This Is How Derivatives Trading Swallowed the Entire Market

For a long time, the world of derivatives trading was a niche thing, largely occupied by professional investors who used them for hedging purposes. During the pandemic and the Robinhood boom, the retail masses started discovering them, and activity exploded. Since then, the use of options, swaps and other levered positions has grown among both individual traders and the big professionals on Wall Street. There are countless influencers on social media promising "guaranteed" returns from various options selling strategies. New ETFs have been launched that embed derivatives inside them. And institutions which might historically have employed simple, sleepy investments, are now making them part of their core mix. So how did this happen, and what effect is it having on the market? On this episode, we speak with Benn Eifert, partner at QVR Advisors, about the evolution of this world, why you should not get your trading advice from Instagram, and how this trend has reshaped the entire market.

Read more: World’s Largest Options Market Weathers Indian Regulatory Curbs

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Episode Transcript

Speaker 1 (00:00):
Hey, there are aud Loots listeners. It's Tracy Alloway.

Speaker 2 (00:02):
And Joe Wisenthal.

Speaker 1 (00:04):
We are very excited to announce that Audlots is going
to Washington That's right.

Speaker 2 (00:09):
For the first time, we are going to do a
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going to be March twelfth in Washington, DC at the
Miracle Theater and guests will be announced in the coming days,
but in the meantime you can find a ticket link
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Speaker 3 (00:27):
Lots, Bloomberg Audio Studios, Podcasts, radio News.

Speaker 1 (00:46):
Hello and welcome to another episode of the Audlots podcast.
I'm Tracy Alloway.

Speaker 2 (00:51):
And I'm Joe Wisenthal.

Speaker 1 (00:53):
Joe, as part of my preparation for this episode, I
have spent the morning on TikTok and Twitter, slash x
Instagram watching videos.

Speaker 2 (01:04):
Did you find any good techniques that you are going
to employ for generating two hundred thousand dollars a year
on two hundred and fifty thousand dollars in capital by
selling short term options? You know what?

Speaker 1 (01:16):
First of all, there are so many accounts that are
basically pitching trading with derivatives options. Some variation of those nowadays.
I did, to your point, find a guy a video
of a guy saying that one thousand dollars is only
nine doubles away from becoming a million, and a million. True,
a million is only ten doubles away from a billion.

Speaker 2 (01:39):
So that's true too. Now, I think that sounds roughly right. Yeah,
so what's the catch? You know, someone's got to do it.

Speaker 1 (01:45):
No catch, Joe, It's it's all good. We can all
be billionaires. No, I think. I think the thing about
derivatives trading nowadays is when it's started, it was very
much a retail phenomenon. It was, you know, the guys
on Wall Street bets Yo, lowing into some crazy derivatives trade,
basically buying a lottery ticket on the market. But what's

(02:07):
happened since then is derivatives have really gone mainstream in
various ways. So, for instance, if you look at options
like across the S and P five hundred right now,
something like sixty percent of the volume is shorter dated options.
So yeah, zero DT or one DT, which is kind
of crazy.

Speaker 2 (02:28):
It's totally crazy, you know. I remember first, do you
remember Tracy early on when we started at Bloomberg, You
brought in. There was someone I forget who it was,
but there was someone from some sort of like actual
like institutional options trading research firm that came in and
did this little like mini seminar for some of the

(02:50):
reporters on like how to analyze options data. Do you
remember doing that you brought in anyway, But one of
his points was is that the purpose of options are
like they're largely hedging instruments. They're sort of tactically used
by institutions for very specific purposes, you know, insurance essentially,
that options sort of played this role as insurance for

(03:12):
specific things. And then since then I get the impression
that the world is just like totally changed. And I
think the other thing that surprised me. I would have
guessed that if we're sitting here in twenty twenty five,
that that craziness of twenty twenty one would have been
some sort of peak. Right, there is Robinhood here, Memestock,
ere et cetera. I would not have guessed the durability

(03:33):
of it, especially with the FED having hiked and everything
that we've seen transpires.

Speaker 1 (03:37):
Since No, that's my point, right, Instead of like the
Yolo crowd basically reducing their options trading. Instead, we had
Wall Street yoloing into options trading to serve first. Okay,
So options, derivatives, they're everywhere right now, and you have
different groups of people, so institutional and retail using them.

(03:59):
You have a bunch of different strategies, you have a
bunch of different products that deploy them, that give again
new types of traders access. So we should talk about it.

Speaker 2 (04:09):
Let's do it.

Speaker 1 (04:10):
And who do we call to talk about derivatives? The
perfect guest, one man, the perfect guest. We have Ben
i for managing partner at QVR. Back with us, Ben,
thanks for coming back.

Speaker 4 (04:21):
On Tracy Joe. It's so good to see you, guys.
I'm really excited about this. It's always so much fun
talking to you.

Speaker 1 (04:26):
It's been a while. I have to say, maybe just
to start out with videos' favorite.

Speaker 4 (04:34):
The one actually from a few days ago that I
just absolutely loved. I'm gonna I'm gonna forget her name
off the top of my head, but she's called the
she Wolf of Indian options trading and she has a
whole show. She was actually reacing me. She was recently
banned by the Indian government from you know, doing what
she's doing because she's sort of so controversial, but she's
very intimidating it. Like I like to kind of take
on these option influencers and sort of say, look, you know,

(04:56):
come on, guys, this isn't right. I don't know, man,
she's she's pound, you know, pounding the table about making
one hundred percent in ten minutes, you know, like guaranteed profits,
interdate options trading over and over again while like a
band plays in the background and fireworks go off. It's
like truly incredible stuff.

Speaker 2 (05:13):
I'm reading an article on livemint dot com SCBI, which
I guess is the Indian regulator banning her from capital markets.
But one hundred percent in ten minutes sounds pretty good.

Speaker 4 (05:25):
What's the kid, what's the cat? Well, it turns out
it's a lot better money for her than it is.

Speaker 2 (05:32):
Usually Well what is Okay, that's a very extreme example,
but we all, you know, we've all seen these videos.
The modal TikTok options is influencer. What is the sort
of the gist of what they're telling viewers that they
can do.

Speaker 4 (05:46):
Yeah, absolutely, I mean the things that you that they say,
you guys just kind of joked a little bit about
this earlier, but you know, make twenty thousand dollars a
month in passive income, you know, easily with only a
two hundred and fifty thousand.

