The Big Trade Underneath the Strangely Calm Surface of the S&P 500

For much of this year, the S&P 500 has marched steadily higher while measures of stock market volatility, like the VIX, have stayed pretty low. But looking at the headline index only tells you part of the story. Beneath the surface of the S&P 500, individual stocks have been moving up and down a lot. And of course, traders have figured out a way to make money on the difference between the quiet overall index and all that volatility happening in individual stocks. This is the dispersion trade that's gotten quite a bit of attention in recent months. But figuring out exactly who's doing it and how pervasive it is isn't that easy. In this episode, we speak with Michael Purves, CEO and founder of Tallbacken Capital Advisors, and Josh Silva, managing partner and CIO at Passaic Partners, about this new volatility trade and what it means for the overall stock market.

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Episode Transcript

Speaker 1 (00:02):
Bloomberg Audio Studios, Podcasts, Radio News.

Speaker 2 (00:18):
Hello and welcome to another episode of the Odd Lots Podcast.
I'm Tracy Alloway.

Speaker 3 (00:23):
And I'm Joe Wisenthal.

Speaker 2 (00:24):
Joe, how would you describe current market conditions?

Speaker 3 (00:28):
Up into the right every day? Basically we're recording this
June thirteen, and we're probably like at new highs in
the futures. Yeah, it's just everything just goes up all
the time, and it's pretty easy. Yeah.

Speaker 2 (00:39):
But even when you say up into the right, if
you're looking at something like the SMP five hundred, yeah,
I mean it's gone up a lot. Yeah, But on
a day like Wednesday, when we had the FMC decision
and we had inflation data coming in softer then expected,
even then the SMP five hundred was up by like
less than a percent.

Speaker 3 (00:59):
Yeah, But you add a bunch of less than a
percent put together a historical year of returns.

Speaker 2 (01:04):
I mean, but no one wants to wait for all
those days to pile up. So if you look at
the single stocks, I mean, there have been days when
in video was up like almost ten percent.

Speaker 3 (01:15):
So this is the thing, you're right, And this is
the thing about the market, which is like I am
like a boring s and P five hundred every month,
like put you know, a few dollars into some ETF.
But then I see other people around me getting like
really rich because they bought in video, and it's really annoying.

Speaker 2 (01:32):
What if I told you there was a way that
you could square those two things, so boring indices and
the volatility in single stocks.

Speaker 3 (01:42):
I don't want those volatility in single sex talk of
the upside of single stocks, Okay, but yes, if I
can have both getting really rich and being boring, that's
fine too.

Speaker 2 (01:50):
Okay, So today we're going to be talking about something
that I've wanted to do an episode on for a
long time. We're going to be talking about the dispersion trade.
Have you tried at that? Not?

Speaker 3 (02:01):
No, I mean, basically other than the prep that I
did for this episode fifteen minutes ago.

Speaker 2 (02:05):
No, I'm going to try not to be offended because
I did write about it a few months ago, which
should actually I wrote a story about it, and I
wrote a newsletter, an all thoughts newsletter. Joe, Yeah, go on,
all right, it's a good thing. We're having this conversation then, Okay,
the dispersion trade. So basically it sort of falls into
the bucket of another type of short vault.

Speaker 4 (02:27):
Trade, and the idea I sort of do that.

Speaker 2 (02:30):
Okay, good, we're getting somewhere. The idea is, basically, you
have traders that are using equity options to bet on
this is the important thing, the relative volatility between single
stocks and stock indexes. Okay, so you know, typically you
might see someone go long volatility in a basket of
individual stocks using single stock options while simultaneously betting that

(02:56):
volatility in an index like the S and P five
hundred is going to stay relatively low.

Speaker 3 (03:02):
So implicitly, I guess there's an opportunity to sell that
volatility to the people hedging a portfolio and then doing
the other set on the other side. Yeah, that's exactly it.

Speaker 2 (03:11):
So you kind of need two things for this to work.
You need the market dynamics to basically be volatile single
stocks and kind of boring, you know, overall benchmark indices.
But you also need the cost to make sense, so
when you're buying that volatility, it all has to kind
of net out. But recent months, for a while now
that has been the case, and there's a lot of

(03:33):
anecdotes on Wall Street that this trade is absolutely booming.

Speaker 3 (03:37):
Yeah, I mean we talk about these from time to
time on the show. Sometimes it's expressed more directly and
some sort of implicit short vix trade. Sometimes it's talked
about very explicitly, like a few years ago, I don't know,
twenty eighteen in or whatever, like the real short vix
trade that blew up and never wanted to get it,
the Vollmageddon trade. I don't remember what either. There was

(03:58):
like twenty seventeen or two twenty eighteen or something like that.
But from time to time, one thing that seems to
be clear is that there are various flavors of trades
that become very popular, and all that needs to happen
is for roughly you don't even need the market to
go up or anything like that, You just roughly need
the status quota persists.

Speaker 2 (04:17):
Yeah, absolutely, I mean traders are very good at making
money off of anything, sometimes even nothing. Basically the continuation
of what's been happening.

Speaker 3 (04:26):
And you know the one thing and that you said
it and you're intro and the consistency is that among
people who say, like own the broad index or just
own risk assets period, there is probably a persistent inclination
to overpay for downside protection that premium, and that creates
an opportunity then for someone to get on the other
side and sell that premium.

Speaker 2 (04:46):
Yeah, and we are going to get into all of this.
I'm very pleased to say we do, in fact have
two perfect guests for this particular episode. We're going to
be speaking with Michael Purvis, CEO of Tall back In
Capital Advisors, and also Josh Silva, managing partner and CIO
at Passaic Partners. So, thank you so much for coming
on the show.

Speaker 4 (05:06):
Thank you great to be here.

Speaker 5 (05:08):
Why don't we.

Speaker 2 (05:09):
Start with an introduction? Tell us who you are and
how you know each other.

Speaker 6 (05:13):
Well, I'll start. This is Michael Purvis, Tollbock and Capital Advisors.
We are a cross asset research for which means we
get into the major asset classes on how they kind
of define each other. That means equities, that means rates, FX,
sometimes commodities, but also volatility. I sat on various option
desks over the years and I like to look at
life in the markets a little bit through the lens

(05:34):
of volatility. I'll let Josh describe himself and his firm.

