if we should be calling premium collection income, and they’re
Scott Phillips 27:08
just returning capital, right? I mean, if you look at it, you know, they’ll say, if you look at the total return and the price Return of the ETF, they’re returning capital to the end investor. They’re returning them their own dollar, not in income structure. So those always get me. They always get me. But
Jeff Malec 27:26
even maybe they’re smarter than us by half, right? Because,
Scott Phillips 27:30
well, yeah, they got our heck of a lot more money. But
Jeff Malec 27:34
it’s like their their worst case scenario, as we just laid it out, is you were down less than the market, and then you were up less than the market. But you’re right, so the market ripped up 30 off a down move, and you were only up five or something, yeah,
Scott Phillips 27:49
but the up down capture ratio is completely, completely thrown off, right? Because maybe they’re down, you know, they’re down 98% of what the market is. The market’s down 30, they’re down, you know, 28 right? But the market’s up 30 and they’re up five. Yeah, that’s not a good ratio. That’s
Jeff Malec 28:07
not a good look. But I feel like the the people are investing, sort of, we’re like, well, but we lost less, yeah, and I’m just it’s consistent. The rest of the time it’s consistent,
Scott Phillips 28:17
yeah, yeah. I mean, it took, if you go pull up the charts, it took, I think it was until 23 Don’t, don’t quote me on this. But if you go put look at the charts on some of those ETFs that were around, or mutual funds that were around that run, ran these strategies through 2020 it took them almost two or three years to recover to their high water mark. You know, when equities took what, six months, you know,
Jeff Malec 28:46
and the more insidious problem, too, is they’re having to get closer and closer to the market, right? Like, the more they come online, the more they’re trying to sell, the calls they’re more demand, more supply.
Scott Phillips 28:55
Yeah, way more supply on the market. That’s driving the price down, that’s giving them lower premium, give them lower break evens, all that kind of stuff. And don’t get me wrong, like I think there is, I am not in the camp of, you know, kind of the more, the more. What’s the right word I’m looking for? I don’t want to offend somebody, but you know, I’m definitely in the camp that there is definitely a time to sell call option. Some people believe there’s never a price to sell equipment, but I believe there’s, there’s certainly a time and or price to sell a call option, but it’s not systematically done. You know, on a regular Well, you’ve
Jeff Malec 29:35
locked yourself into that. What when are the times and places to sell?
Scott Phillips 29:40
So I think it depends on what the investors objective is, and there’s always the argument, like you said, that you should just sell part of your equity right proportionate to what the delta that option is. But in general, I think that I. If you can look at a basically look at the volatility that option. And if it’s normally trading at a 18 ball, right? And all of a sudden it’s a 24 ball for some reason, outside of an earnings or some type of special announcement or something like that, that might be a time to start to look at something all right, so is it outside of what a normal market condition would imply for that underlying equity? Now that doesn’t mean it’s, you know, it’s, it’s risk free, like, right, you know. I mean, you know. And certainly nobody, none of these funds are out there delta hedging that option, right? So, you know, they could be, you know, right for the wrong reasons or wrong for the right reasons.
Jeff Malec 30:50
What’s your take on all the increase in I mean, this has become less and less talked about. But zero DTE, all that volume that’s happening in the index option space, that’s a good thing for you. Doesn’t matter. So
Scott Phillips 31:05
we so we do trade a decent amount of zero dt, that markets gotten much more efficient. But there’s still pricing anomalies there. I think, I still think that there is a price anomaly in the zero DTE space, but it’s not it, you know, kind of widens and skinnies up at various periods in general, you know, zero DT fully came online in what may of 22 June of 22 when they listed all five days, yeah. And that’s kind of how I define zero dt, that you could do one every day of the week. You
Jeff Malec 31:37
know, not, right? Because there was always zero dt. You just had to trade it, yeah? How to trade it on Thursday,
Scott Phillips 31:41
right? Yeah, yeah. So that’s kind of my, my definition of when real, you know, five day a week, because you zero DT came online, and I’d seen, I’ve seen that market get a whole lot skinnier. Now, it’s also possible because, you know, we’re trading in a 2030 vix environment, most of 2022, right? So, you know, you look over various periods, you know, when ball realized ball has been trading, you know, into the low teens over the past month or two, and some of those premiums start to look like what they did back in 22 not quite there. They’re still lower. But as realized fall picks up, they generally tend to follow realized ball,
Jeff Malec 32:20
which makes sense. That’s like, yeah, what they are? If it gets realized, you’re gonna realize, yeah, yeah, exactly, exactly. And who do you see as the main players? And there’s a retailer, institutional.
