In this emergency pod edition, Jeff Malec is joined by Vineer Bhansali, Founder and CIO at LongTail Alpha, LLC, to break down the market’s wild rollercoaster ride that demanded immediate attention. When markets hit new lows only to rocket back with a stunning 10% rally, we knew it was time for another “WTF episode” – our signature emergency broadcasts reserved for the financial world’s most shocking moments.
Together, Jeff and Vineer dissect the tariff chaos sending shockwaves through global markets, with Vineer providing insights on the critical liquidity crisis unfolding across stocks, bonds (especially long-term), and their derivatives. This episode delivers the expert analysis and perspective you need when markets go haywire – just like when we talked crude oil’s negative plunge and the GameStop rebellion that took down a hedge fund in years past.
No scripted talking points, no scheduled interviews – just raw, unfiltered market commentary when you need it most. The world’s financial markets just had a moment… and so did we. SEND IT!
From the episode:
Relationship Between Trend-Following and Options (whitepaper)
Previous episode with Vineer: Taming the Tails with LongTail Alpha’s Vineer Bhansali
Check out the complete Transcript from this week’s podcast below:
WTF is this market? – with Vineer Bhansali of LongTail Alpha
Vineer Bhansali 00:07
Seriously, after what happened yesterday? I mean, you got a reprieve. You got the VIX dropping from 50 to 30 overnight, and you got the stock market going up from, you know, 1000 points on the S&P and whatever, but 2200 points on the NASDAQ. If you came in this morning and you were not edge and you knew you had to it, there’s absolutely no excuse.
Jeff Malec 00:34
Welcome to the derivative by RCM Alternatives – Send it! Hey, everyone. We got Vanier, Ban Sally here, LongTail Alpha. It’s a Masters opening Thursday. I’ve been watching the Masters all day. I think that slowed down the volatility a little bit today, everyone said, Enough, let me watch them go. But it’s been a crazy week, so wanted to have you come on and tell us what you’re seeing from the front lines. You’re just telling us off camera here You haven’t slept much, not because you’re nervous, but because there’s things to do, right? Absolutely,
Vineer Bhansali 01:19
you know, so for a person in the long vol tail hedging space, we build positions. Obviously, when vol is low, markets are rallying. You have to be counter cyclical, and you build them patiently with investors who understand that the best time to buy protection is when protection is extremely cheap, which it got to incredibly cheap levels. And I wrote about three or four pieces in the last two weeks saying, you know, basically what’s up with ball. Why isn’t it going up with what’s going on? And then, of course, April 1, you know, kind of started to happen and move. And, you know, ball basically tripled. So, yeah. So, you know, we build positions. When ball is low, markets are up, and then when these events happen, which tend to happen more frequently and with bigger frequency. Now we’ll talk about that, why we believe things are faster and deeper. And you know what we’re doing is effectively monetizing, because we have a plan in terms of where we’re going to take some of the hedges off so we can either provide the liquidity to our investors or redeploy them into lower strike options or into other asset classes which might not have moved or going from short dated options to long dated options, basically in all the active management levers of option trading and yeah, so We’ve been up pretty much every night because the index options markets and some of the futures options markets are actually open way, way, way before the official S, p5, 100 starts raining.
Jeff Malec 02:51
Yeah, you were saying they open at midnight, and it’s pretty good liquidity and volume in there. Yeah,
Vineer Bhansali 02:56
California time midnight. Yeah, you know it’s it’s not as great as well. Let’s talk about liquidity in a minute here. It’s not great as the rest of the day, but you can get enough done. You just have to be very careful, because obviously there aren’t too much of the retail crowd out there and too many of the large market makers participating. But you can do enough and size attract size because it’s usually professional traders around the world who are involved there. Now, on this topic of liquidity, I guess I can address Yeah, dive in. Yeah. So, yeah. So there’s a few metrics, right? And the biggest one at the most super professional level, the highest level is, you look at the depth of the E Mini futures contract stack the order book, and it’s basically evaporated, right? So the easiest way I can say that there is no liquidity. So if you think you can get anything done in the futures market of any size, you’re just fooling yourself. Because you know, even now, during the all day today and all day yesterday, and maybe last week, you could see in the debt monitor, maybe about 102 50 total contracts, that whole stack of all the bids and offers that you can see, versus normally, probably 500 to 1000 maybe 1500 you know, it can get very deep, especially near closing Time and opening time. So you’re running at 110 maybe even less than that. But yeah, that’s a symptom in the equity market. If you go deeper into the layers, for me, you know, the hierarchy in my brain is the most liquid thing is obviously cash. There’s nothing more liquid than cash. Then you have T bills, then you move out the duration spectrum to the Treasury bond market is a good metric of how liquidity scales with just duration risk. And the 30 year bond, as we all know, has no liquidity right now, it’s, you know, moving 3040, basis points a day, and that then sort of gets a. Absorbed into asset classes that rely on that risk free asset or discounting, right? So equities? What are equities? Equities are very long cash flow instruments. You have to discount that back on the long bond, or 30 or 50 or 100 year bond, so there’s no liquidity in the 30 year treasury. By extension, you can say the thing that you’re going to discount those cash flows on equities will have very little liquidity. So given that there’s so little liquidity in the treasury bond market, I’m actually surprised that there’s any liquidity at all in the equity market right now.