Speaker 5 (05:39):
Sure, my name is Josh Silva, I'm the CIO and
founder of Passaic Partners, a Deriva based asset manager who
uses Deridis as a tool either to reduce risk, enhance risk,
or manage a multi asset portfolio, looking at implied volatilities
as an indicator of when to take risk and when
not to.

Speaker 6 (05:57):
Josh and I have known each other for I don't
know what ten years, twelve years now, and in full disclosure,
Josh is a client of Tolbach and we also share
office space, so.

Speaker 4 (06:06):
We're constantly talking about the markets.

Speaker 3 (06:08):
So Tracy and I don't have to do anything. We
could just listen to gab about vall and that can
be our episode.

Speaker 4 (06:14):
Yeah.

Speaker 5 (06:14):
I don't know how exciting everyone else would find that. Yeah,
at least the two of us would be very excited
about it.

Speaker 3 (06:20):
Tracy described it, and I pretended to sort of have
some maybe intuitive sense of going on. But how would
you either one of you could start like basically describe
the legs or the basic construction of the dispersion trade.

Speaker 5 (06:35):
This is Josh. I'll start off first thing. I think
you did a very good job of describing the trade
quite frankly, but I will go into where the origins
of it which is more fun. Yes, so you have
an old Chicago pit trader. So let's go back in
time to the old Chicago pits and.

Speaker 3 (06:50):
Yeah, already speaking our language.

Speaker 5 (06:52):
So it really came out of the ability to manage risk.
I mean, were talking about a trade that was originally
designed as a risk management trade. You know, post eighty
seven and crash. You know, Chicago used to be just
a bunch of single traders managing their own money. Post
eighty seven crash, the people who survived ended up running
a lot of big trading groups which I could have
fifty to one hundred traders working for them in various pits.

(07:13):
You know what ended up happening was when you survived
the eighty seven crash, you learned I don't want to
experience the eighty seven crash. And so this version trade
came out of the ability to manage quite frankly, the
tale of that risk back in the nineties. That changed
as we got into dot com. And what I mean
by that is it's sort of a familiar little taste
to it. You have a certain sector which everyone's buying

(07:35):
and everyone's making money while the rest of us are
lonely owning the SMP and they're chasing upside, and so
what that ends up doing is you would come into
the pit. And I remember this with AOL specifically, if
you can talk about an old stock, and all day,
every day they were buying calls. Every day they were
buying call spreads, and so you had to collect inventory
to prepare for that coming bid into options. And so

(07:58):
you ran that inventory long and to reduce your THETA
or your decay bill, you would sell some index and voila,
you have the start of the dispersion trade. Now, granted,
that was at a time when spreads were significantly wider,
volumes were significantly smaller, and the size of the notional
amount was significantly smaller as well. And so that's how

(08:19):
this sort of came about. And I think Tracy put
it perfectly. You own a basket of single stocks, and
you use the index to help reduce that risk. And
at the end, both sides of that trade made money
in the nineties as well, and so it became a
very very profitable trade, which leads us into the two thousands.
And again I've been doing this wait probably too long.

(08:39):
I like to call it a trade in the nineties
and someone taught me this a long time ago. There's
trading and there's investing. It became an investment in the
two thousands. In other words, it wasn't traders just moving positions,
because when you trade, you can be very nimble, very quickly.
And that's what market makers are very good at doing,
which is we like to call picking up the nickel

(09:00):
in front of the steamroller. And that's what the dispersion
trade was originally in the two thousands and leading into
two thousand and eight, two thousand and nine, it became
an investment. In other words, I think I listened to
your old podcast and EXIV became an investment. That's what
the dispersion trade is becoming.

Speaker 2 (09:19):
Well, I have a question, which is it's kind of
hard to tell how popular this trade actually is. Everything
is sort of anecdotal. I remember when I first heard
about it. It was actually from one of Michael's notes,
and you've laid it out perfectly, Michael. But then I
went back and I started doing some research and searching

(09:39):
for mentions of dispersion trade, and one of the things
I found was, you know, a mention in the Bear
Traps Report where they were talking about multi strat funds
putting quote massive amounts of money in the dispersion trade.
But then you can't find actual figures, like it's very
hard to find estimates for how much of this is
going on. So walk us through, like what indications you

(10:02):
might have or what you're looking at in order to
determine how popular this trade actually is.

Speaker 6 (10:08):
Well one way to get a sense for that. And
it's all kind of indirect, right, there's no big government
report that talks about how much you know, how many
options are in this trade, or how much capitalist is
in this trade. But if you look at the CBO
Implied Correlation Index, it actually is just now the three
months implied correlation index is actually at the lowest levels
it's ever been, and they have a couple of the

(10:29):
one month implied correlation is also not exactly at record lows,
but very very close to it. So that's a little
bit of an indication where you can infer that certainly
people are pushing this trade here.

Speaker 5 (10:41):
Yeah, and it's working, right, Everyone's making lots and lots
of money on it, which is typically what happens in
short ball trades. People tend to make a lot of
money until they don't, right, and so you could go
back to different ball events. I mean, we could talk
about nineteen ninety seven, and we could talk about ninety eight,

(11:01):
we could talk about eighteen, we could talk about twenty.
There's different vall things that have occurred where you didn't
know how big the trade was until you knew how
big the trade was. And it's sort of the nature
of short vault. It's so funny is that I've been
doing this for a long time, marketing shortfall strategies. In
twenty and twenty twenty one, you might as well had
your hair on fire because nobody had any interest in it.

(11:22):
Now everyone's interested in why, because it works, and when
it works, it works very very well. The problem with
all these things, as I always like to say, is
when it becomes too big for the market and there's
too much leverage, and so the question always is where
is the size and where is the leverage and how
much leverage does it take. We've learned through all these
shortfall events it only takes one bad participant to create

(11:45):
an unwine or a liquidation. And that's what we saw
in ninety seven, that's what we saw in ninety eight,
that's what we saw in twenty eighteen. So again this
is not an unheard of thing.

Speaker 6 (11:55):
Right, I think, just to add on to that, I mean,
one of the things you know, and I know Tracy
and Jo are always focused on that vomaged in from
February of twenty eighteen, which was this ETF right where
you could see that ETF every day and you could
see how that ETF crew. One of the things today
with this dispersion trade and whether this will become a

(12:15):
vommageddon two dot zero is that you don't have that clarity.
It's a little the waters are a little bit murkier here.
So you can pick up anecdotes here and there, you
can look at implied in disease. You get a sense,
you know, Josh is in the options market every day,
and you pick up things, but it's hard to put
a crisp number on it.