Scott Phillips 32:30
I think institutional does a ton of it, yeah, but you’ve seen a decent adoption of retail ETFs utilizing them. So like, there are some zero DT put selling funds out there, call selling funds, they typically do at the money I think, I think one of them does like 1% of the money call, or 1% of the money call option. They express it by selling a 1% of the money put option. But even that, you know, it’s a little bit different when you’re selling that put versus call, because of the carry environment we find ourselves in, you know, what? Seven years ago, or, you know, four years ago, didn’t really have to worry about much of the difference in carry, because rates were zero. Now, you know, there’s, you know, you’re looking at at the money put in SPX, you know, in and out the money call in SPX, and there’s a one to $2 you know, difference there because of the carry and that call. So
Jeff Malec 33:23
you don’t see any problems with zero to, like, two years ago, when it became everyone was talking about, right? It was like, this is going to cause a big crash. There’s going to be liquidity problems. Do you see that? Or it’s a balanced book, and it’s just, is what it is. It’s just, instead of once a month, now we have it every day of the week. Yeah, I
Scott Phillips 33:41
think it’s, we have it every day of the week. I mean, look at the flow and look at the volume. I mean, you’ll trade, I mean, on a single line item, they’ll trade 70, 90,000 SPX, yeah, you know. And they go to the similar it’s interesting watching that flow throughout the day and watching the market react at those levels, and how the market trades around those levels where primary volume is that’s a pretty interesting exercise, if you ever want to, want to follow along one day, because you generally tend to see the market react, you know, positively or negatively around those those levels, depending on If it’s put in the call. But I think that there’s, I think there’s plenty of liquidity there. I don’t think that they’re, you know, instruments financial Armageddon. I just think, you know, at the end of the day, like they do, they go away and, you know, everybody kind of might be able to get up in arms about, well, they’re, you know, you can trade them intra day from a margin perspective. And your prime. May not know it, right, but they still expire at the end of the day. Yeah,
Jeff Malec 34:46
that doesn’t drive clicks we need. We need some hotter takes there. These things are Armageddon. What are the so it’s not buffered notes, it’s not covered. Call funds, it’s not zero. DTE. What else we got? Anything else we want to dispel the myth of. Yeah, just outright put selling.
Scott Phillips 35:03
I don’t think you’ve seen as much of that in the market. It’s coming back a little bit, but I don’t see a ton of flow there. I think it’s primarily on the call side, right, or it’s synthetically covered calls. They’re selling a put, they’re selling their money put. So where do I see it? I see, yeah, I see some of that, but still, like, there’s no, there’s no leverage in the system on that, right? And, I mean, they’re not the if they were levering that, then, sure, all right, but I don’t see the kind of leverage there. And those funds certainly can’t be levered, right? So, you know, selling a 1% in the money put to replicate a cover call. Okay, markets down five. They’re down, you know, 4.8 right? Whatever it is. So, yeah, I don’t see that.
Jeff Malec 35:56
So you said you’re mostly all discretionary, or it’s all discretionary, mostly
Scott Phillips 36:00
discretionary. Yeah, I mean, we have a rules based kind of process framework that we utilize. We’re a team of four, three on the trading side, but in general, I would say there’s always a discretionary override. And I think options strategies get in trouble when there’s not but
Jeff Malec 36:19
expand on that, because it’s not that simple, as we outlined before, like the price will be the right, right?
Scott Phillips 36:26
Or knowing what to do, you know? I mean, you know, knowing what to do the morning of August 5, right? Knowing that that spot ball beta was so out of whack, right, that not doing something to your portfolio there, if you did not monetize and the early morning hours are right around the open despite the market being extremely wide, right? Even in SPX man, SPX was trading like 20 points wide on some
Jeff Malec 36:51
stuff, versus half a point. Yeah,
Scott Phillips 36:53
yeah, if not tighter, yeah. Not being able to realize that that is a time that there needs to be some discretion exercise, right? You know, you would have missed an opportunity there to do something good for your portfolio. I think so things like that, where, you know, something gets so far out of whack, you know, zero DTS, you know the straddle today, where it traded 20 bucks. Roughly $20 at the close today, starting to get pretty low on a, you know, $6,100 index, 61 $40 index,
Jeff Malec 37:32
on what on the close for tomorrow’s expiration? Yeah,
Scott Phillips 37:35
yeah, $20 SPX straddle, you start getting much lower than that. And it’s that’s as low as I’ve seen it since zero DT started trading.