Speaker 2 (05:57):
What's the gist of that stor we all are very
skeptical results, But what is the basic thing that they're
saying that you.

Speaker 4 (06:03):
Can absolutely achieve. The typical thing these days is they
want you to sell short data, short term options, right,
And there's various formats that might take. The really popular
stuff might be just selling puts, you know, one month
puts on your favorite stocks or on the equity index,
or maybe weekly puts or maybe zero DT puts, sort
of daily puts over and over again. Could be selling

(06:24):
covered calls or uncovered calls. Could be selling you know,
straddles or strangles or whatever it is. But the common
idea or the kind of they'll pack all of these
different handwavy justifications into why this is free money or
why this is really easy. You'll hear people say, oh,
ninety percent of options expire out of the money, so
it's just super easy. You just make money on all

(06:45):
these trades, you know, and then and then anything that
could go wrong they explain away as how it's not
really a problem. You know, Oh, well, if you sell
the put and the stock goes down, then you get
to buy the stock really cheap and the stock is
going to go back up and it's kind of fine.
Or you know, oh, you reduce your cost basis on
the stock over and over again, and then then you
get the stock for free. For all of these things
over and over again. Where at the end of the day, Look,

(07:06):
if you say you can sell an option, that's fine.
It's just a trade. It has a payoff profile. You
get a little bit of premium and maybe you lose
a bunch of money or maybe you don't, and you
can kind of analyze that trade the same way you
would analyze any trade. It's not free money, you know.
But the justifications and explanations and persuasiveness that goes into
this from these from these kind of influences is very powerful.

Speaker 1 (07:25):
Do we have any sense of what people are using
these four And you know, one thing I hear in
particular on shorter dated options from this mostly comes from
institutional traders, but the idea that well, these allow you
to be more precise when you're hedging. This is a
tactical move versus a strategic move. But then of course

(07:46):
you look at something on a subreddit or something like
that and people are just basically buy lottery tickets.

Speaker 4 (07:52):
Yeah, I think that's exactly right. So, you know, derivatives
have been around for a long time, and options have
been around for a long time, and they certainly enable
you to make very customized, precise bets or hedges in
intelligent ways if that's what you're trying to do, and
you know, that's super. But most of what you see
being sold on YouTube or on Instagram is much more.

(08:15):
You know, you should just do this all the time.
This just makes sense. This is basically free money. It's
really easy.

Speaker 1 (08:19):
There's no accompanying strategy.

Speaker 4 (08:21):
There's no accompanying strategy of when and why might something
like this make sense? At what price? How do you
know if it's a good trade. There's none of that.
It's just justification that somehow this is a cheat code
in markets that just lets you unlocked the infinite money,
an infinite money cheat code that lets you unlock sort
of spectacular returns.

Speaker 2 (08:38):
One day, Tracy, We're going to do an episode on
the cheat code that I did find in markets, which
I have I think i've hinted it.

Speaker 1 (08:44):
Wait, you found one and you're still here.

Speaker 2 (08:46):
Well, the short version is, I did find a cheat
code in nineteen ninety nine. I didn't know that I
had found a cheat code at the time, and so
I was like, oh, at some point I'll pick this
back up. But in retrospect, I should have gotten all
my friends and family to go all into it for
a month. I could talk about it some other time.
I did briefly find it. Cheat coulde in the markets,

(09:07):
and I thought, I was like, you know, and.

Speaker 4 (09:08):
He didn't tell any of.

Speaker 2 (09:09):
Us, Yeah, I didn't. I was like, oh, this is
kind of cool. I made ten thousand dollars. You know,
we talk about volatility, right, and so just a very
crudely you know, they're you know, maybe higher vall opportunities
present good times because you're getting large premium or whatever
for some of the options trading, et cetera. What are
like people who find who like walk into these extremely

(09:32):
naive strategies, Oh, option ninety percent of the time options
expire out of the money. What does the payoff look
like for them? How many days do they how many
pennies can they pick up before they get steamrollered?

Speaker 4 (09:43):
Yeah, totally. I mean, these kind of strategies again, if
you're just doing them all the time without thinking about it,
without thinking about the price, and you're just going out
like on the S ANDT for example, and selling options,
you know, most of the time these days, because that's
a crowded one way trade where lots of people sell
short dated options. You'll tend to make kind of a
little bit of money at a time, sort of choppily
for a while, and then once every you know, three

(10:04):
years or five years, you'll kind of get wiped out
and end up down.

Speaker 2 (10:08):
You just start getting into it the day after the
wipeout exactly.

Speaker 4 (10:11):
And actually that's and actually there is something to that.
Usually usually it's like a month or two after the
wipeout because you don't know if there's going to be
another big leg down or something. But there does tend
to be some excess risk premium and options markets a
little while after a big market crash that blows out
a lot of these guys and kind of causes people
to panic, that's totally true. And then that tends to
go away after another you know whatever it is year

(10:32):
or two years or something like that.

Speaker 1 (10:34):
So just in terms of the expansion of all different
types of derivatives. I don't want to focus too much
on shorter dated options because there are some other things
out there that look really interesting. One of them is
I saw a headline float by about the University of
Connecticut's endowment dropping some of its hedge fund exposure in

(10:54):
favor of buffer ETFs. What are buffer ETFs?

Speaker 4 (10:59):
Yep, So this is a a big new manifestation of
a relatively old popular idea. So buffer ETFs are usually
pitched as sort of defined outcomes in some sense over
some time period where they say, well, what you're trying,
what we're trying to do is give you equity exposure,
but you have protection. You have a buffer down to
say ten or fifteen percent, where you're not going to

(11:19):
lose money as the market goes down, and then beyond
that point you're exposed. And in order to do that,
you're going to sell an upside call. You're going to
give up some of your upside And so what this
is it's basically just a put spread caller, which is
a very standard kind of option structure. You sell a
call to buy a put spread. That is for many
many years and decades, by far the most popular thing

(11:41):
that a Wall Street derivative salesperson will run around trying
to pitch to their clients. It's a very easy thing
to conceptualize, I'm giving up some upside, I'm getting some protection.
They can be structured so that there's sort of zero
premium outlay where you sell a call and use that
same amount of money to buy a put. So if
you're an aggressive salesman, you call that like a free
hedge or a zero cost hedge. Of course you're giving

(12:03):
up upside, so you can it can be very cool
to pay.