Speaker 5 (12:32):
It's the unknown, right, you're testing the unknown.

Speaker 3 (12:35):
So the thing about that inverse VICXYTF that blew up,
it was a trade that existed in various forms for
a while, and then someone went along and like productized it,
and so then suddenly like you could see like it's
am or it's daily volume. Just a quick definitional thing
because I just so that listeners can understand when we
talk about the c BO three month Applied Correlation Index,

(12:57):
and it's basically at all time lows or near all
time lows or something like that. That is just saying that
based on the volatility of all the stocks that exist
in the index, it suggests that there is a wide
level of expected dispersion among the outcomes.

Speaker 6 (13:13):
Yeah, it's not every stock in the indexes, it's the
top fifty. It's typically market cap weighted there, which is
I think it's very relevant to today's discussion.

Speaker 3 (13:21):
Actually, can one of you explain just sort of like
from a fundamental standpoint why it is that not in

(13:44):
a realized basis, but on a trading basis, essentially, implied
volatility for the index tends to be higher than if
you add up all of the implied volves for all
of these individual stocks.

Speaker 5 (13:57):
So it actually ends up the index ends up being
lower because of the relationship of stocks with each other.
So you know, when you think about it's like, but
people pay more for the protection of the indet, they
pay more for the implied versus real lias.

Speaker 3 (14:09):
Okay, that's that's sorry, that's right.

Speaker 5 (14:11):
Yeah, yeah, that's it. So they and the reason you
know they do that is because, as you said, they're
hedging downside. They're not hedging downside as much as they
normally do right now. But that's a different conversation for
a different day. The way it works is to think
about it is that if you have this basket of
single names that create the vall of the index is
a combination of all those added up their variants plus
their covariance, which is the matrix of how they're related

(14:32):
to each other. So if tech stocks goes up and
utilities go down, well, then that reduces the volatility index
because they're moving in opposite directions. When they all move
together is when the correlation trade has a problem, and
that usually occurs in some sort of liquidation events.

Speaker 4 (14:47):
Okay, right, so think about it this way.

Speaker 6 (14:49):
So in a good benign market like we have right now,
you could be long Metavol and you could be long
Exxon ball and Exon might disappoint for some reason and
the stock goes down and the ball explodes, maybe metas
stock price or just higher for some reason. The ball
may go up to there, you know, ignoring the actual
weights of the in the index. If those two stock

(15:10):
events cancel each other out. Yeah, the S and P
is kind of flat, right, you know on those two things,
but the dispersion trader may have made very good money.

Speaker 5 (15:20):
And Tracy put it perfectly. It's like, then the video
is going up and the index is just kind of
quietly moving higher, and that's because of correlation. I mean,
if they're all correlated together, the index would be up
as much as the video. So that's another way to
think about it, which it's not right.

Speaker 2 (15:33):
Fund managers can dream, yes, we can all.

Speaker 6 (15:36):
Dream, right, but Joe just to put this kind of
prosaically right, Yeah, like you know, when correlations go up
really high and when this trade gets unwound viciously, right,
think of that as the equity asset class being sort
of in a zero one condition, Like people are just
getting out right, They're like, Okay, I'm exiting equities because
something bad is happening and I need to sell everything,

(15:57):
whether it's Exon and Meta or a small cap or whatever.
Right in a more benign condition where people are you know,
I want to be inequities, right, but I'm going to
really be able to discriminate among the fundamentals or whatever's
driving that stock picking exercise, then dispersion works correlation both
implied in realized drops.

Speaker 5 (16:14):
Yeah, I mean another way to think about it is
it's another way of being short tails. Okay, Yeah, the
hedge funds love being short tails. That's how they make money.

Speaker 2 (16:22):
So I want to go back to something that you
touched on earlier, Josh Ware. You were talking about previous
historical instances, and when I hear portfolio insurance that this
is a type of portfolio insurance, I think black shoals,
And then I start thinking about correlation, which we already
touched on, and I guess people, you know, trying to

(16:42):
figure out the correlation across a portfolio and maybe not
doing it that well as you know the experience of
nineteen eighty seven kind of taught us. Talk to us
about the maths that go into this, and like, what
guarantee I guess, or what comfort can we take that
people are actually calculating correlation correctly, because again, like correlation

(17:04):
is one of the trickiest concepts in all of finance
and history is absolutely littered not just with nineteen eighty seven,
but I mean you could argue two thousand and eight
and the ghostiand Copula was also an instance of a
failure to accurately capture correlation risk. But it seems difficult.

Speaker 5 (17:20):
It's incredibly difficult. And what I remember again going back
in time, is when you look at these old Chicago groups,
MO second most important person in the group was the
risk manager. Because we're talking about times when you know,
we're talking about Intel four twenty five trips or whatever
those things are called. You know, we used to run
risk matrices and stuff that you'd have to run overnight.
Those computers are actually less powerful than your current phone,

(17:42):
So that's the kind of way you'd have to look
at it. So you need a really good risk manager,
and you need someone who understands what that tale event
looks like and what the portfolio is going to do.
Do I have faith that, you know, I call some
of the smartest people in the room, some of the
people that I stood next to in the pit are
going to be fine. Yes, I think they're actually going
to make money on this event. Yes, because they're the

(18:02):
smartest people in the room. I do think there are
funds who probably do not have risk managers who understand
that that do not have properly quantified that tail event
risk and the biggest issue, which is the thing that
scares me the most, is the liquidity aspect. And you
can see what's happening in single stocks. I think BAA
call it what the fragility index. I think was what

(18:24):
they call it, which I thought was one of the
funnier names. But that's a whole other thing. Stocks are
moving all over the place, and why because there's no liquidity,
and so wonderful thing about liquidity is when you're putting
on a trade or an investment, as I like to
say this again, I say, is an investment when you're
training it like a market maker, it's a trade when
you're putting it on and setting and forget it, it's
an investment. Is that when you try to get out

(18:47):
of it, it's really hard. And that was the experience
of twenty eleven. Twenty eleven correlation traded over one. Why
because you couldn't get out, and to get out you
had to pay. And that's how these things go. And
so what I like to say about these events is
that when there is a liquidation, it'll be hard, it'll

(19:07):
be fast, and it'll be dramatic like we saw with
Vallmageddon or in nineteen ninety seven, which was a put
seller that blew up, But typically the market after that
is pretty awesome.