Jeff Malec 37:44
And what’s that implying that it has to move a third of
Scott Phillips 37:48
a third of a point? Yeah, roughly.
Jeff Malec 37:52
Let’s go put that on that does seem a trend, yeah. But isn’t it a case of like in theory, you could systematize all those thoughts, or is it just not worth the right? Like, okay, if it is this far out of whack based on standard deviations or versus the average, don’t trade or do the opposite. Or, yeah, like, in theory, it could
38:14
all be, yeah, all right,
Jeff Malec 38:18
right. It’s not that it shouldn’t be that it hasn’t been. You can
Scott Phillips 38:22
definitely systemize, systematize to a point, but I still think, and you know, in normal times, like having a systematic, you know, systematic expression should be just fine, right? You take all of your rules based, you know, framework, codify that, systematize it let something run that but you have to be able to override that system. So, like, yeah, like, you know, the past couple weeks, things, not much has been happening. All right, early in the month, you know, we had a little bit of a dip, and not much has been happening. You could certainly systemize, just tie something for a pretty normal or benign environment. But outside of the, you know, we start getting on the tails, outside the media distribution there, I think that’s the time to over.
Jeff Malec 39:07
What you have any thoughts on, what breaks us out of this low realized regime? Right? Like Trump seems like he’s doing everything in his power, but nobody cares. Yeah,
Scott Phillips 39:17
I think you have a tug of war. There’s a lot going on. I mean, on one hand, you know, deregulation should be pretty good for markets, you know, on the other hand, you have this massive amount of debt right at the fiscal level, US level. On the other hand, you got Elon Musk out here, you know, Storm and Fort dock, creating unemployment, yeah, and cutting costs, left and right. So I think that there’s all these kind of things swirling around on the under the surface in the macro world that are kind of canceling each other out and the markets traded now, since what? Since I. Uh, maybe not August, September, October, November. Until now, in a range, we’ve traded 5100 you know, just the past few days that we’ve broken out of the 6100 you know, top side of the range. But we traded 57 5050, 860, 100 for 345, months now, markets digested some of the Trump move.
Jeff Malec 40:20
Writers, everyone, traders, are just like, Don’t stick your neck too far out, one way or the other.
Scott Phillips 40:26
Yeah, I don’t know necessarily that. I just think that. I think that people, there’s so much of that swirling around underneath, right? So maybe you’re right. Yeah, people haven’t fully grasped what the next move is going to be,
Jeff Malec 40:44
right? I don’t know. And at the same time, yeah, I was just
Scott Phillips 40:49
gonna say, like, at the same time, you know, we’re consolidating at the top of, you know, a pretty large range here on a after a massive run, you know, over the past two years, what it’s been since the 70s, since the market’s been up this much back to back, 23 and 24 I think the I saw a stat somewhere that it was 73 or something, 7374 since we had that type of run again, I have to go and look that one back up. But that’s a big run. That’s a big move, that’s an anomalous move.
Jeff Malec 41:18
And what are your thoughts on Nvidia? Mag, seven, huge concentration. Like all of those stats are that basically that hasn’t been seen since 2000 2001 as well.
Scott Phillips 41:30
Yeah, but you have a lot of dispersion there, I think, like, look at those seven names. I mean, Microsoft traded, you know, it’s 15% off its high set last summer for nine months. Now it’s traded around 404 20 bucks and video, kind of the same. You know, went to one. It’s trading 121 40 for a period. Now, really the only ones that have actually gained traction, and, you know, higher prices attempted higher are meta apples kind of traded in this range, 200 to 240
Jeff Malec 42:04
Yeah. But that’s kind of right, of like, if one of them, if one of the sevens down, down the other, load up on the other, yeah, right. And so yeah, the game keeps going. And then people decide all seven need to go up,
Scott Phillips 42:20
yeah. And then the options world too, like, look at the volume and all those names, right? I mean, once you get outside of the top 2030, names, you know, equity names, like, volume just falls off a cliff in the options world. So
Jeff Malec 42:34
do you do any dispersion trading kind of stuff like that?
Scott Phillips 42:37
No, we don’t. I think it’s, I think they’re great. I think it’s been a wonderful trade. Fully understand it, but it’s just, I think that I don’t want to spread things too thin, you know, focusing poor on, what are our what are our businesses? Can we do it? Sure, yeah. Is it time and effort that I would then have to spend, or one of our team members would have to spend Absolutely,
Jeff Malec 43:03
but you will, per that custom approach, if someone’s heavy in tech, be like, Okay, well, we’re gonna edge it with NASDAQ options or whatever.
