Lots More With Charlie McElligott on the Sharp, Strange Selloff

Last week, the US market sold off sharply. The S&P 500 fell as much as 3.6% on Monday alone, entering technical correction territory. Momentum trades were hit particularly hard and stocks that had been winners for years suddenly became losers, while ones that had been losers suddenly outperformed. Perhaps the strangest thing though, is that volatility didn't really surge as things sold off. The VIX — sometimes called Wall Street's "Fear Gauge" — went up, but it didn't even reach levels that we saw in 2024 or 2022. So what happened? And why was the selloff so short and kind of strange with the lack of vol? On this episode, we speak with Charlie McElligott, Nomura strategist, about what exactly has been happening. Read only: Hedge-Fund Momentum Bets Crater All at Once in Volatile MarketsThe S&P 500’s Meltdown Into a Correction Only Took 16 DaysOnly Bloomberg.com subscribers can get the Odd Lots newsletter in their inbox — now delivered every weekday — plus unlimited access to the site and app. Subscribe at bloomberg.com/subscriptions/oddlotsSee omnystudio.com/listener for privacy information.

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• 0:54Speaker 02

  Bloomberg Audio Studios. Podcasts, radio, news.

• 1:00Speaker 03

  It's good. It's good. You know, markets are fun and, you know, as we said, spring is here.

• 1:06Tracy Alloway?

  Yeah, markets finally got interesting.

• 1:08Speaker 03

  Oh, man. I mean, I have so many thoughts.

• 1:10Joe Weisenthal?

  Oh, good. All right.

• 1:11Speaker 03

  If you can't tell from my normal stream of consciousness operation.

• 1:15Tracy Alloway?

  You know how I know it was bad, Joe?

• 1:18Joe Weisenthal?

  Go on.

• 1:19Tracy Alloway?

  It was one of those weeks where we talked about negative gamma quite a lot.

• 1:24Joe Weisenthal?

  What's gamma again?

• 1:26Tracy Alloway?

  Interestingly, we didn't talk that much about standard deviations, which is kind of funny. Normally, those two kind of go hand in hand, but not last week. It was weird.

• 1:34Joe Weisenthal?

  What's gamma again? I feel so dumb because I know we've talked about gamma and it's just one of those things like, what is it again?

• 1:40Tracy Alloway?

  Should we get you a refresher?

• 1:42Joe Weisenthal?

  Yeah, I need one of those Guide to the Greeks books or something, like a little like laminated card that I can like.

• 1:48Tracy Alloway?

  Someone should do a coffee table book.

• 1:50Joe Weisenthal?

  Yeah.

• 1:50Tracy Alloway?

  Yeah.

• 1:51Joe Weisenthal?

  Guide to the Greeks. I like Greek stuff these days, you know, because I'm into like ancient history and everything like that. I know what alpha is. I know what beta is. After that, I started to get a little dicey.

• 2:03Joe Weisenthal?

  I did a dead list.

• 2:03Tracy Alloway?

  I am both the most popular trader and most successful trader at Citadel.

• 2:08Joe Weisenthal?

  Fed is going viral.

• 2:09Tracy Alloway?

  Uh, barges.

• 2:10Joe Weisenthal?

  This is an after school special, except.

• 2:12Tracy Alloway?

  I've decided I'm going to base my entire personality going forward on campaigning for a strategic pork reserve in the US.

• 2:18Joe Weisenthal?

  Black gold.

• 2:19Tracy Alloway?

  These are the important questions. Is it robots taking over the world?

• 2:22Joe Weisenthal?

  No, I think that like in a couple of years, the AI will do a really good job of making the Odd Lots podcast. One day that person will have the mandate of heaven.

• 2:32Tracy Alloway?

  How do I get more popular and successful?

• 2:34Joe Weisenthal?

  We do have. The perfect guest.

• 2:37Tracy Alloway?

  You're listening to Lots More, where we catch up with friends about what's going on right now.

• 2:42Joe Weisenthal?

  Because even when Odd Lots is over, there's always lots more.

• 2:46Tracy Alloway?

  And we really do have the perfect guest.

• 2:51Tracy Alloway?