Jeff Malec 05:34
Yeah. And do you think that is that a function of actual liquidity, like people? I mean, I guess this is a philosophical question of, what is liquidity, but Right? Is it in my brain? It’s because people are scared to death, not normal investor people, just the market makers of like, I’m not putting my neck out there. It’s going to get chopped up, right? There’s, I can’t make it wide enough for it to be profitable for me. If we can rally 200 points in the s, p, in a matter of six minutes, whatever it was like, Where, where can I put my marks in order for to be safe as a market maker? Oh,
Vineer Bhansali 06:07
yeah. I mean, not six, 200 by the way. I mean, sorry, I know you and I have come from it was big, 800 points, right? The NASDAQ was up close to about 1800 points yesterday, right? The NASDAQ future is 1800 points, 10% so, yeah, so, and in a matter of a few seconds from that, you know, tweet that came out, whatever, yeah, these days, not the tweet, yeah. So, to your point, truth, social, yeah. The point is that, yeah. So, over the last few years, the ecosystem has changed. And I’ve talked about this before. I think even in your last podcast I came on, and it has, human beings have been replaced with automated trading bots, because they never sleep. They never get tired, and they’re basically making that bid offer spread continuously. And what happens in these kind of episodes is the algorithms, or algorithm makers, are very smart. They calculate what they need to clear a certain volume, and they just say, well, we’d rather shut it down and let somebody else do it. Then step up and try to make markets when the S, P futures is jumping five points between bid and ask. So the market makers, for the most part, the electronic market makers, are just out. So what you’re seeing here is probably boutique people, or maybe humans. So it comes back to COVID, or COVID type of episode versus, you know, I call it this mano, a mano trading. It’s human against human and and humans are extremely risk averse when it comes to providing liquidity, right? If you remember in the old days when there was a bond futures pit and floor, there were one or two guys like Tommy Baldwin and others would be at the bottom of the pit, and the whole pit would basically stop when, you know, this guy would show his hand, because it stopped with him. He could turn markets around. Yeah, he’d bid 5000 5000 he take it, and he would like, boom, the market would reverse and go the other way. Doesn’t happen anymore, because that person does not exist. Because nobody wants to be a hero. And electronic market makers are exactly the anti hero. They basically say, oh, wait a minute, this tsunami is coming. You know, instead of stepping in front of it and saying, I’m the man, I’m gonna actually join the tsunami and, you know, run with it. So I think that’s the ecosystem is very different
Jeff Malec 08:22
right now. Sidebar rumor, I’ve heard Baldwin actually went and tried to do NASDAQ stocks on the screen and lost a fair amount of money because he couldn’t be that guy in the NASDAQ market, which you’d think the bond market’s bigger, but there was the physical, as you’re saying, the physical, human nature of it, let him do that. But right? Like, that’s a weird thing, because liquidity, to me, means, oh, there’s not trades on both sides versus the market. I don’t know if there’s a question in there, but Right, that’s a little nebulous. Of what does that mean? Exactly like, there’s plenty of people wanting to buy and sell, but the market makers aren’t there, so that we just can’t, you can’t match them up, I guess, yeah.
Vineer Bhansali 09:01
And also, you know, we have to also admit and agree that there’s a lot of retail participation. I just spoke with, you know, somebody recently who basically have been selling naked zero DTE options, right? So, so just like, literally just selling it and collecting the binary daily payoff is like it goes up through my strike or down through my strike, I’ll lose money, but if it doesn’t, then I’ll collect so So what has happened is, because in the ecosystem, there’s a lot of retail traders who want to trade, but they are not necessarily hedging with futures or with spy or anything else. They’re just literally not in naked positions. You are finding that with these kind of moves, many of these positions are just losing money, so they’re losing money, so they’re backing off, right? So one of the key structural underpinnings of the markets recently has been to buy the dip mentality, because retail comes in and buys it because they can get the. Liquidity at the end of the day to sell it. Right now, there isn’t there. So retail has just stepped back because they’re just not there, maybe margin calls, maybe too much losses. They’re not stepping up and providing the buy the dip liquidity, because they must have, they must have gotten hit pretty badly over the last week or so, except
Jeff Malec 10:17
for yesterday, right? They thought they’d won. Oh, buy the dip. Worked again. Well, interesting.
Vineer Bhansali 10:22
You say that because I actually had to go and get just a routine physical done. So I went to my doctor’s office, and my doctor came in, and he was clearly, he had a great guy. I’ve known him for a long time, but he was a little, you know, impatient. He was like, basically, what he said was, you know, I could have bought that dip if he I wasn’t here to, you know, to give you a physical when the news came out, and I could have made a few bucks just by, you know, pushing my phone. So you should
Jeff Malec 10:46
have been like, well, if you’re invested with me over here, you wouldn’t have to worry about
Vineer Bhansali 10:52
buying the dip reverse today, right? As we know, yeah, half of it reversed. So we don’t know what comes next.
Jeff Malec 11:02
You speaking of the zero dt, have you heard any, right? I think when this first started become a thing, and that volume started to take over, I think what’s it been 60 or 70% or more of the option volume, right? The a few things were one, this is overtaking the VIX. The VIX is not useful anymore because of all this zero DTE was a theory two, there’s going to be some huge blow up when these types of moves happen. One of the primes or market makers is going to go out of business. So dismiss either of those, or both of those. I haven’t heard anything of any big firms going under because of zero DTE, not
Vineer Bhansali 11:42
yet. I mean, I hope not yet, but yeah. But you know, you never know, right? Somebody who’s under capitalized and overexposed, and you know, maybe preemptively, a lot of people who are a lot of firms who might be allowing that kind of speculation are probably not allowing that, but I don’t, anecdotally, we don’t traffic in those markets. But, you know, again, zero dt is somewhat maligned. I do think there was an economic rationale, you know, during the COVID era and other times, you know, when people kind of had to take out their gambling instincts in the, you know, index options market. But right now, there’s very little rationale to speculate on short, dated options, you know, is because, because, again, coming back to liquidity, there isn’t really much you can do unless you’re willing to, you know, do a coin flip trade every single day, right? Nobody had a business yet.