Speaker 2 (12:05):
For it, but only implicitly by some notional change that
you're not thinking about.

Speaker 4 (12:09):
That's exactly right. And there's three legs to the trade,
so there's lots of bit offer spread and lots of commissions.
So salespeople and traders really like that, and they're very,
very very popular now. Buffer ETFs these days enable a
retail investor or a high net worth individual to go
and get that just by buying an ETF, you know,
with a seventy basis points management fee or whatever it is,
instead of having to, you know, be involved with Wall

(12:30):
Street banks or doing trading themselves. People love that. There
are very famous mutual funds like the JP Morgan one
that everybody talks about, and it's twenty two billion dollars
of assets or something like that. And now there's I
think something like ninety billion dollars of bufferytf's doing the
same kind of thing. And they're all doing something very
very similar, which is again they're selling call it an
eight percent or ten percent out of the money call

(12:50):
or seven percent of the money call. They're buying an
apt the money or slightly downside put and then selling
out another like a ten percent down or fifteen percent
down put to kind of give yourself this bus on
the way down. You're giving up upside on the way up.

Speaker 1 (13:03):
One thing I don't get is like, why would you
prefer doing that versus just buying a bunch of equities
and maybe hedging in a more traditional way like buying
some bonds.

Speaker 4 (13:12):
So this is exactly the right question. So the first
thing that you know, a derivatives person looks at when
you look at a trade like this is Okay, what
does this do to the delta the equity exposure of
your position? Right? So if you buy some equities that
is a one delta, A derivatives guys would say, it's
just a delta one position. Market goes up a percent,
you make a percent. If you trade a typical put

(13:33):
spread caller against that, you buy a put spread, you
sell a call, you're probably going to take that one.

Speaker 2 (13:37):
Sorry. What's a put spread?

Speaker 4 (13:38):
Is a posh to put? A put spread would be
you buy say the out the money put, but then
you sell a ten percent out of the money put. Okay,
So that's going to give you protection only for ten percent. Okay.
So if you do that kind of a trade, you
might take your one delta option down to like a
point six down to a sixty delta, So now you're
only participating kind of sixty percent in the movements of
the market. And if you look at how these kind

(13:59):
of trades perform over long periods of time, they actually
act a whole lot just like having sort of sixty
percent as much stock, right, because ultimately they're rolling these
it's not really like a buy and hold to maturity thing.
It's like they're rolling these options to kind of maintain
this kind of exposure. And if you were just to
take the counterfactual, which is why don't I just own

(14:20):
sixty percent as much stock? And put forty percent of
the rest in T bills. Turns out your fees are
way less and your performance is probably better. Right, So
you're doing this creative, smart sounding options thing, but actually
you're underperformed.

Speaker 2 (14:49):
Are there institutions, you know, trace you mentioned the University
of Connecticut. You know, institutions have sometimes very specific needs
they need to have, like a guarantee return very long term.
They may not be optimizing for maximum returns. They have
to dole out a certain amount for student aid, whatever

(15:10):
it is. Are there certain types of institutions where, whether
we're talking about the buffer ETFs specifically or analogus to
that strategy, that this is, in your view, in alignment
with the institutional mandate.

Speaker 4 (15:24):
So that there are cases when that's to some extent true,
at least with some kinds of derivative structures. So you
will have cases where there's like a big dispersement that
has to be made at some future date and they
want to lock in for sure the fact that they
can make that dispersement. But usually something more like an
outright put is going to be a better match for that, right,
Because the thing about the put spread or the put
spread collor is you've only got like this, say, ten

(15:45):
percent buffer of protection, and what if the market crash, So.

Speaker 2 (15:48):
If the stock falls, or if the market falls twenty
five percent, which does happen, you're actually not protected against
all of that.

Speaker 4 (15:54):
Yeah, exactly right. So this stuff really doesn't like lock
in defined outcomes to the downside. It just gives you
of some buffer of protection in exchange for some upside
that you're losing.

Speaker 1 (16:04):
You touched on this earlier, but talk to us a
little bit more about the commissions and the execution and
whether or not you're getting a good deal on those,
because my sense is these all seem to be algorithmic, right,
very mechanical, So I'm not entirely sure what you're paying for.

Speaker 4 (16:20):
He yeah, no, So this is a really important point.
So generally these are not always, but typically these kind
of structures exist in fairly popular, fairly liquid underlyings. Right.
This isn't like microcapstocks. This is S and P or something.
So the you know, the bid offer spreads don't look
that wide when you look at it. But you have
to keep in mind if you have a twenty two
billion dollar fund that once a quarter is rolling this

(16:40):
giant collar and everybody knows about it and knows exactly
what you're going to do and knows exactly when you're
going to do it, then obviously the market just moves
right ahead of you, right and everybody positions first trade.

Speaker 1 (16:51):
What happened during Vollmageddon as well, very much so.

Speaker 4 (16:54):
When when you have a big tray that everybody knows
what you're going to do and when you're going to
do it, they're going to position ahead of that. In
this specially in a poor liquidity environment, you know that's
going to really hurt you. Like markets can you know,
the markets can move very significantly as market makers and
arbitrazurers and volatility people sort of position for this big
trade that's coming. And so the execution you end up
getting in these trades is really poor. And usually they're

(17:17):
not again they're doing something very simple, very mechanical. They're
not randomizing their trades in small batches to work into
position really efficiently. They're just outsourcing execution to some agency
only broker who doesn't care at all about how they
just have to get a filled and they put it
up way over the offer side of where the market
really should be.

Speaker 2 (17:34):
Are there funds that claim to do something more sophisticating,
because it does sound obvious, like all the rules are
out there, the prospectus, the mechanics, the timing, et cetera.
It does seem very I guess front runnable. Do they
have tactics or approaches to avoid what sounds like the
most obvious risk in the world.

Speaker 4 (17:53):
Yeah, I mean certainly there are you know, volatility arbitrage
type of funds like ours and like others out there.
We will work with institutional clients that are trying to
do some similar kinds of things, but in an intelligent way.
And yeah, the way we execute in the marketplace is
very different, right, So we take the same objective of
the exposure we want to get, but we're going to
work into it sort of passively and secretly and quietly

(18:13):
in very smart ways and try to kind of get
mid market execution and have nobody know what we're doing.