  Oh, the definition, I feel like I've done this before, but gamma, gamma is the option sensitivity to the change in delta and delta is the option sensitivity to the underlying price. So gamma is like the change of the change. It's a function of the underlying price, but it's second order. And I guess negative gamma, that's when delta is in the opposite direction to the stock price movement. So delta goes down if the underlying asset price is going up and then it becomes less negative if the underlying asset price is

• 3:31Tracy Alloway?

  falling. And we usually see people talk about this during market sell offs because all the options traders have to basically sell or buy stuff to hedge all that changing exposure. And the suspicion is always that that hedging activity are pushing the market in one way or the other. I think that's it. Okay, I did it. Charlie, you should write a book, a coffee table book on the Greek letters.

• 3:58Speaker 03

  I'm liking this like Spartans versus Romans history vibe we're going.

• 4:03Joe Weisenthal?

  Yeah, that's very you. I feel that's very.

• 4:05Speaker 03

  Yeah, yeah. It resonates. It resonates. Could have something to do with the beard. Well, if you just think about it with regards to who is long and who is short in option at a certain level. And that's so much of what we're asked to do, you know, and our job is to get a sense for where these potential acceleration points or potential gravity points are. And you're looking at the whole spectrum of strikes across the S and P index options. And you're then doing your kind of risk calculations and your Greeks calculations and you net out all of those strikes. You have to identify calls sold, calls bought, puts sold, puts bought, multi-legged trades. It's quite complex. I think in the past, there is a lot of false narrative because people made kind of two core assumptions

• 4:49Speaker 03

  on dealer positioning before you had the actual exchange tagged data, which now gives you the actuals. Those two prior assumptions are that dealers are short puts to hedgers and long calls from over riders. These VRP vol sellers that you hear so much about these days that create dynamics where the market is trapped in long gamma. Right. Because we're constantly, dealers are constantly getting stuffed from these premium collectors.

• 5:15Joe Weisenthal?

  Yeah.

• 5:15Speaker 03

  But short gamma matters because that's where you get these potential jump off points where you, you know, blow through level or a dealer is short a strike and then you get that prevailing market move is fed into. So that matters.

• 5:28Tracy Alloway?

  In case you can't tell, we are here with Charlie McElligott. He is, of course, a strategist over at Nomura, the person to talk to when it comes to this kind of market technicality. And we are recording this on March 19th. We're either stupid or brave for doing this like right before a Fed decision. I'm going to choose brave because the bar is fairly low nowadays.

• 5:52Joe Weisenthal?

  Well, and like, so my view is like, there's been so much volatility lately, Tracy, regardless of what happens in the 48 hours. But today, now and then, there's enough to talk about.

• 6:01Tracy Alloway?

  Yeah, for sure. Okay, so speaking of what happened last week, you mentioned specific points at which the sell-off can accelerate. And I think in your notes, you had like 5,650 and 5,560, something like that, as your points on the S and P 500, at which point the sell-off could accelerate. We did get to a low of like 5,500 on the Thursday, but we saw stocks recover. Why did that happen?

• 6:33Speaker 03

  So there was two large short gamma strikes in the S and P index options diaspora for dealers. And I think it was, I think it was 5,600 and then 5,565 a particular level, which is part of this large listed trade in the market that is well socialized out there that at the end of this month, so not this week's options expiration, but the end of this month, the March quarterly exists and is part of something called a put spread collar, where a call is sold out of the money to then help finance this put spread in the market. And that 5,565 is a short strike, which means that in this case, it looks like short gamma. I think the

• 7:18Speaker 03

  fact is about that, however, and thus this idea of like, well, at this point in the month, where it's still a few weeks out from happening, it could in fact, potentially behave as you would think is this acceleration point through it. And once you did, you kind of bounced around, it held three or four times, and it kind of cracked through it. The thing is, is that the market knows that this trade gets rolled, rebalanced, I should say, into the next quarter's trade at the end of this month. And you know that there is going to be a ton of Vega for sale as part of this. And so then this strike in some ways actually ends up looking quite dissimilar from your typical idea of short gamma as this acceleration point, depending

• 8:03Speaker 03

  on where the market is at the time of expiration, which will affect what the client does with those strikes and sets the new put spread collar. But I think the larger conversation that I want to have about Vol is that much of the incoming

• 8:16Tracy Alloway?

  Yeah.

• 8:17Speaker 03

  has been about, why is Vol actually seemingly unresponsive?