Jeff Malec 12:33
Most of those are probably most of the retail is selling them. Do you believe? Yeah, yeah. So, so, I mean, this scenario, maybe they should be buying them, yeah, but which leads me to my naively, and I was talking with some guy who does some options stuff. He’s like, why don’t you just buy the straddle every day, right? And the market’s going to be up or down 5% I’m like, well, because I think the straddles priced in for it to move even more than that. So, right? What? What have you seen with that of like, what’s working in terms of straddles and strangles, or that’s everything’s just the price is blown out.
Vineer Bhansali 13:06
That’s a short dated, absolutely correct. So short dated, implied or trading. I mean, you can go look at your screen right now, at the money, 5300, s, p puts. You probably get 40 points on a put and a call, 80 points, right? For a one day option. I mean, that’s huge, right? So, so when do you get paid whatever percent and a half or 2% for just a daily options? It’s very tempting that you can get that kind of premium, but to your person’s point, you just don’t know when you’re going to get a 5% move or a 9% move like we had yesterday. So 1% premium earned in a 9% move is a very bad thing to earn. So realized is realizing 200% and implied is 60% or whatever the number is. So short dated options, in my view, are coin flip trade, right? So volatility as a metric should not be used for short dated options. And that’s the change
Jeff Malec 13:56
in the ecosystem right now. Well,
Vineer Bhansali 13:59
we don’t know, right? So if your it is right. I mean, it was kind of jokingly talking to somebody yesterday that, you know, you know, I’m a quant by training, and you know, I do financial modeling to figure out what’s good and what’s bad. And right now, on my screen, I just basically put a feed from truth social is, because, you know, any analytical model I can come up with, will get overwhelmed with what that signal comes out for, good or bad? I don’t really know, but, but really, you know, modeling doesn’t make for short, dated options any sense. You can come up with your best quantitative model and like in the person you were relaying the information from. So yes, markets moving 5% today, but you could come in tomorrow and make moves 0% in which case your 5% premium is completely decayed. Because, right, so. But having said all of that, if you go longer dated, and, you know, I wrote a piece just recently on why longer dated volatility is still quite subdued. Moved a little bit, but it has moved very much. Credit default swaps spreads a move, but haven’t moved very much. And again, credit default swap spreads are like extremely long volatility. And I think the reason really is fundamentally people believe that what has happened over the last few years is going to happen again, where either the Fed is going to ease or we’re going to get a pivot from the administration, and the markets will just stabilize. So that belief is what I think it’s holding longer dated volatility, still at very low levels. And again, I’m not making a forecast here, but the blue is that if what we’re seeing today, and this is this whole game theoretic formulation for me right now of what’s going on in the world is multiple people, multiple agents, playing multiple games. We don’t know what the games are. We don’t know what their strategies are, we don’t know what their payoffs are. We don’t even know what norms they’re following. The tails of the distributions are very fat and flat, as people say, right? So you can have movements in the market that actually start taking their own life. So something happens in the market that creates reactions like maybe what we saw yesterday, that then results in a completely new set of reactions. This bad dependency could result in longer volatility for longer, a higher volatility for longer, in which case, what we’re looking at in the long date space right now might just be too, you know, extremely cheap. So, um. So anyways, um, and
Jeff Malec 16:31
define what you’re what we’re talking about here with short term and long term, just put some numbers on it. We’re talking,
Vineer Bhansali 16:36
yeah, three months and in I would call it short term, okay? And then anything year or longer, or nine months or longer, I’d go long term, and then three to five years, I call extra long that you can’t really buy, you know, a lot of index options there, because that’s not a liquid market, but you can do CDs and credit default swaps and things like
Jeff Malec 16:57
that. And then I just took on my other point. So you when you were saying short term is like a coin flip you were saying right now, not a year ago, or not in normal times, you can model out some short term, of course,
Vineer Bhansali 17:08
yes, yeah, in the short term, right? Exactly in the short so in a normal time, if you saw a implied volatility. I mean, again, volatility is not a good measure for long. But assuming you take this simple coin flip binomial model, and you translate it to an implied volatility using Black Scholes, which people do, you’ll get an implied volatility of 60% in the old day that you got paid. 60% implied volatility, ie, 80 s, p points or a at the money straddle for one day, you would take it all day long. But right now, why isn’t everybody selling it? Is because the dangers are that you move 300 points either side before you get to do anything. Yeah,
Jeff Malec 17:50
right, because no one’s willing to buy it. So you’ve mentioned credit default swaps. Talk a little bit about what else is in your right outside of index options, what else is in your toolbox in terms of all these different path dependencies, and how you kind of view that side of tail hedging, yeah, so we think, and what it’s been doing during all this, you know,
Vineer Bhansali 18:18
yeah, yeah, absolutely. And, you know, when we think about hedging, we think again, kind of, given the engineers and quants we are here in terms of the trade off between reliability or dependency, or how much you can trust is and cost, the most reliable thing, obviously, to hedge. I mean, other than just selling all your equities and just, you know, going into cash, the most reliable thing that you can do is buy a contractual option, you know, like we’re just talking about, like, you know, index options and so on, against your beta in the portfolio. As you become allow for less reliability you can do cross market trades, right? So instead of hedging equity options and equity options, you can hedge it with CDX credit to false swaps. We talked about that briefly. Then you start moving in the spectrum, and you start thinking about things that respond, possibly slower, but if this continues, they should respond. And the thing I’m thinking about there is duration, so you can buy bonds in your portfolio. Now, unfortunately, in the most recent episode, bonds have been dismal for good reasons, because as equity markets have fallen, people have started romancing. And you know, these tariff issues have escalated, people are romancing basically an escalated tit for tat game in which foreigners who subsidize our treasury bond purchases might not buy them or maybe even sell them. So treasuries and long term duration has not done very well at all, you know, recently at least. And then you go into strategies like trend following and so on, which people do in various forms, intraday trend all the way to long term trend, again, haven’t done very well so far. I mean, trend following is actually net. Net was down last week and has been down for the. Sure. So in the spectrum, you know, we think we’re not, you know, attached to just tail hedging. We just think about, where is the reliability highest, and where is the pricing the highest? So on the spectrum right now, tail hedging is longer term. Tail hedging is using options. It’s still the cheapest, in my view, because it’s the most reliable. But other things will start kicking in as an if this market continues to move in one direction, trend following duration and other things. So there on the radar screen is just that we’re not overly allocated to them right now, because, you know, basically from my calculation, I still believe long dated volatility is actually quite cheap, so short dated options have become expensive in the short run, or maybe barely priced, one would say, but long dated is still pretty low.