Speaker 1 (18:18):
And so the competitive advantage is really on the execution
side rather than the actual design of the product.

Speaker 4 (18:25):
Yeah, there's probably some of both. I mean, one thing
one thing you want to do is execute really efficiently
without people knowing what you're doing. Another thing you want
to do is just know what the big flows and
big crowded trades in the market are and generally be
trying to achieve the client subjectives, but ideally by buying
something that's getting sold too much as opposed to selling
something that everybody else is selling. Right, So those two components,

(18:46):
that's a kind of a strategy design aspect, and then
there's just an execution implementation aspect that's again really important
and people just aren't incentivized for it. Like when you
think about these the buffer ETFs derivatives using ETFs, it's
really kind of a Wild West type of boomtown scenario
right now, right, And I would say, you know, generally
the first to market has an advantage, and it's all

(19:06):
about distribution and very and you know, implementation details are
very secondary. Right. The people have been really successful are
marketers and distributors hitting the street hard. They're not you know,
vall traders who are designing these things.

Speaker 1 (19:17):
All the influencers. I'm just going to throw out random
derivatives products. So if you could just define them, what
is the wheel and why does it have an E
t F named after it?

Speaker 4 (19:27):
Yes, this is this is fantastic. So it kind of
goes back a little bit to the mean stock options crave.
You know they're ticker. Is it? Is it w h
H E L Wheel?

Speaker 1 (19:38):
Isn't it?

Speaker 4 (19:38):
I think it's four letter. I think it's w h
H E L.

Speaker 1 (19:40):
If you no, I think it's it's w E E L.

Speaker 2 (19:43):
O w E L. That's peerless option wheel, peerless that
they put peerless, Yes, tell us about the wheel.

Speaker 4 (19:51):
Yeah. So the a lot of the original mean stock
option traders who made a bunch of money in g
M and you know AMC back in the day, some
of them sort of migrated from that into getting really
interested in options selling, and in particular kind of a
strategy called the wheel, where the idea is you're going
to sell against short data options. You're gonna start out
selling cash secured puts, so you're gonna sell some puts

(20:14):
on the S and P or on your favorite stocks,
and then you're going to keep doing that unless the
market goes down enough that you get a sign on
that put and you take a loss. Then you long
that stock, and then you're gonna sell some calls against
it and have a covered call strategy until the stock
rallies enough that that call gets assigned, your stock gets
taken away, then you sell a put, and so it's
sort of you know, the end. The way they'll describe

(20:35):
this is it's almost as if it's this continuous money machine,
because all of these outcomes are good. If the stock
doesn't move, you get the premium, that's good. If the
stock goes down, you get the stock cheap, that's good.

Speaker 1 (20:44):
And you're sort of you keep moving with the market, right,
and the one thing you know is the market's gonna move. Probably.

Speaker 2 (20:50):
It seems like there's some assumed mean reversion here. The
cycle of life.

Speaker 4 (20:56):
Yeah, there's very much like a cycle of life. There's
this idea that no matter what scenaari, there's a justification
for how anything that can happen is sort of good.
You know, the stock goes up, you made money. You
didn't make as much money as you would if you
hadn't sold the call, but you still made money. And
then if it goes down, the same thing like you.
And ultimately, what's not described in these pitches is how
this is a it's a short volatility trade. What you're

(21:17):
exposed to is the stock going down a lot and
then back up a lot, and then down a lot
and back up a lot. Right, Because what happens is
stock goes down a lot, you're going to lose money
on your short put. Now you're gonna get assigned the stock.
You're going to sell a call. What if the market
goes back up a lot. Well, now you didn't make
money on the reversion because you're short of call and
you're just getting chopped up by this volatility. Right. So

(21:38):
people love to pitch options trades in ways that don't
have anything to do with volatility, when they're inherently volatility trades, right,
they like to pitch them as you know. One of
my least favorite phrases, right is people will say, these
influencers will say, selling a put is just like having
a limit order out there in the market to buy

(21:58):
a stock really cheap, but you get paid for it,
So it has nothing to do with the price, has
nothing to do with it. If this is like a
good risk reward for the premium that you're getting, it's
as if you can just buy a stock for really
cheap when it goes down and you get paid for it.

Speaker 1 (22:14):
Do we have any historical data on how these have
performed in the past, so most of them are new.
So I imagine we have finite information about performance.

Speaker 4 (22:24):
Yeah, totally. If you look at benchmark indices for things
like call over writing or cash secured put selling, those
have been around for a very long time and they
know back tested, way way back. So there's something called
BxM index on Bloomberg that you can pull up, and
something called put put index on Bloomberg that you can
pull up for call writing and put writing. And what
you see there is it actually tells a really nice story,

(22:46):
which is from about nineteen ninety line going up from
about the lines going up from about and you want
to compare that to just the SMP. So from nineteen
ninety to about twenty twelve they look pretty good. They
kind of keep up on average with the SMP, but
on somewhat lower volatility with a little bit lower draw downs.
And that was really the pitch that investment consultants and

(23:07):
pension fund consultants started making after the credit crisis to
their clients.

Speaker 2 (23:12):
Is this what made off claim to be doing some
sort of like right.

Speaker 4 (23:16):
He was claiming to be doing like conversions and like
diagonal spreads and stuff, so like a little bit funkier stuff.
But yeah, he was out there saying, oh, we're doing
this kind of really cute option stuff. So this stuff again,
it it looked recent decent in this sort of back test,
and but the whole point is of you know, very
much like any back test in finance, option selling looked
good when nobody was doing it in size right, there

(23:37):
were it was not you know, option markets were backwater.
There were funny little things that some hedge a few
hedge funds did and a few kind of people, but
there were no giant pension two hundred million dollar pension
funds doing like option selling. And then those pension fund
consultants started writing white papers and they started pitching to
their clients' boards, and by like twenty eleven, twenty twelve,
twenty thirteen, they started to get some traction, and you
started to have you know, giant two hundred million dollar

(23:59):
pension funds saying sure, we'll put ten percent of our
assets and move it from equity into option selling. And
that grew and grew and grew and grew and grew,
and so what you ended up with then is volatility
term structures steepened, which means that short dated options that
were getting sold really heavily went down in price because
that's what everybody was selling. And what happened was you

(24:20):
see the performance then of in kind of the out
of sample period, if you want to think of it
that way, from a back test for BxM and put index,
which are the benchmarks for this kind of stuff, then
really deteriorated relative to S and P, where they sort
of had very similar risk but much less return. And
that was like, how does this actually look once real
money goes into these strategies, Because at the end of

(24:41):
the day, derivatives' markets are big and deep in liquid,
but they're not primary markets, right, They're derivatives markets. You
can't they're not designed for like global asset allocation for
twenty percent of the of all the money in the
world to go into selling them, right.