• 8:20Tracy Alloway?

  Yeah, so the VIX, like, I know the VIX went up, but I think it went to like 29 and you compare that to like, it was above 80 in 2020 and even in 2022, it was like 36 or in the 30s. Vol was really quiet.

• 8:35Joe Weisenthal?

  Even in 24.

• 8:36Tracy Alloway?

  Yeah.

• 8:37Joe Weisenthal?

  So, August 2024 got nearly to 40. Anyway.

• 8:40Tracy Alloway?

  Yeah.

• 8:40Speaker 03

  So, the last time I was in here was after that August shock and that was a proper, as I, as I kind of framed it at the time and still will, the world was aggregated around this soft landing viewpoint and all of a sudden, in the span of one day's worth of data, but it was really even a week of data.

• 8:58Joe Weisenthal?

  Well, the VIX got to 65.

• 8:59Speaker 03

  Yeah, and, and that was because we repriced the left tail. All of a sudden, there was a hard landing risk because the labor data shocked us, you know, that U rate jump and then the NFP miss. The difference this time around is that since the election, right, Donald Trump is the personification of a gamma agent.

• 9:18Tracy Alloway?

  You are the only person I know who describes Trump as a gamma agent.

• 9:22Joe Weisenthal?

  Everyone has their terms.

• 9:23Speaker 03

  Right, but I mean.

• 9:24Joe Weisenthal?

  A living personification of gamma.

• 9:26Speaker 03

  And I think, look, hi- his mandate is to break status quo.

• 9:31Joe Weisenthal?

  Right.

• 9:31Speaker 03

  And we talked that last August shock about the idea that the concept of a carry trade, because we were being asked about, oh, the young carry unwind, which is kind of like this false narrative. But the idea of any sort of carry trade or positioning, high sharp ratio trade, right, high risk adjusted return, is that you need a period of low volatility to kind of aggregate that position, to build that leverage into the trade because it keeps working. The vol is low, the price keeps working higher, that builds the leverage in the system, that hence builds the risk, right? Stability breeds instability. In this case, Donald Trump, even if the market was misidentifying the macro of his policies at the time, which we should talk about.

• 10:12Joe Weisenthal?

  Oh, you're just never going to get that risk buildup.

• 10:15Speaker 03

  Well, in this case, starting November.

• 10:17Joe Weisenthal?

  Yeah.

• 10:18Speaker 03

  You know, when it really took shape and I think the market had been sensing, certainly since kind of the summer. SKU is steepening. SKU matters, right? Just as a relative measure of kind of demand for downside versus demand for upside. Put SKU, which is like deep out of the money downside relative to at the money put, was jacked 90 something percentile because of all of the potential chaos agent.

• 10:41Tracy Alloway?

  So fall is getting more expensive.

• 10:42Speaker 03

  So fall was already quite expensive going into this scenario, even if maybe the macro catalyst went the wrong way. And I think there's two big things that happened. So let's talk about this past week, or really it was past three weeks.

• 10:55Joe Weisenthal?

  Yeah.

• 10:55Speaker 03

  You had crowded narratives and crowded thematic positioning with a lot of leverage. Right? That is what the prime brokerage data shows and frankly still shows like gross exposure for your longs and your shorts in aggregate, still kind of 90 something percentile, was 100 percentile. Coming into the year, though, we also had high nets. So you had a lot more long than short. Either way, a lot of leverage in the system.

• 11:35Speaker 00

  What's next for virtual assets? I'm Jacob Greece, host of Economy Scale, a series exploring growth in key global sectors. And in this episode, we're diving into the digital forces shaping finance. Sean McHugh from Dubai-based Virtual Assets Regulatory Authority has this to say.

• 11:51Speaker 06

  We're seeing a lot of institutional players come in. Digital asset, dedicated hedge funds, high frequency traders and that sort of thing. And folks who service institutional clients.

• 12:00Speaker 00

  As more capital enters the market, adaptive regulation is likely to become increasingly key. Reese Merrick of Ripple says.

• 12:08Speaker 07

  A lot of regulators globally would like to keep the industry at arm's length. That's the opposite here. I think also what you'll find is that regulation and frameworks can come out, but some of them are maybe a slight iteration on some 80 year old policy and not actually in line with what the technology can do and offer. And again, that's very different in Dubai.