Jeff Malec 20:54
And what are your thoughts on the bond duration trade? If that’s just a blip, it sounded like you were thinking that still works long term. Um, yeah. Was it the basis trade blowing out like all the headlines were saying or what? What are your thoughts on? What happened yesterday? Right? What was that last track of time? Wednesday night when it was down,
Vineer Bhansali 21:15
yeah, five points in the long bond, yeah, I was there, yeah, awake in the middle of the night when you were up. 30 basis 2530, basis points, intra at night on Yeah, around midnight, yeah. So when you came back, okay, so what’s going on there, right? So again, having been a professional bond trader for, you know, PIMCO and others for such a long time now, that’s kind of where I, you know, cut my teeth, I guess, in trading. Yeah. So the bond market, I think, has a few things not going for it right now, and the basis trade I’ll talk about in a second that obviously is, is technical. I think it’s more of a technicality that requires a little bit more explanation. But at the highest macro level, I think the it’s just inflation coming from terrorists, right? The terrorists are attacks, and the market is basically saying, in the short run, maybe the value of having a treasury T bill, call it, or a two year treasury, overwhelms the inflation risk, because short run inflation might spike, but at least you’re not locking it in for multiple years. But in the long run, if inflation goes up and duration should obviously not do well if inflation goes up, because yields will be higher. There’s really no reason to justify, you know, buying a long bond at 475, or 480, or five, whatever the number is, right now, right? So that’s number one. That’s the macro reason. Number two is that it’s extremely ill liquid and the bond volatility has gone up a lot. So equity volatility, of course, has spiked to 50. But also what people look at is the move index for rates volatility or swaption volatility and so on. Interest rate volatility is extremely high. So if you think about what the risk in a bond is, the bond’s risk is effectively the duration of that bond, 30 year bond of the duration, call for 28 or 29 years times interest rate volatility. So if interest rate volatility goes up a lot like it has recently, the total price risk of a bond is very high. So if you could have justified holding a bond maybe a year ago with the same duration at a lower volatility today, you cannot, because interstate volatility is about 30% higher. The move index has moved, I think, like, from 100 to 130 or something like that. So where’s that
Jeff Malec 23:29
from a historic level, like historic highs above COVID, where I
Vineer Bhansali 23:33
don’t think so. I think it got, I think, during the one of the European, big European crash. And let me just put it up here. Put down the spot 200 No, I can put it up here because, yeah, if I remember, in 2008 during the financial crisis, it got to 200 basis points annualized. That’s the move index. The whole curve moves differently. And right now, if you think about it, 130 so it’s only about a half. But if you look at the long term charts, it is getting to the point around actually, I’m sorry it’s exceeded COVID. COVID, my peak shows about only 110 so we’re trading above COVID, for sure. So think about it from the port part. You know, portfolio construction metrics. So somebody who follows like a risk parity portfolio stocks plus bonds, but the risk parity has done really badly too, because both bonds have gone down and stocks have gone down. If you’re following a risk parity framework and your bond volatility goes up, you have to proportionately de risk your bond allocation, because the way risk parity works is you have a total volatility budget and add to your stock code, well, exactly the odd margin you add to the stock, but your total volatility has gone up, so you’re basically saying de risk stocks and deresponse at the same time, because risk parity portfolios run with a total ball target, let’s say 10% total volatility, and that’s allocated proportionately to stocks and bonds and other things based on their own. Volatility. So stock volatility goes from call it 20 to 50, or maybe it’s trail usually disparity looks at historical policy 20 to 30 or 20 to 40. You’re going to deal with your stocks. Bond volatility goes from call it, you know, 100 basis points annualized, to 130 annualized. You’re going to de risk it also, so you’re de risking everything. So that leads to this kind of correlated thing. So that’s number two, and that kind of is related to, you know, illiquidity in the in the bond market. Number three is just this fear, and as an existential fear for the market, is that if the Fed doesn’t come in, and does QE, who is going to fund this massive deficit that we’ve got, right? I mean, we got whatever. You know, today, there was a 20, $30,000,000,000.30 year bond issue. It went through okay today. But can we keep doing this if the people who buy our bonds are not going to subsidize or maybe, you know, not provide that funding? So that’s number three. And then number four. We can talk about the technicals, the basis trade, which kind of, you know, basis trades blow up frequently, but the one that has blown up this time is the bond versus interest rate swap. If you’re interested, I can talk about the tech
Jeff Malec 26:14
Yeah, I’ll go back to number three for a second, because this is interesting. Me, right? Of like, the and this is true in the stock market too. Of like, Have we lost American exceptionalism, right? What’s our USPS 20? The rest of the world’s 15. I’m just throwing random numbers out there. Maybe they’re 10, but whatever. So if we both lose a billion dollars in earnings, our market is going to go down a lot more than the people who are trying to right. If we try and make it fair, it’s going to hurt the us a lot more than the rest of us, but that’s a side argument. But if we’re right, is that the argument of like, we’re losing American exceptionalism. We don’t deserve to have a premium on our bonds, on our stock market, on everything, which is why you’re seeing both sides sell off. Yeah, I
Vineer Bhansali 26:56
think, yeah, that could be true, and I don’t really know how it’s going to play out in the long run. Maybe you know, it’ll play out just fine, but in the short run, you’re exactly right. It’s like the dollar has been sold, not bought, which, in other
Jeff Malec 27:06
words, saying people are losing trust that right, that we’re gonna do what we normally do, right?