Scott Phillips 43:10
Oh, certainly, yeah, certainly, yeah. And, I mean, it’s always a, you know, cost benefit analysis, right? If you can get, you know, 50% or 80% of your hedge effectiveness through triple Q. Put versus buying a, you know, put on meta like, go for that.
Jeff Malec 43:36
We got one last segment we’ll do for you. Then here, if you could travel back in time to any big market event. What would it be? And how would you trade it?
Scott Phillips 43:52
One that I was president or one that
Jeff Malec 43:54
I would it could be anything. Could be Napoleon or something, yeah,
Scott Phillips 43:56
yeah, really go back there.
Jeff Malec 44:00
That’s the, I think that is the, I don’t know if it’s truth or rumor of Rothschild right? The Rothschilds in Europe had a carrier pigeon. This was like the first ever high frequency trading. So someone witnessed that, an appointed lost sent back a carrier pigeon to England, and he knew that before, and was trading based off that knowledge,
Scott Phillips 44:24
yeah. So one that I always thought is super interesting is when the hunt brothers traded supermarket. Yeah, no idea how I trade it, but would have loved to have lived
Jeff Malec 44:40
been in the mother of all short squeezes.
44:42
Yeah, yeah, but
Jeff Malec 44:44
that’s interesting from an option standpoint, right? You would think the obvious answer would be by calls, but perhaps not, man, they’re
Scott Phillips 44:53
like, so meant the ball was so out, you know, so blown out. Yeah,
Jeff Malec 44:56
I’ve seen that data in the you. Internet bubble crash, if you I think the best trade was selling puts. It was which you would think you’d be like, Oh, the market was NASDAQ was down 70% like, buying puts would have been the best, right? You’re naive. My naive brain just goes, Oh, you buy the puts. Yeah. You knew it was going to happen before time, and ahead of time you could have bought, yeah,
Scott Phillips 45:24
I’ve talked a lot about that with one of your good friends, Jason buck. Yeah. He talks about, you know, trying to have something buying puts and losing money on that too. Not only losing money on the other line position, but losing money. You know, how you can end up losing double Right?
Jeff Malec 45:43
Which, what’s their professional explanation of that? It’s just what we started the pod with. It’s because it doesn’t have to just go down. It has to go down more than people are expecting, right?
Scott Phillips 45:52
Right? Because the price, there’s always a price on something, right? So just like 2022 selling puts worked out pretty well for people in 2022 ball was high market stair stepped down. Those that you know were long skew, you know, certainly didn’t have that skew work in their favor. Really, the only thing that worked was, was really just pure short Delta, as close as you can get to it, you know, on on your option side. But again, sensitivity and 22
Jeff Malec 46:23
I think the one year put, right, if you bought it at the end of 21 or these 22 like basically at in the end of the year there it was flat to down, even though the market was down 20%
Scott Phillips 46:36
the at the money. Put, I
Jeff Malec 46:38
think so, no, the 20% out
Speaker 1 46:40
of the money. Put, oh yeah, yeah. The 20% out of the money, yeah, I
Jeff Malec 46:43
nailed it. I got right. I nailed it. Yeah. I thought the market was going to go down 20% I bought the one year, 20% out of the money put and you’re sitting there at the end of the year going, what? What happened? I made no money, right, right. Um, so all of that to say, I’m teeing you up. Say, well, that’s why you need a professional in the in the office.
Scott Phillips 47:04
That’s right. Give us a call. All
Jeff Malec 47:07
right, Scott, I think we’ll leave it there. And now I gotta put my the Houston rodeo on my I went to the Fort Worth one once. What’s that
Scott Phillips 47:15
called at the stockyards? Yeah, yeah, yeah, cow town. You make it down to Houston? Much? No, Texas,
Jeff Malec 47:22
not in a while, usually Austin or whatever. So in Europe, right? Yeah, yeah. So you went Houston College in Austin. Did you ever? You ever been north of Austin, or that’s it, either
Scott Phillips 47:36
north of the Mason Dixon Line or something? I did internship in New York. Thought cold My I was there when the plane crashed in the Hudson. Oh man, I was looking out the window, watching it floating around out there, selling what was his name? Yeah. So. Lee sullen, burger
Jeff Malec 47:56
Selmer,
Scott Phillips 47:57
oh yeah, yeah. Tell me.
Jeff Malec 48:01
Alright. Scott, good chatting with you, and we’ll talk to you soon. All right, appreciate it. Good luck with everything.
Scott Phillips 48:07
All right, thanks.
This transcript was compiled automatically via Otter.AI and as such may include typos and errors the artificial intelligence did not pick up correctly.