• 12:27Speaker 00

  Listen to the full episode wherever you get your podcasts. This series is brought to you by Bloomberg Media Studios and the Dubai Department of Economy and Tourism.

• 12:37Speaker 08

  This is the Bloomberg Tech Minute brought to you by ChatGPT. I'm Carol Muster. Millions of Americans are taking peptides, short strings of amino acids that can act as biological signals for cells. Peptides like insulin can occur naturally in the body, or they can be synthetically introduced to induce a biological process, as happens with semaglutide, the active ingredient in Ozempic. Now Bloomberg's Anika Inamputi reports peptides may be exploring their next frontier, the brain. People are taking peptides for mental clarity and cognitive benefits as alternatives to psychiatric medications and to gain a competitive edge or stave off the effects of aging. Both insulin and semaglutide are approved by the U.S. Food and Drug Administration.

• 13:21Speaker 08

  Because importing or selling unapproved peptides for human use is not legal in the U.S., many people turn to online forums for guidance and overseas vendors with questionable credentials to obtain them. Unapproved peptides, which are marketed as research chemicals, have been circulating in what's become a billion-dollar gray market amid the rise of do-it-yourself medicine as people increasingly turn to social media or artificial intelligence for medical help. Doctors warn against self-experimentation and advise talking to providers before trying any new therapies. That's the Bloomberg Tech Minute brought to you by ChatGPT. Get started at ChatGPT.com.

• 14:00Joe Weisenthal?

  Give us like a little zoom out, basically from mid-November to, as you said, about three weeks ago it started turning. I think the peak on this was February 19th or something like that.

• 14:11Speaker 03

  Yes.

• 14:12Joe Weisenthal?

  But talk to us just about that sort of kind of an up crash in the wake of the election, people loading into everything risky from crypto to Tesla and everything. False narrative. Yeah, what was going on there? And then how extreme did that get?

• 14:26Speaker 03

  Yeah, I mean, that's the perfect segue here because like in the sense that the post-election narrative and remember the rate sell-off beginning in September when the market really got their arms around seemingly some of this polling that was showing much more credible kind of Trump lead.

• 14:43Joe Weisenthal?

  Yeah.

• 14:43Speaker 03

  The rate sell-off, meaning yields going higher, was about this idea that Regardless of who won, but particularly if Trump won, that we had become, both sides become economic populace and that fiscal dominance was this overriding theme where like, we don't have a tolerance for pain as a society. We, we saw the kind of the steroidal impact of fiscal stimulus in the post COVID world, which kind of was the tiebreaker for finally getting an inflation shock as we all experienced. So this idea that he was going to take an already strong economy and overheat it with dereg, with tax cuts and these other stimulative measures completely had the market thinking about further extension of

• 15:25Speaker 03

  US exceptionalism, right? This ability to outperform rest of the world for a whole number of reasons, which is a separate podcast, but like positioning was like long US assets. Europe was going to be cutting sooner because they were feeling the brunt of the slowdown force more so there. China had all sorts of issues, right? Rest of world struggling, US exceptionalism and part of US exceptionalism, not just kind of like global hegemon, strongest economy, deregulation, all these stimulative measures in the pipes was also too, this idea of tech innovation. And tech innovation was the story of last year and the last two years. The last 15 years. Was with regards to AI, right? Yeah, it used to be Fang back in the teens, right? So this idea of mega cap tech, all those things that made people, you know, the completely dictated

• 16:10Speaker 03

  stock market last year, like Mag 7, Mag 8, 35% of the S and P 500, 50 some percent of the NASDAQ, concentration of all of these kind of tech and disruption themes in the market, that was a big part of the US exceptionalism trade. Well, guess what? Those trades are really crowded. They're really loaded into and two shocks happened. The first shock was the market, and this is where I started, you know, going out and talking about hedging for downside in February, was this idea that the market, I think was misunderstanding the phasing or the sequencing of a Trump economic plan, which was you've got to do the painful stuff first in order to get to the stimulative stuff later. And that's spread, that time spread,

• 16:54Speaker 03

  you know, you had to kind of try to engineer a slowdown to then be able to get the rate cuts via the disinflation that he is trying to create, which ultimately, you know, this idea of like fiscal contraction to potentially then fiscally expand, you could even say. The other shock. It's lost in the wash here, and this wasn't just a Trump growth scare, right? We already growth scare every Q1 into Q2. That's an artifact of the post-COVID economic.