Speaker 1 (24:54):
But this is the big debate, right to what extent
is this kind of options trading or derivatives trading action
affecting the underlying which would be the market or you know,
something like the VIX and you hear different sides to
the story. So you have some people arguing that actually
one of the key reasons the VIX has been kind
of subdued recently is because of all this short dated

(25:16):
trading then you have you know, entities like the CBOE
arguing for obvious reasons, perhaps that actually the gamma exposure
from the short dated options isn't that big, certainly not
big enough to move the full huge market. It sounds
like you land on the first one.

Speaker 4 (25:35):
Yeah, the size of short dated options selling is very,
very large. It's very very one way, and there's different
flows in different parts of the option market, right, But
if you look at one month range options that are
not that far out of the money, call it like
twenty five delta put wing to call wing, the overwhelming
end user of that product is selling it for income

(25:57):
or for you know, for a asset allocation type of strategy.
And what that means is, you know, the all of
the flows on the floor for brokers and banks are
giant trades to sell constantly, and the people that are
buying them are people like us who are buying them
because they're too cheap, not because we have any other
reason to buy them. Right, So go ahead, job, No.

Speaker 2 (26:19):
This is sort of where I was going to follow
on to Tracy's question. I mean, if we were having
this conversation in twenty nineteen, what are the fingerprints that
are visible in the market. Obviously, volume is clear, I mean,
but in terms of the fingerprints of when it comes
to price, what are the fingerprints of all of this

(26:39):
retail and now institutional money flowing into this space? And
I presume to some extent the reason you have a
business is because there are these fingerprints.

Speaker 4 (26:49):
What do they look like? Yeah? Absolutely so. Taking this
example of short data options selling, for instance, the first
thing you want to look at is the relative price.
And what is that In the world of options in volatility,
it's the term structure of volatility, which means where is
implied volatility for the S and P for example, which
is one of the biggest parts of this ecosystem for

(27:10):
very short term options one month, two month, three month,
six month, one year. And what does that term structure
look like if you compare it to history, And what
you'll find is really in the evolution that you've had
in that post twenty twelve regime has been the volatility
term structure getting steeper and steeper and steeper, so lower

(27:31):
in the front and steeper and steeper kind of all
the way out to the back. And the reason for that,
again is that the front is being sold very, very
very heavily, and people who are getting put into a
lot of the front, like market makers and like volatility arbitrazures,
then have to go further out the curve to hedge.
You see that very distinctly. Another thing you can look

(27:51):
at is volatility risk premium, which is something you kind
of have to estimate and look at empirically. It's not
just the shape of a volatility term structure. That is
what is implied volatility relative to subsequent realized volatility. So
implied volatility is supposed to be forecasting realized volatility how
much the market actually moves, and the spread between those

(28:12):
two is a risk premium. If you're selling options, you
should get paid a risk premium. It's a risky, long
beta kind of thing to do, so you should get
paid some amount of money for that. In the old days,
before twenty twelve, you used to get paid a decent
amount of money for that, maybe three volatility points on average.
In the more recent years, that compresses and compresses down

(28:33):
to one point or half a point, and then you know,
kind of to Joe's point, that will blow out a
little bit after a major market crash for a little while.

Speaker 1 (28:40):
And then you dive in exactly. Okay.

Speaker 2 (28:44):
One other I think you said you die, that's actually.

Speaker 1 (28:51):
Either dive in.

Speaker 3 (28:53):
Okay.

Speaker 1 (28:54):
One other thing I want to ask about is, of course,
multi strategy hedge funds. So we did a bunch of
episodes on these and options trading derivatives came up quite
a bit, especially in things like the dispersion trade, and
one thing sticks with me. We spoke to a guy
called I think it was Krishna Kumar. Is that right,

(29:16):
Krishna Kumar, and he made the point that at multistrat funds,
you're not trying to maximize long term returns. You're trying
to maximize returns per unit of time, in which case
options sound pretty good for doing that.

Speaker 4 (29:32):
Yeah, that's absolutely right. So, you know, multistrats are a
very interesting business. But I think part of what you're
getting at is one thing that they do very well
from a business standpoint is they have a very short
leash on portfolio managers and on pods. They're notorious for
firing you very quickly if you start to lose any
material amount of money, and that's a risk management thing
for them, right, And so there's this idea that gosh,

(29:52):
I'm probably only going to be here for like a
year or two or three, So I sure better just
make a whole bunch of money as fast as I can,
and if it goes really poorly, then it goes poorly, right.
But and so you're incentivized to do negatively skewed things. Now,
the multistrats have very good risk management. They know this.
They're you know, they're not silly, So they're not going
to just let you go sell a whole bunch of options,
you know, naked and a bunch of puts and see

(30:14):
how that goes. But you can definitely try to do
more creative things that look a little bit more like
relative value and maybe sneak through the risk systems a
little bit better, at least in some size. You know,
Dispersion can be one of those things. Depending on again
who's looking at it and how sophisticated they are. You
can have a dispersion trade where you're buying some single
name options, you're selling a lot more index options. You're saying, look,

(30:36):
this is really correlation, it's not volatility. But depending on
the hedge ratio that you're using, it might just actually
be a very short ball behaving thing where you tend
to make money for a year or two or three,
but then it goes really poorly eventually, and you see
a lot of that. There's dispersions very popular in the multistrats.
You know, a year or two ago, there were many, many,
many pods at some of the big multistrats that we

(30:59):
all know about. Dispersion that's shrunk very dramatically because P
and L has been relatively poor. It's very cyclical. Multi
strats are a fascinating thing in that regard that the
end result to the you know, to the buyer of
the multi strat tends to be pretty good because they
cut off the tails by doing this rapid sort of yeah,
stop out of PM, but it comes with a lot
of weird incentives.