Speaker 6 (19:19):
Just to add on to that, I think what's really
important when we were talking about these sort of vommageddon
twos is to really distinguish that this doesn't necessarily mean
something's broken economically or earnings wise, or fundamentally in any way,
shape or form like we saw with Vamageddon. As we
saw in two thousand and December of twenty eighteen, when
you saw crazy price action, you know, the Vicks you know,

(19:42):
was soaring into just before Christmas of that year.

Speaker 4 (19:45):
There was nothing wrong.

Speaker 6 (19:46):
There was a lot of questions about what power weather
Pal's going to pivot and whether, you know, the whole
far from neutral things setting that stage then, But that
was a lot about modern market structure and the financialization
of the equity asset class, which is very different than
the nineteen nineties.

Speaker 4 (20:01):
Yeah, that's a very important thing.

Speaker 6 (20:03):
If you look at options growth, like you know, Josh
and I talk about this all the time, but like
S and P, options growth has been growing dramatically eight
percent per year, and then that escalated in the last
couple of years to much higher levels. Cash volumes have
been completely flat.

Speaker 4 (20:18):
I'm talking S and P right.

Speaker 6 (20:19):
So when you have that, you're going to get funkier
price action at the index level and at the single
stock level too, with people chasing in Vidia calls or
in Vidio puts, you know whatever, You're going to get
a much more financialized and erratic price action, which can
also then be one of the added matches to light
the fire for you know, a potential VOMA get into.

Speaker 5 (20:40):
Yeah, it's again, it's you only need one bad player.
I think the majority of people are not.

Speaker 2 (20:45):
Well, this is what I wanted to get into because
with Volma get in, like okay, you could kind of
see that coming, and in fact a lot of people
did because you knew that once the Vicks curve inverted,
it was just going to be the end for some
of these volatility products, and two of them in particular
with the dispersion trade. The one thing I struggle with

(21:07):
is like what would be the proximate cause for the unwind.

Speaker 3 (21:12):
Or a telltale sign like the inversion, like this is
flashing a yellow light.

Speaker 5 (21:17):
So in twenty eleven, it was a sovereign debt crisis
that caused a liquidation in public equities or a fear
of public equities movement in nineteen ninety seven, it was
an Asian financial crisis. Everyone forgets that long term capital
losts more money selling vaulve than they did on fixed
income stuff. If you go read When Genius Fails, they
have the numbers in the back, which is quite an

(21:38):
interesting The guy who sold options in ninety seven, he
wrote a book to about three months before it happened,
which was kind of kind of funny.

Speaker 2 (21:43):
Isn't going to read that.

Speaker 5 (21:45):
The event's going to be something macro?

Speaker 3 (21:47):
Yeah?

Speaker 5 (21:48):
Like I always like to say, how do you get
a five standard deviation event? You have to get the
one standard deviation event which causes this to happen, which
is the second which is what can I just fuse.

Speaker 6 (21:56):
Let's try to get to Joe's question. I think, but
if we get a macro shock, right, you get a
big uptick in people wanting to get out of the
equity asset class. Yeah, right, and they run for the
fences because something bad is happening. You know what's going
to happen there is that the VIX index, right, which
your index ball which you're short, is going to be

(22:17):
rising much faster than your basketball. That you're long, right,
and that's where the risk manager taps the dispersion trader
on the shoulder and saying close out, and then you
get a sort of a self fulfilling loop there.

Speaker 3 (22:29):
Well, let me put it a different way, which is that, okay,
the thing that blows this up will be some macro
event almost by definition unexpected. I don't think any of
us in this room probably can like really know like
when some country is going to break, et cetera. So
at any given time you're putting on this trade, you're
collecting premium. There's a risk that it blows up with

(22:51):
a macro event. But at some point in between that
there must be some calculation where you are not getting
compensated enough in order to justify the risk that the
once every five years or the once every ten years
of macro blow up occurs. So what are those signs
or whether it's in the pricing where it's like, yes,
you could still make money on this trade because the

(23:13):
math is there. But given the fact that there's going
to be a macro blow up of some sort every
few years or everybody like this is no longer worth
the risk.

Speaker 6 (23:20):
The math is still there, you know, implied correlations are
still higher than realize correlations. Okay, that's helpful, But the
VIX is not at twenty five right now, right, It's
down in this thirteen fourteen level. Right, so your risk
return is not as constructive. Josh, just a grief if
you will. But I don't think it's as constructive now
as it was coming off this massive Vall spike we

(23:43):
had during COVID, right where we've had this sort of
general reacclimization to the shortfall thesis and various forms of fashions.

Speaker 4 (23:51):
Now it's just gone too far, too long. Yeah, I
mean certain.

Speaker 5 (23:54):
And it's funny is that you actually pay decay in
this trade because of the basketest single names is more
expected incident when you're collecting on the index. I look
at it as sort of you have the fixes at twelve,
like how much more money can you bleed out of
this road? I mean, it's really at that point. And
that's what I'm saying about. The people who are smarter
will have reduced this trade who aren't as an investment,

(24:15):
like the Vall traders reduced short ball in twenty eighteen
because they knew that twenty seventeen was a multi decade
low moment we were moving what we moved two percent
that year in the SMP on a two percent ballve
because we want up one percent every month. You know,
the joke is if we go up one percent every
month for twelve months, it's the all of the SMP zero.
So it sort of becomes one of those things. And
so you just get to the point where you're a

(24:35):
risk managery go what's the upside downside? And the downside
becomes greater. So when I look at it as a
person who's managing risk, I just reduce because how much
more money can you take out of it? Now? Again,
a lot of this is fundamentally driven by stocks and
what's happening with stocks and who's making money. A friend
of mine pointed out, you know, thirty five percent the

(24:56):
SMP is now AI, right, So you know, how does
that look?

Speaker 6 (25:00):
Think we should just set the table a little bit
about what's been Why is this trade so popular right now?

Speaker 4 (25:05):
Right?