• 17:21Joe Weisenthal?

  That's right. We had a good piece from Neil about, Neil Dutt about that.

• 17:24Speaker 03

  Anyway, keep. Yeah, so that matters, right? You know, that was part of my thesis, like, look and see the trajectory. We have these overheated animal spirits Q1 numbers, and then the seasonal adjustments kick in, and we have a growth scare in Q2 or into Q3. But the other element here was the deep-seak story and tech innovation and that market concentration. And guess what? There's all sorts, those names aren't just massive parts of index and massive thematic parts, retail investors and hedge fund longs and things like that. Think about their impact in the leveraged ETF space, which has just absolutely grown massively. That's a source of synthetic negative gamma in the market, which, you know, on their end-of-day rebalancing into an up day, they've got a ton to buy at the end of the day. And 80% of those assets happen to be concentrated in kind of like concentric tech disruption circles.

• 18:07Speaker 03

  So you add in this massive rethink on what had been the perpetual motion machine of AI capex and that deep-seak shock, and Nvidia trades down 17% kind of after that realization, that weekend of what we're looking at. All of a sudden, a massive valuation shock and an earnings repricing effectively.

• 18:27Joe Weisenthal?

  Tracy, did you see this from Eric Balconis yesterday? Vista shares filing for an animal spirits ETF, A-N-I-M, and a 2X animal spirits ETF, Wild, which will hold the five fastest-growing 2X single-stock ETFs at any given time.

• 18:44Tracy Alloway?

  Isn't that just called momentum?

• 18:46Joe Weisenthal?

  Yeah, but that's not, that momentum isn't enough.

• 18:49Speaker 03

  It's momentum with leverage, and guess what? There will be options on it, too. So there's synthetic negative gamma and actual real negative gamma. So the final point here is you had these two shocks to what consensus was, consensus positioning and consensus narrative. Now, all of a sudden, this realization that phase one is going to have to engineer a slowdown to get the stimulative stuff that Trump wants to do.

• 19:10Tracy Alloway?

  Yeah, isn't that weird? Like, why are we crashing economic growth to boost economic growth?

• 19:15Speaker 03

  Well, because I think in this case, like, there is something credible to the idea that. The deficit spending was a market concern, right? I mean, think about what rates were doing last year when we were talking about fiscal dominance. What's ironic here is that you then get punished for trying to address it. So look at Europe, for instance, and this is like a big trade in the market right now. It's like very simplistic, but this is the way that asset allocators think and move, right? Who's fiscally contracting and tightening? And who's fiscally expanding and stimulating? Europe, right? Trump said, look, we might be talking about the end of Bretton Woods, post-World War II Pax Americana here, right? We're no longer going to protect you for you to buy US dollar assets and use our currency. So guess what?

• 20:00Speaker 03

  Europe has to go out, create this financing. And with that, all of a sudden, now they are a fiscal expander after years of being

• 20:09Joe Weisenthal?

  So it's a total, it's a real regime shift.

• 20:11Speaker 03

  It's a real potential regime shift, even though I think this ultimately creates the conditions where if you do kind of crash the economy and you can't stick the landing on this engineered recession, then you inevitably have to fiscally expand. And that's why I think a lot of these like long Europe, long China trades will be quick to move their feet. I don't, I can't say this is a tectonic permanent structural shift yet, because the worse it gets for us and we get punished and you have fiscal tightening and markets sell off and all those bad things that create a negative wealth effect, which in the short term help get the disinflation to get the Fed cuts.

• 20:47Speaker 02

  Right.

• 20:48Speaker 03

  Right? To get the stimulus through, right? This is all part of this kind of second order thinking that you need to be looking into.

• 21:08Speaker 08

  This is the Bloomberg Tech Minute brought to you by ChatGPT. I'm Carol Muster. Millions of Americans are taking peptides, short strings of amino acids that can act as biological signals for cells. Peptides like insulin can occur naturally in the body, or they can be synthetically introduced to induce a biological process, as happens with semaglutide, the active ingredient in Ozempic. Now Bloomberg's Anika Inamputi reports peptides may be exploring their next frontier, the brain. People are taking peptides for mental clarity and cognitive benefits as alternatives to psychiatric medications and to gain a competitive edge or stave off the effects of aging. Both insulin and semaglutide are approved by the US Food and Drug Administration.