Speaker 2 (31:17):
An episode that I'd love to do that will probably
that will probably never do, is talk to a multi
strat PM essentially about how they gained the risk parameters
that are imposed on them by their manager. Maybe we
could talk to a risk manager and a retired pe yeah,
and how they sort of try to find pennies in
front of steamroller strategies that will work for a year

(31:40):
or two before they get fired, before they're just sort
of identified as having done that all right, here's another question.
I don't get certain assets like bitcoin or micro strategy,
which is you know, an exotic wrapper of bitcoin in
some way are extremely volatile that and that's part of

(32:00):
the fun, I guess, like that, why is there the
appetite for even layering on more volatility? So there exists,
like you know, there's like a three x micro strategy ETF.
Who is the like customer for like, you know what
micro strategy? Just not volatile enough for me? Not enough
daily not enough daily swings here or like what's good?

Speaker 1 (32:22):
Like it reminds me of remember the like multi blade
razor commercial and why we have three blades? We have
four blades?

Speaker 2 (32:29):
Why why not have a ten xm micro strategy ETF?
Why stop at three?

Speaker 4 (32:33):
Absolutely no, that it's it's really fascinating. My best sense,
you know, from watching Twitter and people asking me questions
is you know, there's this there's a community of people
and kind of a voice for Hey, look I've only
got twenty thousand dollars. Yeah, and I don't want to
work my job at Starbucks anymore. Yeah, how am I
going to really make it? And this idea that you
can really make it and you can kind of get
rich from only having twenty thousand dollars, and how are

(32:55):
you going to do that? You need as much leverage
as you can possibly imagine. Right, So cryptos and attractives
because of this, because some of the things in crypto
that you can do get one hundred times leverage or something. Right,
So if that's your benchmark, actually three x mstrs is
relatively boomer. Exactly, it's pretty boomer. But yeah, these ETFs exist,
and they're really fascinating because normally the way that a

(33:16):
leverage GTF works is that the ETF fishuer will do
a swap with a bank and get some get two
x leverage or get three x leverage, and it's a
fairly simple and clean thing. But no bank is going
to give you three x leverage on micro strategy, right
because the wipeout risk possibility is very is very real.
The collateral is not going to cover a massive move

(33:37):
down in micro strategy. And so what you would think
of is vanilla things is just a leverage GTF. It's
not a crazy derivatives thing. Actually it is, because they
have to buy call options in order to have a
risk profile that's acceptable, but generates the leverage that they need.
And so what that means is these things are really
big and they actually dominate the options market on you know,
some of these underlyings and you know, micro strategy can

(33:59):
go up a bunch and this huge etr this triple
levered ETF has this giant call options position that's now
deep in the money and illiquid, and it has to
go out and like roll and buy a ton more
of this of you know, call options on micro strategy
when there's very little appetite from the dealer community to
provide liquidity on that. Yeah, and it's a you know,
a big.

Speaker 2 (34:16):
Mess other options on the three X micro strategy ETF.

Speaker 4 (34:21):
I would actually have to check some of the leverage
some of the LeVert ETFs actually do. And yeah, we
it's kind of a running joke, right is you've got
like the you've got like the triple levered you know
et F on the thing. You've got the covered call
selling ETF on that thing. You got people running the
wheel strategy on that just in sort of an infinite
recursion of you know, option selling abyss.

Speaker 1 (34:42):
Amazing just going by to options influencers. So one thing

(35:03):
that you see a law is not necessarily like here
is an options trade that will make you a bunch
of money. But here's how you really make money in
options by selling? Yes, how do you make money in
options by selling? Like I get the sense that it's
not just it's not just you buy a put, it's
something else.

Speaker 4 (35:20):
You're exactly right. So normally, the way a derivative trader
would think about it trade is what is this trade?
What is the price, what's the upside, what's the downside?
Why should I do this trade? That's not really the
approach with options influencing. It's this idea of this cheap
code in markets, right where people just don't know this
one cool trick and I'm going to show you for
only ninety nine dollars a month, right, And the typical
pitch again is you're just going to be doing some combination.

(35:43):
Maybe you're selling puts, maybe you're selling calls, maybe against stock,
maybe not. And the idea is they're pitched in terms
of the premiums that you're selling are like income, and
we just talk about how much money you're making solely
in terms of how much premium you're generating from option sales.
And that's why it's like, oh, I can make two
hundred thousand dollars a year on a two hundred and
fifty thousand dollar account. But obviously that's not your profit

(36:06):
from the trades. You're just doing trades and you're selling
that pinion. But you might lose money. You might lose
money on those trades. Yeah, right, you're that's not income.
And you know, I get a little bit triggered by
the use of the word income with respect to this stuff,
because like, income to me is like you own some
treasury bills, right and you're making four percent and you
don't just suddenly lose thirty percent on your income thing, right,
Like it's you know, these are trades, but this community

(36:27):
is not expressing what is this trade, Why is it good?
When is it good, what's the price? What's going on.
It's just saying, look, you can just sell these options
and this is income, right, which is totally crazy.

Speaker 2 (36:38):
So people come to you from time to time. Your
a voice of reason. When we had you back on
a few years ago, you know, people reach out like, oh,
I really want to learn more. I imagine that getting
into options is a little bit like converting to Judaism,
where the rabbi is supposed to send you away three
times and say no, just buy a S and P
five hundred index CTF. Don't do it. But and then finally,

(37:00):
if they keep knocking at their door, then like, okay,
maybe we'll teach you something. Where should you start? If
you're like actually serious and like you know, I do
know most of the time you're like, just buy an
ETF and.

Speaker 4 (37:11):
Live your life. That's what a perfect analogy. Thank you?

Speaker 2 (37:14):
Well, where would you say? We're going to get DMS?

Speaker 4 (37:17):
After this?

Speaker 2 (37:18):
I want to learn more about how to do it right?
Is there a way to start to learn to do
it right?

Speaker 3 (37:23):
Yeah?

Speaker 4 (37:23):
Absolutely. Usually the first thing that I do is I
send people kind of collect a thread that has a
collection a lot of people contributed to on good reading
material and stuff on how to educate yourself about options
and how to use them and what they are and
how to think about the risk and all this stuff.
So that's a really good kind of first thing to
do to just have some kind of clue what you're doing.
And then you know, the next thing that I tell
people is what do I think are kind of reasonably

(37:45):
safe uses of options that if you really want to
dedicate time to figuring this out, you might kind of
start with right, And so I'll say, look, if you
have some kind of fundamentally driven or tactically driven process
with for coming up with a view on STEF, and
you have a timing view, then sure could you use
a call spread or a put spread to express that view?