Speaker 6 (25:05):
And there's a lot of fundamental reasons that you know,
if you're a dispersion trader, why you go to your
boss and say, hey, we need to do this, here's why, right,
And the reality is is that We're in a strange
economic cycle, right. We have a risk on condition obviously, right,
VIX is low, SMP keeps putting on good returns, and
other risk assets do, right. But how these different sectors

(25:28):
are moving with each other and the different stocks is
incredibly low.

Speaker 4 (25:32):
Right.

Speaker 6 (25:32):
Part of that's because we have an unusual cycle. Like
if you remember, you know, during COVID, oil prices went negative.
Before that, Oh my god, why would you want to
own Exon, you know at all? Because of ESG and
all that, And then of course that reversed oil went
to one twenty and Exon became you know, the new
Google for a few months. Right, So you had a
lot of strange things coming out of this COVID shock

(25:53):
and all the compounding things there. But of course, you know,
just in the last year you have AI, right. And
so one of the things I like to look at
is sort of how each sector correlates across with other sectors,
not unapplied on a realized correlation, just the historic trading.
And what's really interesting there is that if you average
all the cross sector correlations ten sectors and you see

(26:13):
how each one, you know, you get a grid. Right
now that average is about the lowest it's ever been, right,
the cross sector correlation. But what's I think even more
relevant is that the tech sectors correlation is the lowest
it's ever been but for nineteen ninety eight nineteen ninety nine.

Speaker 5 (26:31):
Which keeps getting us back to nineteen eighty eight nineteen
ninety nine, right.

Speaker 6 (26:34):
And the tech sector is particularly important because the dispersion trade,
generally speaking, is market cap weighted, and of course the
tech sectors are dominating the S and P five hundred here.
So that's one reason why you know, you can say,
oh my god, like, look at Nvidia, it's so different
than so many other stocks that if you look at fundamentally,
the BAG six earnings of this year have exploded twenty

(26:57):
two percent, the SBX equal weights to four percent. Right, Like,
there's a lot of fundamental arguments suggesting why this trade
makes sense here. I think what Josh and I are
collectively saying is that the trade's been pushed too far here.
And there's another point I really want to make here too,
which is that you know, there's a lot of cross
ass at comparisons with the late nineties right now, interest rates.

Speaker 4 (27:17):
And so forth. Here.

Speaker 6 (27:19):
But what's really interesting is is that the correlations for
tech and the correlations broadly speaking on a realize basis
are much more similar to ninety eight and ninety nine
than there were today. But the VICS back then was
twenty to twenty five to thirty. It was not go
back to twenty seventeen, super low VIX, right. You know,
we even had nine handle prints at one point there,

(27:40):
and the correlation was very low then. It's very low
now here. But twenty seventeen was a period when you
had a very different central banking environment. One of the
sort of broader cross asset theses I'm arguing is that
we are normalizing a lot of central bank policies. Are
not normalizing to twenty seventeen, but to something else, right,
and if that happens, we may see the vis. I

(28:02):
think the VIX is getting into a higher range here,
a higher floor, if you will. And if that happens,
maybe you don't even need a macro shock to derail
this dispersion trade. If the VIX is going to start
sort of grinding higher just because that fed put is
too far out of the money right now.

Speaker 5 (28:19):
And I think one of the big things you're seeing
is the lack of put buying in general compared to
nineteen ninety eight. And the big thing in nineteen ninety
eight is that we had never seen a FED put
come in like we have since, and so I think
the market is comfortable with the FED put coming in,
So why own puts.

Speaker 2 (28:50):
I definitely want to get into more of like the
outlook for volatility in general, but before we do, I
have one more question on the dispersion trade, which is
can you walk us through who is on the other
side of this? So maybe hedge funds or some other
type of trade or are putting this trade on, who
is selling or buying that volatility from them? There's two
legs to the trades.

Speaker 5 (29:11):
So back when I was more on the cell side,
not just more, I was on the cell side. So
it's twenty eleven.

Speaker 4 (29:18):
You had a.

Speaker 5 (29:19):
Lot of structured retail product trades coming out of Europe
and Asia that put a lot of single stock vall
onto investment banks books. They would then sell index as
a way of getting out of some of that because
there wasn't enough liquidity in certain things. They did the
same thing with dividends. They typically get long dividends, and
so you assume certain dividend growth, and so that's the

(29:41):
sort of the growth of the dividends swap market as well.
So they would then use hedge funds as a way
of off laying that concentrated single stock versus index risk.
And the reason being is because it doesn't look great
on of our perspective because you're short tails, and so
when your var numbers get a little bit too the
wrong way, obviously the risk march investment banks that you

(30:01):
need to offload this, and so that what happens is
they do tend to off load that risk. You know
where it's coming from now. And again this is totally
me guessing on the fact of what I'm seeing. Is
it seems like the market is short single names and
long index. In other words, if you look at you know,
with the Burgoci'll put out, oh, the you know, the

(30:23):
broker market is long ten billion dollars of front month
gamma or one day gamma going into CPI and then
the market moves like three percent and everyone's like, well,
how's that happen. I'm like, well, it's because they're probably
short single names and a lot of this data. And again, Tracy,
you put it perfectly like there's no central depository of data.
We become so data centric in this world. Like I

(30:44):
feel like when I started in this business, I was
like the data junkie, and I always obsessed with data
and what it meant. And then I've realized, well, if
you know, it's like kind of like looking at baseball,
when everyone's using data, sometimes you got to move away
from it to a degree. And there isn't a good
data set. The only data that we have is what
Michael's point out is, there's just a massive growth in
volumes and open interest in options. Everyone's using them, everyone's

(31:07):
paying attention to them. And so my general feeling is
that the market is probably long a little bit of
index and short a little bit of single names.

Speaker 2 (31:15):
So I know you guys are both options guys for
the most part, But what impact does all that growth
in the options market end up having on the cash market.
This is something that comes up again and again, and
as you say, like the figures if you look at
the overall market are just stunning, and particularly for things
like the short dated options, so the one or the

(31:35):
zero day options. I don't have them in front of me,
but like talking about lines that go up into the
right it's just been stunning growth.

Speaker 5 (31:43):
Yeah, is I like to say the tail starts wagging
the dog a little bit. And I've seen this when
I was in Europe, when options got bigger, almost than
the ability to trade stocks. They become the market. You
see this at month end, where you see large positions
and options determine how we end the end of the month.
Is people play cards to determine where we're going to settle.