Vineer Bhansali 27:11
And you mean, think about this, right gold we’ve been, you know, again, reluctantly, so, because I’m definitely not a gold bug, but I wrote three years saying, you know, I don’t have a choice right now, because I’ve done the analytical exercise, and it all says, and here’s the top 10 reasons. I wrote a paper with top 10 reasons why there is an alternative, and I call it g, I T, a gold is the alternative. And there’s, like, three years ago, Gita, right is because I don’t think there’s a choice. So what basically is going on right now for people is, if you de risk out of the US dollar, what other market can take it? European bond markets can take it, but they’ve got their own problems. Some money is going to go to European bond markets. Somebody’s going to go somebody’s going to go to Europe in equities, and a lot of it is just going to go to precious metals and maybe base metals. So gold’s been a pair. And again, I’m not making a forecast here, but I would not be surprised if we see like another 20 to 30% move in gold up in like a flash, in like a month. And people will say what happened here? And that’s the power of you know what you were referring to is like the the secular reallocation of assets from one block to another block. If there’s a mass exit out of dollars, it’s probably going to end up in other currencies. And then gold in particular,
Jeff Malec 28:28
and then, but was one of the craziest things that when gold was down 3% or whatever it was the other day. So then right inside of all this are these moves that make sense, and then moves that make absolutely zero sense, yeah, um, that was the same day the gold was going down. So that that day made me feel like there were mass liquidations. Yes, right? Of just people, I have to sell everything in my portfolio because I need to meet X, Y, Z, margin call. Like, I haven’t read much that that was actually happening, but that’s what that felt like to me when gold was selling off at the same time.
Vineer Bhansali 28:59
Yeah, and I think you might have read, there was a couple of articles, I think they are believable, that the thinking was that everything would get tariffed, including metals, but then precious metals were excluded, and all the people who did the geographical arbitrage, where they flew in bars of gold on Jet, private jets from London to save them from tariffs, right, though. So they figured out kind of what the approximate tariff rate was, and they said, If Gold is trading inside of that value, then we’re going to, you know, put them on a plane, bring them to the US, and when the tariffs come in, we can sell it inside of tariffs, because they’re already inside the US. But precious metals,
Jeff Malec 29:38
I miss that Argo. So people were like flying them on Monday in private jets. Absolutely. I gotta go back and look at the flight aware if there was, like, a huge stream of jets, there’s a
Vineer Bhansali 29:46
great article. I think I probably dig it up for you. It said there were more charter, live charter flight, and then the whole trade data was distorted because of the gold that was it has to be obviously disclosed, because you can’t, yeah. Muggle it in. It was disclosed and that we brought this in, and it actually skewed the trade flow data because of the amount of gold that actually came in, like a billion dollars worth a few billion, a few billion, but then people found that these bars were actually not going to get tariffed, or there was no benefit to future gold purchases being you know, they were not going to get there. So that premium just evaporated, and that resulted in the sell off. That’s kind of one, one of the stories I
Jeff Malec 30:31
heard my favorite gold one was Jim Cramer on Monday saying he buys it on his Costco. I guess you can buy gold bars at Costco on his Costco credit card and gets 3% cash back. So it’s like continents. Back. I’m like, I’m sure their gold bars have at least a 3% markup, so you’re probably just about even. But it sounded good. So three, Yeah, who knows what happens there. But we and then four you were talking about this basis trade. So yeah, we don’t need to go too far in the weeds. But is it the same, similar to long term capital management, where they’re doing on the run versus off the run? Yeah,
Vineer Bhansali 31:12
it’s a little bit different in this case. So this is treasuries versus interest rate swaps, right? So the one of the biggest anomalies that is out there, which is everybody to see, and everybody can trade. And people did trade on it is that the 30 year bond, let’s say, is at 495, whatever typical number a 30 year interest rate swap, where you receive fixed effectively replicate that bond coupon and pay floating rate interest using the sofr rate. That rate is about three, 4% round number, 95 basis points lower. So you scratch your end and you say, why is it that the Treasury yield is at, you know, call it 495, and the swap yield is at four, four. They’re effectively the same duration instrument and all that. By the way, the treasury is full faith and credit of the US government. The interest rate swap is basically a contract, fully collateralized, but contract between banks and banks. So what am I going to do? Well, I’m going to buy a bunch of treasuries, and then I am going to, you know, I’m sorry, I’m going to receive a bunch of swaps, basically buy the swap, earn the swap coupon and sell the Treasury
Jeff Malec 32:22
because it’s floating right? Yeah, I said backwards the
Vineer Bhansali 32:25
first time. I’m sorry. You might have read this out of my brain. I’m going to buy the treasure because I’m getting a 495 yield. Yeah, I’m going to pay fixed on the swaps, so my duration is head. I said it right the first time there. Okay, I’m receiving a treasury, buying a treasury at 495 and I’m funding it, but I am now paying fixed on the swap at 4% I’m keeping that 90 basis point spread, and I have no interest rate risk. Sounds like a great trade, doesn’t it? Yeah, the reason and every year, by the way, much leverage, but yeah, 90 basis points you leverage five times, you can make four and a half percent a year, right? Just from no duration risk. So that’s a very classic basis trade, just like the LTCM trade you talked about, or the futures versus cash bond trade that is very popular. The problem is that when a lot of people do it and something and it’s leveraged, something kind of goes awry here, in this case, funding rates or Treasury volatility, then some people get tapped out and they have to liquidate, even though this is a great trade in the long term, you cannot hold it if you’re running at 5x and 10x levered, because every 10 basis points is a big mark to market hit and you might get shut down on it. And how do you buy a treasury? You buy a treasury? You buy a treasury, but you have to fund it using a repo contract anyway. So the bottom line here is that because of the Treasury, volatility, illiquidity, et cetera, people basically, I think, got forced out margin con margin calls on the Treasury side, and then they effectively had to liquidate both edges of it. But you know, for somebody who’s got capital, who wants to enter it now, it’s a better level. I don’t know if it’s again, but it’s a better level now.