(38:06):
You say, oh, I really like earnings on this on Tesla,
like next week, could you buy a two week call
spread around the range where you think the stock could
trade to And you can obviously make money or lose money,
but you know exactly how much money are risking. Yeah,
it's kind of a safe thing. You're not going to
just blow up one day on that. I think that's
kind of okay. If you really need a little bit
of kind of cash efficiency or leverage, again not too crazy.

(38:28):
You know, you can do things like buy a combo
in the option market, or buy a call and sell
a put that give you a very similar profile to
buying a stock but are a little more cash efficient.
If you just really feel like you need fifty percent leverage,
you know, or something like that. And if you want
to be really thoughtful about options selling, you know, to
try to generate yield over time, there's ways to do that. Too,
But you really have to read up to understand how

(38:51):
to think about the risk award of a trade that
you're doing, not just believe there's something you can do
all the time because somebody told you it's a great idea.

Speaker 1 (39:00):
Your favorite options blow up or derivatives blow up. And
I'll say I'm partial to Vallmageddon in twenty eighteen because
I wrote a lot about it, and I'm still traumatized
by the reaction of vol twit when I said it
was going to blow up when the vix was going up.
But what's your favorite?

Speaker 4 (39:18):
Well, Vallmageddon is a great one. You know, you've talked
about that. Everybody everybody else has two, So I'll give
you something else. I mean, I think possibly my favorite
was was alions Structured Alpha, which blew up in twenty
twenty in March, and the reason was, you know, the
Allions is a huge sort of safe conservative firm that
everybody would look and say, oh, they would never be
doing something kind of crazy, right, because it's you know,

(39:39):
they're very buttoned up, they're very serious people. They own
Pimco and so they but they had these French kind
of option traders and Joe laughs. It's always there. It's
always the French. There's just something in the DNA. And
you know, they were doing something where they would effectively
they would usually sell downside put spreads. They'd sell a
put and then they'd buy back a lower strike. That

(40:00):
was the main They'd do a few other things like that.
Didn't think of that as like the core thing they
were doing, right, and that's kind of safeish, right, you're
getting some a credit if you're earning some premium, but
like you're supposed to know how much you can lose. Yeah,
and then but their returns were pretty good. They actually
kind of kept up with equity markets, which didn't really
make a whole lot of sense. And it turned out
the way that they were doing that was that they
were just not buying back the downside put or buying

(40:22):
or they were buying it back but like way way
way lower strike than they said that they were buying
it back, right, so that's obviously one way to make
more money. Kind of that sounds really bad. Yeah, that
was really bad, and they they were doing that for
years and years and they actually it's really great. There's
a whole SEC complaint about this. You can read all
the details. They had to show this to investors what
they were doing, right, because that's part of the business.
And so they had spreadsheets with all these kind of

(40:44):
hard coded cells and made up numbers to sort of
be able to lie to investors and say that they
were doing what they said they were doing when they weren't.
And because that's complicated to manage to have all these
big spreadsheets faking your returns and faking your risk and everything.
Then they had a word document with an eight team
points on like how to do all of the lying
and number printing for all their analysts to be able
to follow, and you know it instructions on how to

(41:06):
not hover the how do you structured alpha Greg Toront
and it's like, you know, don't hover your mouse over
a formula. It's supposed to be a formula, but it
is hard coded because the investor might see the stuff
like that, right, And you know, with very detailed emails
on all this kind of how to lie kind of
kind of stuff, the fun and then what happened was,

(41:26):
you know, obviously in March of twenty twenty, the market
went down a lot, so their fund was down much
more than it should have been because they weren't actually
buying back the insurance that they were supposed to be,
and so what do you do obviously in that circumstance, Well,
maybe you could hedge, or maybe you could kind of
come clean. What they actually did was they went to
the vix options market and they say, gosh, why don't
we just sell a massive amount of vix calls because

(41:48):
then when everything comes back, we'll just make that money
back and we won't have to tell anybody we lost money.

Speaker 2 (41:52):
This SEC complaint is amazing. Defendants reduced losses under a
market crash scenario in one risk report send to investor
from negative forty two point one five zero five seven
four eight nine seven five five seven four seven percent
to negative four point one zero. They just removed a number.

Speaker 4 (42:09):
That's rights. They just took off a decimal took off,
that's right. It was all just hard coded. They didn't like,
they didn't have some sophisticated methodology for this. They literally
just type the numbers into the spreadsheets.

Speaker 2 (42:18):
Sometimes and it gets this gets to the I mean,
to be honest, you don't really even need to be
French to do that's right, Like any I could have
come up with I could have come up with this one.
I don't need to go to strategy, I don't need
to go to air call polytechnique to come up with They.

Speaker 4 (42:36):
Just go to sell C six. So you just overwrite
the number.

Speaker 2 (42:38):
Some people do screw up math, like some even sophisticated
traders like sometimes math is tough.

Speaker 4 (42:44):
At this level. Yeah, but no, this was not sophisticated.
This was just you type over the cell. And so
what happened was they sold lots of vix calls with
the front month of exed futures at about twenty five,
and then the front month of fixed features went to
eighty five, and so they were they were liquidated middle
of March in the huge catastrophic explosion that people like

(43:04):
us were shown the auction and everything, and they drove
the relative price of the Vick's options and futures to
twice as high as it had ever been relative to
S and P. In this sort of spectacular implosion, you know,
they went to zero. They lost billions and billions of
dollars for you know, teachers, pensions and all this kind
of stuff in just total and utter fraud again at

(43:25):
a very big buttoned up place, and actually one of
the one of the funny takeaways from it was in
all of the lawsuits, you know, leons stepped up and
settled lots of lawsuits and paid investors back, you know,
all this money and cost them many billions of dollars.
And so actually, in a twisted sort of way, the
logic of investing with the big safe place actually worked.
But it wasn't because they managed the risk or had
any idea what these guys were doing, and it was

(43:47):
just that you could sue them and they would pay you.