(32:06):
I like to say, like the month end is like
kind of the old fun way of trading. If you've
ever seen the movie Rounders, which is one of my
favorite movies, which is a bunch of professional poker players
from New York go down to the taj and they
sit at a table and go, we're not going to
sit here and play against each other, because it's the point.
And then people sit down at the table that don't
understand how it works and they just start making money.
And that's what's happening at month Then there's large passive

(32:30):
option positions that people are aware of and they trade accordingly.
And so in that sense, yeah, the tail is wagging
the doll. And again, when you look at this again,
it would happen in the nineties where you have if
every day people are buying calls on AOL or calls
on Navidia or calls on Apple like they are in
the last few days, it can drive a stock significantly

(32:52):
higher or lower. And that's why I think you see
these large ranges occurring because the options are wagging the dog.

Speaker 2 (32:58):
It's almost like it becomes kind of reflexive at that point, right,
Like you have all the options that are betting on volatility,
and so because of all those options, you start seeing
bigger swings correct.

Speaker 6 (33:10):
One of the interesting things is that, you know, we
talked about like the VIX floor being twenty back in
the late nineties, but even though the equity market was
doing generally quite well most of the time, but the
peak of the vics in that same time frame, you
had the Russian ruble crisis, you had the Asia crisis.
The peaks there were exceeded by vomag Edden speak or
at the same level here, which was again not a

(33:31):
fundamental driven thing. So it's really a good way to
think about just that was sort of a more normal
VIX environment because there was just you didn't have the
financialization of the stock market the way you'd have it.

Speaker 5 (33:43):
And again, this is a short tail strategy. It's like
a converts or a short stale strategy. You know, credits
to short tail strategy. There's what hedge funds live with.
I mean, that's what they're really good at doing, is
selling that tail and managing that risk. And so that's
where we are.

Speaker 2 (33:57):
Also, Joe, I think people forget nowadays. But like the
Vollmageddon blow up, so that was like two relatively small etns. Yeah,
that ended up going belly up, but that sparked a
sell off, a pretty big sell off in like the
cash market in the S and P five hundred. People
forget that, Yeah.

Speaker 3 (34:14):
I forget that element of it that it did break
containment so to speak, outside of the etns themselves. Can
we go back to I don't want to just talk
about AI because AI is a thing, but the AI
risk factor, which is it seems like a lot of
the market now many things are being shoved into an
AI thesis. So it's like Uve, Nvidia, Obviously, you have

(34:36):
other chip companies. Obviously you have Apple hitting all time highs.
You have that feeds into Berkshire Hathaway, which owns a
lot of Apple et cetera. Can you talk a little
bit more about this sort of not necessarily price correlation
because we know that I guess you know, the charts
are the charts, but this sort of thematic correlation, and
then how you see that affecting the risk.

Speaker 4 (34:58):
Or narrative correlation? Right, narrative quarter coperate or utilities are
a utilities?

Speaker 3 (35:03):
Yeah, totally industrials.

Speaker 5 (35:05):
I like to say, Wall Street's good at doing one
thing really really well, selling.

Speaker 4 (35:09):
Greed and telling stories.

Speaker 5 (35:12):
And so they can tell a story about getting people
to get greedy about this theme. They're really good at
making money off of it. And so everybody wants to
sell this theme right now, Like you can sell this theme,
sell the theme of AI. I mean na video Navidio.

Speaker 3 (35:27):
By the Stocks sell the thing.

Speaker 4 (35:28):
Yeah.

Speaker 5 (35:28):
I mean it's if you think about I mean, the
video is making incredible amounts of money. I mean the
amount of money they make in a quarter, I mean
I never thought was imaginable. Yeah, so of course it's
a great theme to sell. Now is everyone else going
to be as good at this theme as them? I
don't know, But it doesn't mean that Wall Street isn't
going to sell it.

Speaker 6 (35:43):
But to answer, your question about is there like theme
correlation to.

Speaker 3 (35:49):
All these training models and one day it's like, you
know what, they're mostly good for making, but we can't
figure out how to make money on them canceling the orders.
But then what happens to this trade?

Speaker 6 (35:58):
I think that's a really good question and very relevant one.
But I'm going to put up back like my market strategy,
equity market strategy had on, not my options had on.
And the thing you have to recognize about today's equity
market is that it's not necessarily particularly expensive at the
s and P five hundred level.

Speaker 4 (36:16):
There.

Speaker 6 (36:16):
Obviously there's always parts of it that are a little
bit high, a little bit low. The SMB is not
cheap by most any standard here. But what's very important
is that we're not really driven with a pe expansion
type of bull market right now. It's really earning's driven here, right,
And if you look at what sectors are moving higher,
it's very correlated with how much earnings growth that they're

(36:38):
doing here.

Speaker 4 (36:38):
Right.

Speaker 6 (36:39):
So let's say, okay, let's say if utilities just don't
generate their earnings that some of the AI narrators might
suggest they will, Well, that's going to be reflected and
the quarterly reports, the analyst estimates, and it doesn't necessarily
have to mean that there's some big blow up risk
because of this AI thing. I think it's we're dealing with,
in many respects, one of the healthiest equity markets we've
seen in a long time time, because it's not really

(37:01):
about pe expansion. It's really about really strong earning.

Speaker 3 (37:05):
Screen and it hasn't been about zerp or rate cuts either.

Speaker 4 (37:07):
Now exactly what companies are making money.

Speaker 6 (37:09):
We're having great returns last year with a hawkish or
at least maybe not hawkish fed but as we saw yesterday,
but not like, oh my god, we got a cut
rates to get the s and p up another ten percent.

Speaker 4 (37:19):
That's not happening.

Speaker 5 (37:20):
I mean, companies are really making money. And so when
we talk about this dispersion trade, from a fundamental standpoint,
the companies making money or going up and the ones
who aren't are going down, and so fundamentally it's a
risk trade. I think, Joe you put it once, it's
like owning equities is kind of a short ball trade
to degree, and that's kind of what this is. It's
a short vaulta degree and owning equities is part of that.

(37:42):
And you know, that's a trade that people are comfortable with. Now,
is there a time it goes Yeah? But I truly
think that, you know, Vall gets a bad name and
options get a bad name in a lot of ways
because we have these once in a while bad players
in the market. I mean twenty twenty we had a
bad player as well. I mean, that's a lot of
what happened. And at the bottom was a VALL related event.

Speaker 2 (38:02):
But that's are you talking in treasury or no.