Jeff Malec 34:07
But was, Do you think I was enough to make that full Wednesday night move, or that just once it started building on itself. People just were putting it exactly,
Vineer Bhansali 34:17
and there’s no liquidity, because if you know, there’s a lot of sellers. Foreigners are sellers. Try these. Basis traders are sellers, and there’s very little buyers. And there’s two auctions coming, which we know, we had two auctions this week. The question is, do you want to stop step in front of that train and try to, you know, buy more bonds? And people will say, No, I don’t want to. Yeah. So
Jeff Malec 34:39
what? What what do you think this does for a lot of tail hedging type stuff where, like, oh, the the index falls too high. I want to go takes, which I would call basis, but not as we just talked about, but take some basis, whereas, right? And I’m going to gold options or bond options or some other cheaper ways to get that sort of tail. Just think that breaks that for a while, and people move out of that space. No,
Vineer Bhansali 35:03
I think you can. I mean, we call them indirect touches. That’s, you know, for one of our, I guess, tools in the trade, so to speak. But volatility is very cheap, as it was about a month ago or two months ago and 15, you know, we were saying, Look, don’t take basis risks. Just be buying straight options, taking no contractual, indirect correlation risk, etc. But now that volatility in the short end of the curve, three months and a it’s kind of high, you want to take more basis risk there. You want to take do things like put spreads. Perhaps you want to do indirect hedges and other asset classes, right? Because here, here’s one speculative thought that, you know, if this thing continues, perhaps the Fed actually gets forced to cut. So one typical indirect hedge that people will start looking at is just so for call options. So can you buy call options on the short end of the you know, used to be the Euro dollar curve, but now as a sofr curve, the more far afield you move, like gold calls or currency options, or, you know, hyg high yield and so on the more basis risk you’re taking, but it becomes a trade off between, yeah, between how much basis risk you’re taking and how much kind of cheapness you’re going to get. So it is very attractive, but you kind of have to be able to evaluate the relative value of all
Jeff Malec 36:20
of them, and hard to know, like, in this example, right? Like, we should have all bought Swiss Frank calls, right? What’s been up like, 30% in two days or something, or not 30% but it’s been up huge in two days. But how do you know which one that’s that’s the risk, right? That’s the basis risk. How do we know which of these other items are going to hit, yeah.
Vineer Bhansali 36:41
And I think you know what people typically do there is they run some sort of correlation analysis, right? So they say, What are traditionally the flight to repatriation, flight to quality, right? So if everybody’s going to buy gold, where’s most of the gold of the world, cap, Switzerland, let’s going to have to somehow get into Switzerland. Services by Swiss franc. So Swiss franc is still, quote, unquote, a very reliable tail hedge. Because of that reason, it gets a premium, I think, and interest rates are kept very low there. The Yen used to be like that in the old days when the yen, yeah, you know, was the reserve currency of sort of savers, people would flock into the yen. And you can see the Yen has moved, but it hasn’t moved that much. Is it hadn’t moved 30% for sure. And the reason is because Japan’s got its own problems. And, you know, they’re, you know, in one of the they’ve got their own problem. But, yeah, so where do you go? So you could go to gold, natural
Jeff Malec 37:39
gas. Yeah, exactly. It’s so low it can’t go any lower the Yeah, where do you go? But so if I’m calling you on that Wednesday morning, we’re down, making new lows. What do I do? Right? That’s, well, it’s, it’s too late then, or you start to walk through these other items, like, Okay, well, this is somewhat cheap, this is still somewhat reasonable,
Vineer Bhansali 37:59
yeah, yeah. And I know comes back. My first question is, you know, what is your pain threshold, right? So it’s down, how much are you willing to lose by doing nothing? And at that point, people can kind of calibrate, and they’ll say, I’m willing to lose nothing. At this point, I want protection below 10% or 10 20% that means that, you know, they’re going to want to hedge it somehow. And then you look at relative value, right? Buying an outright index option for one month makes no sense, because you’re paying a lot of premium, but if you want to go out and lock it in for six months or a year, you can do index options. Otherwise you go into these indirect hedges. And again, the common theme there is, yes, if you take basis risk, it’s not as reliable as just buying a cheap, pure S, P Index option, but having some hedges on is better than not having any hedges on if you’re at that point with your portfolio, and
Jeff Malec 38:52
then talk through if you could, we’re down whatever when we’re down 20% for the highs, Yeah, and I want to put on another 20% right? Like, when does it become, in your mind, too far away, right? If we’re down 60% do I go down another 20% like I get in theory, can always go another 20% but it seems like there’s a practical limit to, like, I should stop getting way out of the money.
Vineer Bhansali 39:17
Yeah. So, you know, that’s something that we usually I mean, I know my own kind of utility function and objective function and so on, and I try to never get into that type of situation, obviously. But if you’re already in that situation, you’re down 50% and we know that market sell off of 80% has happened maybe once or twice, right in the Great Depression. You really kind of have to think about it and say, Do I really want to hedge down 20 at this point or not? But if an investor says to us, yes, I understand it. That’s never happened before. But if it happens, if it happens, the severity of that outcome will be so huge for me. I’m out of business. I’m out of business or, you know, I lost my life savings, or whatever it is. I. Yeah, then that tells me is that some hedge is still required, even though the premium will be egregious. And at that point, you know, just have to kind of give them the trade offs and say, here’s the trade off of doing nothing and versus the trade off of doing something at this price. But
Jeff Malec 40:17
back to current rate we’re at now, right? We’re down 20% and people are saying even now, like, well, it’s too I missed it, right? I forgot to do, or I didn’t do my tail edging. Now it’s too late.