Speaker 1 (43:50):
Since you mentioned PIMCO, one of the interesting things about
PIMCO is, as you said, there is this perception that
they're sort of like an old school just buying bond
type fund burgers and bonds. That's right, But actually if
you look at their portfolio and talk to people who
are actually doing these trades, there are a lot of
derivatives involved. There is like Euro dollar futures and swaps

(44:14):
things like that. Do you see the explosion of derivatives
trading reflected in fixed income as well? Like the type
that we see in equities that we've been talking about,
is that happening in fixed income too?

Speaker 4 (44:27):
Very much? So? So I actually had a little poll
I put out on Twitter the other day, which was
you know, who do you think is the best derivatives
trader of all time? And my choices were Bill Gross
of PIMCO, Warren Buffett, Who else was it? Oh Yaes
of Susquehanna and Jim Simon's of Renaissance. And everybody was
really confused because they're like, none of these people are

(44:47):
derivati Well, jeff yass is a derivative trade, but all
these other guys are what are you talking about, Warren Buffett?
But yeah, Bill Gross has traded more derivatives notional than
the GDP of the world. They're you know, massive traders
of things like futures. As you point out in fixed
income also, Bill Gross and PIMCO was by far the
biggest option seller in the fixed income complex for many,
many years, or tens of billions of dollars of piano.

(45:10):
People don't really think about this, right, They think, oh,
it's kind of boring bond stuff. But no, there's massive
involvement of you know, big sophisticated institutions in you know,
all of these spaces. So like retail investors aren't involved
in fixed income volatility because they don't really have an
instrument to do that. I mean, they could trade like
treasury futures options, but that's kind of like a weird
funk thing. They don't You don't really have listed options
that people can sell as easily. But you know, big

(45:31):
institutions have been involved in this stuff for a very
long time.

Speaker 1 (45:35):
I guess it's probably coming. If it makes people money,
I'm sure there's going to be you could sickorize it. Yeah.

Speaker 4 (45:40):
Absolutely. They made a vix for fixed income called move
mov Oh.

Speaker 1 (45:43):
Yeah, yeah, yeah, Well, Ben, that was so much fun
and we so enjoyed having you back, and you're going
to have to come back on the show relatively soon,
as soon as we have a blow up.

Speaker 3 (45:54):
Come back.

Speaker 4 (45:54):
Yeah.

Speaker 2 (45:55):
We'll definitely be calling Ben the next time there's a
blow up.

Speaker 4 (45:58):
That's actually a recurring theme in our right. I do
a talk with you guys about something, and then it
blows up, and then you bring me back to talk
about how it blew up.

Speaker 1 (46:05):
Consider this a warning.

Speaker 2 (46:06):
Can I just this one more quick question?

Speaker 4 (46:08):
Of course?

Speaker 2 (46:09):
Why like you lay out these with the buffery tfs
and all this stuff, and like how really like they
don't get you what they think? Do you have a
theory for I get it for retail, the person at
Starbucks who wants to find a way to get leverage
on that much cash, Now, why is it so big elsewhere?

Speaker 4 (46:26):
So a big part of it is that the kinds
of institutions involved in these type of trades are just
are very slow moving and very backward looking, and they're
not that sensitive to performance outside of like catastrophic events. Yeah. Right,
So if you think of like a typical pension fund,
it took the consultants like three years to get this
call overwriting stuff through the board in the first place,

(46:49):
and then they put on the trade that they put
it on with a couple of managers that they like,
and they go out to dinner with them once a year.
It's in the it's a footnote in a long report
on performance. And as long as it's just kind of
my underperforming expectations, like, nobody cares if it blows up.
That's a different thing. But this kind of thing doesn't
really blow up, not the kind of strategies that the
institutions are doing. Yeah, that retail is different, but you know,

(47:10):
call overwriting, you know, call unlovered, call over writing doesn't
blow up. It just underperforms in their performance. It's gonna
take them ten years to ever decide to stop.

Speaker 1 (47:17):
All right, Ben Iffer until the next blow up.

Speaker 4 (47:20):
I guess wonderful guys, really fun.

Speaker 1 (47:35):
Joe. That was fun.

Speaker 2 (47:36):
I love talking to Ben because he's a funny, fun
guy and also just explains things really well.

Speaker 1 (47:42):
I'm wondering, should we get the she Wolf of Indian
options on together with Ben to fight it out.

Speaker 2 (47:48):
Yeah, let's just do just a rigorous one on one
debate about whether you can really earn one hundred ten minutes.
It's really funny that they actually like as a regulator,
They're like, you have to stop this, that you have
to get out of the market.

Speaker 1 (48:01):
Yeah. But I also think it's an important episode because
if I was going to pinpoint one thing that has
really changed in the market recently, it would be I
guess a pervasive sense of short termism on the part
of investors, and options fit perfectly into that, right, Like
why wait ten years to make a decent reliable return

(48:24):
when you can buy zero DT options and make a
bunch of money in a day.

Speaker 4 (48:29):
You know.

Speaker 2 (48:29):
The line between investing and speculating or investing in gambling
has always been a blurry one. Right, that's just a fact.
But then you see things like, you know, prediction market
platforms where you can invest, you know, make bets on
where the FED is going to go right alongside, like
bets on you know, who's going to win the coin

(48:51):
flip of the Super Bowl and stuff. Or you see
like Robin Hood selling futures on who's going to win
Super Bowl football game or whatever. The line is gone,
like it's still a spectrum, I guess, but the idea
that there's any sort of bright line or line at
all between the two things like there's no line anymore.

Speaker 1 (49:09):
Yeah, well, shall we leave it there.

Speaker 2 (49:10):
Let's leave it there.

Speaker 1 (49:11):
This has been another episode of the Authots podcast. I'm
Tracy Alloway. You can follow me at Tracy Alloway.

Speaker 2 (49:18):
And I'm Jill Wisenthal. You can follow me at the Stalwart.
Follow our guest Ben Eiffert. He's back on Twitter after
a hiatus. He's at Ben Piffert. Follow our producers Carmen
Rodriguez at Carmen Arman, dash O Bennett at Dashbock and
Kelbrooks at Kelbrooks. For more odd Lots content, go to
Bloomberg dot com slash odd Lots where we have a
newsletter and a blog, and you can check out all

(49:40):
of these topics twenty four to seven in our discord
discord dot gg slash.

Speaker 1 (49:45):
Od Lots and if you enjoy odd Lots, if you
like it when we reminisce about volatility blow ups, then
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And remember, if you are a Bloomberg subscriber, you can
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