• 21:52Speaker 08

  Because importing or selling unapproved peptides for human use is not legal in the US, many people turn to online forums for guidance and overseas vendors with questionable credentials to obtain them. Unapproved peptides, which are marketed as research chemicals, have been circulating in what's become a billion-dollar gray market amid the rise of do-it-yourself medicine as people increasingly turn to social media or artificial intelligence for medical help. Doctors warn against self-experimentation and advise talking to providers before trying any new therapies. That's the Bloomberg Tech Minute, brought to you by ChatGPT. Get started at ChatGPT.com.

• 22:31Tracy Alloway?

  Okay, so we had a wild but not disorderly sell-off.

• 22:36Speaker 03

  Mm-hmm.

• 22:36Tracy Alloway?

  Sounds like my high school report card. But I imagine it was still painful for certain investors. So we just mentioned momentum, like that must have been painful. Multi-strats must have had a hard time because we saw a lot of the overperformers underperforming and the underperformers suddenly overperforming. How was it? Give us some like market color.

• 22:59Speaker 03

  Well, in some of those, I mean, you look at the biggest multi-strats that have been 100% of the net alternative investment or hedge fund inflow over the past X number of years, right? So like, long, short, isn't where it's at anymore. It's about the market neutrals, and that's just speaking to like their equities components. But of course, they have these other risk diversifying strategies with incredibly tight risk management, tight stops. And that's how, when you apply a lot of leverage to these small controlled market neutral gains, you then get these incredible annual returns that those biggest shops have been posting. But the fact of the matter is, crowding happens and leverage on top of crowding happens. And then shadow leverage happens, this leverage Leverage ETFs.

• 23:42Tracy Alloway?

  Leverage on leverage.

• 23:43Speaker 03

  And vol control, target volatility and CTAs and all that stuff is synthetic negative gamma in the market. So, and even where, you know, there's a very well-publicized loss with regards to index ARB, you know, at one of these funds, whatever. I think that was probably negatively impacted. They have to model out the flows across the diaspora of things out there at the end of the day to do their index adds and deletes. Well, they're probably getting screwed with by a lot of the leveraged ETF flows at the end of the day that are completely nuking and creating these big overshoots and these big negative gamma type moves. So, the long story short is that for the month of February, let's say, talking with people deep in the inside, senior traders and whatnot, these were losses, one-month losses that people had not experienced that have been there, you know, four, five type years, in places

• 24:27Speaker 03

  that just don't lose money. They just stop you so effectively. Now, it is a tribute to the model, however, that there's no blowups, there's no LTCMs here. I mean, yeah, they didn't make money. They might have had a worst month or in the start of March was also, you know, going the wrong way too, but you're not going existential here.

• 24:45Tracy Alloway?

  Yeah.

• 24:46Speaker 03

  So that actually speaks to the model working. The bigger issue, and I think the bigger thought process takeaway here is that when you have trades over a period of time are built on the status quo of US exceptionalism, right? That is effectively a carry trade. Yeah. And we had leverage built into the system for 15 years of QE. We had leverage built into the system from modern monetary theory and the outright money drops that we've done over the past five years.

• 25:12Tracy Alloway?

  Joe, that's your fault.

• 25:13Speaker 03

  So. Yeah, might be. Yeah. So, I mean, all of these things created this ugly deleveraging effect, even at market neutral shops. The good news is it wasn't a vol feature, it wasn't a vol event, because we were already hedged. That's why SKU was high, implied vol was high, all the put SKU was high. So, it didn't become a vol event, which is where you get some of those accelerant flows to kick in.

• 25:37Tracy Alloway?

  On this note, I have a slightly weird question, but could we ever get to the point where the volatility complex is so large and so in demand that you're just never going to have a volatility event like we saw in 2018, something along those lines? Because everyone is paying through the nose for downside protection.

• 25:56Speaker 03

  Well, I mean, ironically, it's when you're well hedged that you then have a condition where you can. Create the crash, right? Which means that dealers are short all these puts. I think

• 26:07Tracy Alloway?

  I guess you have to have sellers on the other side, too.