Vineer Bhansali 40:29
Oh, I mean, seriously, after what happened yesterday? I mean, you got to reprieve. You got another chance getting got another chance. So, like, I mean, I’m not just saying this, because this is the business I’m in is like, you got the VIX dropping from 50 to 30 overnight, and you got the stock market going up from, you know, 1000 points on the s, p, and whatever it was, 2200 points on the NASDAQ. If you came in this morning and you were not hedged and you knew you had to it, there’s absolutely no excuse for you to not have done something, and that’s kind of our mentality right now, is that we’ve only receded back down about half of the sell off of the last week, and you’re still only down 10% at least in that and before the year. So it’s mainly, I mean, you’re, you’re sitting in correction territory, not in bear market territory, yeah, and we were bear market territory yesterday.
Jeff Malec 41:25
Yeah, 15. That’s how crazy it’s been yesterday. Bear market today, just correction over the long term, doing hedging at VIX, 4050, doesn’t make a lot of sense, would you? We’d agree. Well,
Vineer Bhansali 41:38
again, it comes back to the portfolio, right? So we ran an analysis, just a composite, and I can’t give you, obviously, all the private details. We just run a research thing of, you know, one type of portfolio, and we said, If over the last five years, and you can go back and look it up, if you had bought S, p5, 100, and if you had edge continuously and spent premium through ups and downs, you know, through the debacle of 2022, and all that, where would you have ended up yesterday? And guess what? You ended up, obviously, S P is higher, so you would have made money on the S P. What was shocking to me was to find out that if you had done it pro cyclically, if you had bought hedges when they were somewhat cheap and done less hedging when they were expensive, but still hedge, you actually have made cumulative money, even on the hedges in isolation, including and all of that has come literally in one week. And so that’s a kind of par for the course in this space, is that you spend, you spend, you spend, but when the house is burning down, your insurance pays off. So you got to live in the house, ie, the SNP went up, and you got to pay for the insurance that paid off, and now you can build a brand new house. I mean, I can’t do any better than that, so, right? So if the price of insurance in California, we know I’m going to California resident here. You know, it’s crazy right now, right? Because of the fires and everything, and everything and insurance companies are just jacking up the premiums, we have two choices, not buy insurance and not have home insurance, or live in our house and live in beautiful California and have home insurance. I think most people’s choice will be as long as he can afford it, live in California and buy the home insurance if he can, you know, afford it. Yeah, I think that’s basically what it is. So I don’t try to time insurance, but I do try to plan it so that at the appropriate time you can re renegotiate. Right? That’s the beauty of index options and financial market options markets, in a sense, when the price goes up of insurance, if you already have insurance, you can renegotiate the price to a different insurance contract. You can strike it down, or whatever you want to do.
Jeff Malec 43:54
What sort of things would you want to see or my brain goes to some big private credit funds blowing up, or private equity marking down 30% things like that. Either. What would you see that start to say, like, Okay, this is picking up steam. This is probably an extended event. Versus what would you see on the other side of like, okay, we kind of have the all clear, and I’m not as worried about things anymore. Yeah,
Vineer Bhansali 44:20
I thought you might I think we communicated this in some other forum here. But my metric was, it’s a CDs spread, CDX spread, which is investment grade index, if the spread moved above 75 or so. I mean, initially my number was 65 but now moved up to 75 if it moves above 75 and stays above 75 then it tells me that the credit markets are coming under stress. And we all know or have read, that the way the transmission mechanism works is that when the credit markets come under stress, corporates cannot borrow easily. They start shutting down factories, laying down, laying off people. So a crisis turns into a. A bigger problem, a recession and so on. And credit spreads went up to about 85 yesterday, then they retrace to about 68 on the massive rally, and they’re back to 75 so we’re right on that boundary. So if I don’t see them grinding back down again, then I start getting worried that this thing is morphing into something else. But if they nicely grind down and things settle down, I would say it’s time to maybe try to dip your toes in and try to, you know, buy risk assets
Jeff Malec 45:30
and what ex, what’s the 75 What’s that represent?
Vineer Bhansali 45:34
Oh, okay, sorry, I should have maybe said that. So that’s basically the spread that you would get on this investment grade credit index over like the investment grade over the Treasury market, basically. So the CDX is an index, a synthetic index of 125 names. And effectively, if you buy an insurance policy on that basket of corporate credit, investment grade credit, you would today pay approximately 75 basis points of insurance premium against defaults, you know, with some other contractual details. And in
Jeff Malec 46:09
practice, because it’s an index, it’s hard for that to move substantially right. How many 100 what’d you say? 125 names? Yeah, 125 names. So even in oh eight, how many names actually went bankrupt? Probably
Vineer Bhansali 46:20
very few, but exactly to that point in 2008 very few investment grade names went bankrupt. But this spread blew out very, very substantially, right into the five or 600 if I remember correctly, and and that basically puts a complete combustion credit, because if you are paying the short term Treasuries are at four and a half. 10 year notes at 425, ish. You add a 500 basis point spread on top of an investment grade corporate has to pay 10% interest to operate. That is a big, big negative drag on their on their balance sheet, so they can’t do that. So that’s my metric, actually, that as we talk right now, it’s 74 minutes, 75 so it’s right on that cusp, and we better see it come in if we want things to settle down. If it doesn’t, then I think this can continue,
Jeff Malec 47:14
but, and I guess these feed into each other, right? My brain’s like, Well, if there’s demand destruction, because I can’t ship my goods to wherever, and I have to shut down factories and lay off people anyway. Yeah, but that’ll be reflected in the CDF,
Vineer Bhansali 47:26
right? It will be absolutely, will get reflected immediately in the region.