Speaker 5 (38:04):
No, no, no, I'm talking about why the market was
going up and down ten percent in one day. We
can't many anymore. There was a product out there that
created a lot of the VALL that occurred at the bottom.
If you go look at the bottom, it was right
when the vics expired. So that's just another conversation for
another day. But that being said, they have a bad name.
And I still think that this market, as long as

(38:26):
Michael puts it perfectly, these companies are making money. There's
a fundamental reason for this. We have fundamentally a reason
why we're going up into the right and as long
as that goes on. As Jo said, this equity market
is a short vault trade. This is a short fault trade.
It will work if we go into an O one,
O two where all of a sudden, what do you
call it, Y two k goes away and everyone stops

(38:46):
making the investment in Y two k, which is sort
of the end or Dogs dot Com all of a
sudden realize we don't have Dogs dot Com not making money,
So it's different. As long as those fundamentals are strong,
this will be fine. You know. I don't think as
options are going to be as big of a problem
because everyone's had problems with them, so people are aware
of it. Again, it's not saying there isn't one player

(39:07):
who is an out there who's over levered, who's put
this on in an investment. And again we started this
as the dispersion trade, not the dispersion investment, and there's
a huge difference between a trade and an investment.

Speaker 4 (39:20):
Yeah, but I.

Speaker 6 (39:20):
Think all of this, Joe's also one of the reasons why,
you know, when I do my trade recommendations for market hedging,
I've certainly been of the view this year that I've
been very constructive on the equity market. Obviously, anything can happen,
but the question is do you want to hedge equity
market risk with S and P puts or with VIX calls.
And I think this is one of the arguments for
going with VIX calls. Not that we've seen anything explosive

(39:42):
yet this year, but if we do see some of
these things unwined, ye, you're going to get a kicker
there where you might see the VICS cruise very quickly
up to forty five. And it probably won't stay there
unless there's a real good fundamental reason for that to happen.
But if you do get this volma get into a
dot zero, that's.

Speaker 2 (39:58):
And you buy that tip to forty five is exciting
given that we haven't really seen that since like early
twenty twenty. But talk to us. I guess about the
general outlook for volatility, particularly cross asset, because so far
the big story for the past few years has been
volatility in fixed income. I'm looking at the MOVE index
right now versus volatility and equities viz.

Speaker 3 (40:21):
The VICS.

Speaker 2 (40:22):
There's just been this enormous gap, like all the interesting
stuff has happened in.

Speaker 6 (40:27):
Yeah, the way I look at it is that the
treasury volatility sort of the foundation of the house on
which so much other volatilities, FX volatilities, equity volatilities, foreign
equity volatilities are sort of sitting on top of So
if you look at the move index and Tracy, I'm
looking at your chart right now.

Speaker 4 (40:43):
If you look at that, it basically.

Speaker 3 (40:46):
Tracy, put your privacy screen up, so.

Speaker 5 (40:49):
I don't have a screen in front of the eyes
too much.

Speaker 2 (40:51):
Joe, don't say anything bad about our guests in the gap.
So far, everything's been very flattering, so we're good.

Speaker 6 (40:57):
But that sharp basically shows the ark of the hiking cycle,
right And if you look at when that move indeck
started breaking out higher, it was March of twenty twenty
two when the hiking cycle started. And officially, I guess,
assuming we don't get any more hikes, which we probably won't,
you know, that was last a lie. It's kind of
just stayed there. And if you look at the long

(41:17):
term history of the treasury volatility or the move indecks,
when you get to that resting place, the ball comes
down a lot. Now, there was a lot of all
late September and October, which was I would argue with
much more term premium ball there. That's maybe a subject
for another discussion. But early this year we had seven
cuts priced and then we went to one cut priced.
And right now treasury volatility should continue to contract, you know,

(41:42):
because we're kind of in the short strokes. There's this
not too much maybe we get something that maybe you know,
I think there's an argument as we get into the
elections that maybe the term premium should expand and we'll
see a little bit more craziness as we get closer
and closer to November. But I think and I think
Josh would agree that we're kind of both bearished treasure
revolve in the near term right now for all the
obvious reasons that you know, we're in a tweaking situation,

(42:05):
not any large scale things, and you know, the CPI
comes a little hot, a little cold, but basically you
sort of know where the trends are and you know,
there's just not much more room here. The broader thing, though,
is that are we going to go see a big
decline in treasury volatility like we used to know? Right
you know, back when we had basically zerup and you know,
like if you look at the ECB's policy rates, they

(42:26):
were like stuck in concrete at negative levels for six
years until finally inflation sort of broke up that concrete.
So if you look at things like the amount of
negative healing debt in the world that's gone from nineteen
trillion a couple of years ago to like zero today,
there is a strategic retreat away from these ultra dubbish policies.
And I think as that happens, and you're starting to

(42:49):
see more geopolitical news developed, you know in Europe, you know,
election wise, deglobalization, they are all that stuff, to my mind,
should help support higher term premium and also higher rate
volatility across the curve over.

Speaker 4 (43:03):
The broader things.

Speaker 6 (43:04):
So I get I want to link that back to
this notion of to remember that you had great equity
markets in ninety eight ninety nine, and you had a
VIX much higher than it is right now.

Speaker 4 (43:15):
I think that's a.

Speaker 5 (43:16):
I mean also, like this summer seems like it's lining
up to be quiet because we have the most that
the most certain yeah, except for August, right, the election
certainty is we know what we got, Everyone knows where
everyone stands, so there's nothing uncertain there. Let's say, you know,
unless one of the two people isn't running, but that's
another question for another day. So that's there. As I
said earlier, I look at and applied volatilities across ASCID

(43:38):
classes across the globe. One of the things I also
look at is credit. So credit is as tight as
it's ever been, and there is a huge correlation between
credit and vall, especially in times of stress. And so
I think that the credit picture, I think would be
the one that would make me the most concern if
we start seeing you know, everyone's talking about, you know,
we're going to come to the cliff, and the cliff
keeps moving of the credit or the real estate market

(44:00):
or whatever. We'll see what happens. Right, everyone says it's
this fall we're gonna find out. So I think the
summer is going to be what it's going to be,
and we'll see what happens in the fall.

Speaker 6 (44:08):
I'm less worried about a credit event. I'm sure there's
going to be isolated credit events, but I think it's
been pretty well signaled. You know, the real state issues.