• 26:09Speaker 03

  Oh, that's the big thing that we've conditioned the behavior, whether it's, you know, Fed stepping in that moral hazard dynamic, or nowadays politicians, fiscal stepping up, whether it's Silicon Valley Bank and 70 different new five-letter acronym liquidity special features in the market that put out fires. And that's why the back test on vol selling strategies and the AUM in vol selling strategies just keeps working. Like you sell the panics. And that's what ultimately what ends up happening when you have this short optionality dynamic in the market, whether it's dealers short real downside hedges, or it's CTA trend flipping from a long to a short and having to sell more the lower it goes, or target volatility funds is like a hedge overlay

• 26:54Speaker 03

  doing the same thing, or leveraged ETFs. You know, you get the point now. What ends up happening is that it's the option sellers that stop the problem. Because they come back in, they give dealers back their gamma, they sell option out, and they sell rich vol. The market stabilizes, ranges compress. You need to keep feeding volatility. Volatility is mean reverting. And if you can't keep having daily one and a half percent moves, which is a big ask, you need persistent new bad news. Otherwise, realized volatility compresses, ranges compress, vol sellers feel more confident. They fill in, dealers get long gamma, we stabilize, people start covering their monetizing their hedges. They take those off, that creates delta to buy, the market starts rallying.

• 27:38Speaker 03

  People buy short dated upside, it squeezes it. That's the cycle that we're on. Like this really short-term ecosystem, but vol sellers are, I would say, the bigger players now than hedge buyers. And that's a real footprint of the past 20 years, ever since QE, where the prior, the previous buyers of volatility were real asset managers, like long onlys and things like that. After QE, a lot of those folks, big pension funds, became sellers of volatility.

• 28:07Tracy Alloway?

  Yeah, this was Bill Gross's thing when he stood up on stage and said, everyone sell volatility. That's like the only trade right now because nothing is happening.

• 28:15Speaker 03

  Right. Nothing's happening.

• 28:17Tracy Alloway?

  You have to bet on nothing.

• 28:17Speaker 03

  Until now.

• 28:18Tracy Alloway?

  Yeah.

• 28:19Joe Weisenthal?

  Maybe, maybe. Until now, maybe.

• 28:21Speaker 03

  One other point I would make on volatility. The reason that it got so wacky in August, for instance, was the fact that conditioning that says sell the rich vol, and remember, like, the non-farm payroll and U rate data was that Friday, and we crashed hard, but everybody was so conditioned that we closed the market that day with anybody in the vol space saying, I want to be short vol, short delta. I want to sell this rich vol but still think the market normalizes here because we can't maintain this richness in volatility. Well, then the Nikkei opened down 12% because it was like a kind of a hot leveraged trade at that time. And it was the second day that got people stopped out. The other point here, too, was that that day of Friday, one of the largest vol players in the market,

• 29:04Speaker 03

  thinking that they were doing themselves a solid and hedging by buying VIX calls, ended up, you know, creating their own demise, in a sense. Because that created some of that short VIX convexity that then really went wild over the span of the next day and a half and created a bigger issue within the vol complex. So this is the idea that when you have buyers of hedges, they actually create the conditions for the crashes.

• 29:29Joe Weisenthal?

  Right.

• 29:30Tracy Alloway?

  Well, I guess we'll see what happens with the Fed meeting.

• 29:33Joe Weisenthal?

  And we'll see if there's like a big regime shift because it's eventually, right? Maybe, maybe something will change. Maybe, maybe one day mean reversion will come to an end.

• 29:43Tracy Alloway?

  Volatility is mean reverting normally.

• 29:46Joe Weisenthal?

  Maybe.

• 29:46Tracy Alloway?

  But we're not in normal times, so we'll see.

• 29:54Joe Weisenthal?

  Lots More is produced by Carmen Rodriguez and Dashil Bennett with help from Moses Andam and Cale Brooks.

• 30:00Tracy Alloway?

  Our sound engineer is Blake Maples. Sage Baumann is the head of Bloomberg Podcasts.

• 30:05Joe Weisenthal?

  Please rate, review, and subscribe to Odd Lots and Lots More on your favorite podcast platforms.

• 30:11Tracy Alloway?

  And remember that Bloomberg subscribers can listen to all our podcasts ad-free by connecting through Apple Podcasts. Thanks for listening.

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