Jeff Malec 47:30
It’s not a credit issue. It’s driven by the fundamental issue. That’s
Vineer Bhansali 47:35
right? And people will start the people will start pricing in stress and less coverage in the future. And then each individual name that’s inside the index, its spread will start widening out, not in the same proportion, obviously, but and then the weighted average will start going up, because people will just say, hey, I need more protection against lending money, basically, which is what this is to a corporate Yeah. So other metrics, people, people watch also the youth curve, steep, steepening trade. That’s a huge, huge signal. You know, the curve has steepened massively, 50 basis points this year. And that basically tells you is, is, again, I think of that as a, you know, straddle on the macro economy. It either inflation picks up long end, you’ll sell off, or rise, or we end up into a deflation, depression, recession, whatever it is. And short end yields collapse because the Fed cuts rates. It perhaps deepened with the market is looking at an indicator also. You think
Jeff Malec 48:33
the vet, if the Fed cutting rates, what does that really do if it’s a in this tariff situation? I don’t
Vineer Bhansali 48:38
think it does very much at all. You’re right. I think maybe it even raises the long rates more. But I think it’s a signal to the market that we have a backstop. And the Fed, as we all know, has something else they can do, which is, QE, right? So they can come back and they can just say, okay, corporate bonds, we’re just going to start buying them to keep the spreads tight. Treasuries you’re worried about, we’re going to buy all the treasuries so and
Jeff Malec 49:04
but my worry is, we start last Trump term, and we did the tariffs and then paid 35 billion or whatever to bail out the farmers. Yeah, because China wasn’t bailing we’re like, maybe they’ll do 500 billion across all these different industries and companies that everyone comes looking for a handout, and then what that’s back to COVID. It’s maybe inflationary, or maybe, I don’t know, yeah,
Vineer Bhansali 49:27
one of my own partners from PIMCO wrote a piece many years ago. He called it, I still remember it. He called it no exit. And basically, like what you just highlighted, is that, is this problem ever going to go away, or is it going to keep recurring? Because we’ve used the tool once, we’ll use it again in a bigger size. And his point was, once you’ve done it, you have no and it’s going to keep coming back. Because if these tools are out there, they will be used at a higher and higher size. Yeah, yeah.
Jeff Malec 49:51
And the CO the COVID lesson was, hey, if we ever want to really juice this economy, just give every person in the country $2,000 that’ll get things wrong. One lastly. I said lastly already, but one more. Trend following, getting smashed in the face. Anyone who wants to throw in the towel on trend following, give them some Hey, this we’ve been here before. This is how it works. Don’t panic. Absolutely.
Vineer Bhansali 50:17
I completely agree. Trend following had a long history, 400 years of working. Three, 400 years. Yeah, people have actually very painstakingly collected lot of data, including rice farmers, I think I don’t know, China or India or something like that. And certainly 100 150, years that you know, some very well recognized people have have done research on. But yeah, every 10 years or so, there’s three to four years for trend following that are dismal because there’s overcrowding and people are running large positions. They get stopped out like maybe we’re getting seen right now, and then got three years of kind of flattish returns, and then three years of amazing returns. So we are in that cycle, and my views are exactly the same as yours is if things continue to move in one direction, trend following will take the hand off from explicit hedging and will start working really well. This is not the time to throw in the towel. This is the time to actually add, in my view, to trend following. Yeah.
Jeff Malec 51:13
And for you as a systematic quant, is these, are these periods, uh, completely frustrating. Like, do you want to pull your hair out? Or did you it looks like you already pulled your hair out? Sorry, but you want to pull more of it out, right? Of, like, what? We’re just moving 10% on a on a tweet. What is happening? I can’t model that. Or do you just say that’s why we have this longer term, right? You’ve created the your own sandbox to play in, in case this kind of stuff happens, yeah,
Vineer Bhansali 51:40
you know, like my, our firm’s model, or the thing that we remind ourselves is, you know, is basically expect unexpected for resilient portfolio, right? So every single day when I come in, I mean, yes, I’m a quant, but I come the grain of salt that I use in my model. It’s like a, you know, like a big sand pile. It’s like, you just have to make sure that you leave a lot of room for error, and the kind of things that happened yesterday, which didn’t really bother me at all, because I am completely expecting those kind of things. You were at the doctor, you weren’t even watching, yep, no, and you know, so it doesn’t bother me. I think it’s going to keep happening. I think you just have to go in knowing this will happen, and your primary tool for modeling is not going to be quantitative models. Your primary tool will be literally market feedback mechanisms and response functions and other players and so on. But that’s all part of modeling. That’s all part of investing, in my view. So
Jeff Malec 52:34
yeah, where do you put yesterday on the your Mount Rushmore of craziest market days? Does it even make it, or was there crazier stuff in your career? No,
Vineer Bhansali 52:42
I think I’ve seen worse during COVID, maybe three or four days, definitely during GFC, the day the Lehman failure. I think some of the younger team members on our team who have not seen, you know, day like this before, were asking me, what was what was it like? Lehman failure, LTCM failure again. You know, all the hair over the last 30 years, I’ve seen events where I can believe that this is happening. And now I just come in and I just go, Yeah, another day in the financial markets, yeah. So, yeah. So, anyways, yeah, unfortunately, yeah. If you cannot get hurt in days like yesterday, you’re doing pretty good, so yeah,
Jeff Malec 53:23
all right, veneer, thanks for hopping on. We’ll hang in there. Keep fighting the fight. We’ll talk to you soon.
53:29
Great. Thank you. Take care. Appreciate it.
This transcript was compiled automatically via Otter.AI and as such may include typos and errors the artificial intelligence did not pick up correctly.