Speaker 5 (44:16):
It's just real tight.

Speaker 6 (44:17):
Yeah it's been real tight, but there's there's good reasons
for it to be real tight, and more buyers. But look,
to me, what I think is interesting and again the
elections are really starting to come into close focus. And
one of the things that I'm thinking, you know, like
you typically get the questions like what do you do
with the equity market on the election? To me, I
think the real question is what do you do with

(44:38):
the bond market on the election? Because what I hear
from either side, either side of the aisle, there's no
real plans not announced yet anyway, about how we're going
to whip inflation. Now right, It's obviously been Biden's achilles heel,
but a lot of Trump's policies have been at the
margin at least as inflationary, maybe more so if he

(44:59):
puts his fingers on the scale of the FED. That's
where I think the bond market, in the bond market
volatility discussion gets love.

Speaker 5 (45:05):
And that's going back to the original conversation. If the
bond market volatility goes up, that's when the dispersion question
becomes more. So you can almost look at dispersion as
a way of thinking about bondball because those are the
correlated one events.

Speaker 4 (45:17):
Right.

Speaker 2 (45:18):
I like that we've come full circle to the beginning
of this conversation. So I mean we could talk for
like hours and hours and hours about.

Speaker 3 (45:26):
All we could just listen to you.

Speaker 2 (45:28):
Yeah, well, listeners, if you are interested in hearing more
from Michael and Josh, they have their own podcast called
the Macro and Volatility Podcast, so you can.

Speaker 3 (45:39):
Definitely check that out.

Speaker 2 (45:40):
Yeah, exactly, Josh and Mike, thank you so much for
coming on all thoughts. Really appreciate it.

Speaker 5 (45:45):
Thank you so much for having us.

Speaker 4 (45:46):
Yeah, this was great.

Speaker 3 (45:46):
Thanks so much, Joe.

Speaker 2 (46:00):
I love that conversation.

Speaker 3 (46:01):
Yeah, I did to, you know, I really liked this
idea trades becoming investment. We once was a trade, whether
it's short volatility, whether it's the dispersion trade, something that
traders put on, and in my mind I sort of think,
you know, like, yeah, it kind of makes sense. It's like,
if you're long stogs your short volatility, why not just

(46:21):
do the short volatility component alone and strip away all
this stuff and just get what you're at. I can
see how these things become investments over time. Absolutely.

Speaker 2 (46:30):
The other thing that stuck out at me was just
the reflexivity of all these changes in markets, and I think,
I hope maybe this is wishole thinking. I hope there
is a greater recognition nowadays that you can get the
tail wagging the dog scenario that Josh described, and we
have seen various instances of it, Vollmageddon being the prime example.

(46:52):
And it seems like when we're talking about a sort
of opaque market activity like the dispersion trade, where we
don't really have a good sense of how big it is.
We can kind of try to triangulate it through looking
at implied volatility and things like that, but we don't
have a good sense. It feels to me like that
is a very worthy question to ask, like how much

(47:16):
would a big unwind actually end up impacting the market?

Speaker 3 (47:19):
Yeah, so we don't have an equivalent of this trait
of XIV. There's not some ETN where you can just
lazily go and click three letters into your robinhood or sit.

Speaker 2 (47:30):
But there is a CBOE dispersion index. So there is, Yeah,
and I think there's a product attached to it, but
I can't remember the exact name.

Speaker 3 (47:38):
Maybe, but oh, by the way, I'm definitely going to
become one of those people that like, so, you know,
i'd check the VIX everyone, so while would check the
move et cetera. I'm going to now add the CEBO
three month Implied Correlation Index to those things that I
tweet from time to time and hopes so sounds like
oh new lo in the CEBO three month applied correlation Index.
Get a few retweets on that.

Speaker 6 (47:59):
Well.

Speaker 2 (47:59):
The other thing I I was thinking about was that
idea of like the rerating of the AI sector what
that would actually mean, because again I think about correlation
and like correlation in many ways is the trickiest concept
in all of finance, but it's also at the heart
of all of finance, and so I guess my question
is if investors were suddenly to become disillusioned with AI,

(48:20):
or if there was a mass recognition that actually the
profits that were expected aren't coming through to the sector,
what would that knock on effect be? Like Josh mentioned
investment and the idea that in the early two thousands
everyone was investing in these new internet companies and then
suddenly that stopped, is a similar situation with AI. Now

(48:41):
what would the mass impact be if AI was rerated,
the investment stopped, and then we get these knock on
effects in the market as well.

Speaker 3 (48:48):
Tracy, I have a really good idea for us. Okay,
there's a bunch of bluegrass songs. They have breakdown in
the headline Bluegrass breakdown, Foggy Mountain breakdown, Earl's breakdown, et cetera.
Can we write it? I saw it together called correlation breakdown, Like.

Speaker 2 (49:02):
Oh, I would love that, right, But also I really
want you to write that other song. Yeah, I gave
you this is a non finance song. But I had
a brilliant country song idea, and I've sold the rights
to Joe.

Speaker 3 (49:13):
Well, we're gonna share them. But yeah, let's write correlation
breakdown sometimes.

Speaker 2 (49:16):
Yeah, let's do it.

Speaker 3 (49:17):
Okay, Okay, shall we leave it there? Let's leave it there.

Speaker 2 (49:19):
This has been another episode of the Odd Lots Podcast.
I'm Tracy Alloway. You can follow me at Tracy Alloway.

Speaker 3 (49:25):
And I'm Joe Wisenthal. You can follow me at the Stalwart.
Follow our guests. You can ping them on the terminal.
Michael Purvis, CEO and founder of Tullback and Capital Advisors.
Josh Silva, managing partner at CIO Passaic Partners. Look for
that green light and say hi and follow our producers.
Carmen Rodriguez at Carman armand Dash, Ob Bennett at Dashbot
and Kilbrooks at Kilbrooks. Thank you to our producer, Moses Onam.

(49:48):
From our Oddlots content, go to Bloomberg dot com slash
odd Lots. We have transcripts of blog and a newsletter
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Speaker 2 (50:00):
And if you enjoy odd Lots, if you like it
when we dive deep into the dispersion trade slash investment,
then please leave us a positive review on your favorite
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(50:22):
channel on Apple Podcasts and follow the instructions there. Thanks
for listening.