Lots More With Charlie McElligott on the Sharp, Strange Selloff

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0:45In addition to all that variety, EasyCater also gives you full visibility of your organization's food spend with invoicing, centralized reporting, and seamless integration with expense management systems, all on one platform. Easy Cater, your business tool for food. To learn more, visit easycater.com slash podcast. Introducing the all new Adobe Acrobat Studio, now with AI powered PDF spaces. Do more with PDFs than you ever thought possible. Need AI to turn 100 pages of market research into five insights with a click? Do that with Acrobat. Need templates for a sales proposal that'll close that deal?

1:23Do that with Acrobat. Need an AI specialist to tailor the tone of your market report to sound real smart in real time? Do that with the all new Adobe Acrobat Studio. Learn more at adobe.com slash do that with Acrobat. Bloomberg Audio Studios. Podcasts, radio, news. It's good. It's good. You know, markets are fun. And as we said, spring is here. Yeah, markets finally got interesting. Oh, man. I mean, I have so many thoughts. Oh, good. All right. If you can't tell from my normal stream of consciousness operation. You know how I know it was bad, Joe? Go on. It was one of those weeks where we talked about negative gamma quite a lot.

2:09What's gamma again? 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. 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? Should we get you a refresher? Yeah, I need one of those Guide to the Greeks books or something. Or like a little like laminated card that I can like. Someone should do a coffee table book. Yeah. Yeah. Guide to the Greeks. I like Greek stuff these days, you know, because I'm into like ancient history and everything like that.

2:41I know what alpha is. I know what beta is. After that, I started to get a little dicey. I did a deadlift. I'm both the most popular trader and most successful trader at Citadel. Feta's going viral. Uh, barges. This is an after-school special, except... I've decided I'm going to base my entire personality going forward on campaigning for a strategic pork reserve in the U.S. Black gold! These are the important questions. Is it robots taking over the world? No, I think that, like, in a couple 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.

3:16How do I get more popular and successful? We do have... The perfect guest. You're listening to Lots More, where we catch up with friends about what's going on right now. Because even when the odd lots is over, there's always lots more. And we really do have the perfect guest. 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.

4:07So delta goes down if the underlying asset price is going up, and then it becomes less negative if the underlying asset price is 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. I'm liking this like Spartans versus Romans history vibe we're going with. Yeah, that's very you.

4:49I feel that's very you. Yeah, yeah. I feel that's your comfort zone. It resonates. Yeah, I know. 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 the option at a certain level. And that's so much of what we're asked to do, you know, in 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 &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.

5:21You have to identify calls sold, calls bought, puts sold, puts bought, multi-leg trades. It's quite complex. I think in the past, there was a lot of false narrative because people made kind of two core assumptions 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 overriders, 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.

5:59But short gamma matters because that's where you get these potential jump off points where you blow through a level or a Dealer is short, a strike, and then you get that prevailing market move is fed into. So that matters. 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. So my view is like there's been so much volatility lately, Tracy, regardless of what happens in the 48 hours between now and then.

6:45There's enough to talk about. Yeah, for sure. OK, 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 &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? So there was two large short gamma strikes in the S &P index options diaspora for dealers. And I think it was, I think it was 5 ,600 and then 5565, 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.

7:46collar where a call is sold out of the money to then help finance this put spread in the market. And that 55-65 is a short strike, which means that in this case, it looks like short gamma. I think the fact is about that, however, and thus this idea of, you know, 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. 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 and rebalanced, I should say, into the next quarter's trade at the end of this month.

8:31And 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 game as this acceleration point, depending 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 has been about why is vol actually seemingly unresponsive? Yeah. So the VIX, like I know the VIX went up, but I think it went to like 29 and you compare of that to like, it was above 80 in 2020.

9:14And even in 2022, it was like 36 or in the 30s. Vol was really quiet. Even in 24. Yeah. August 2024 got nearly to 40. Anyway. Yeah. So the last time I was in here was after that August shock. And that was a proper, 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. Well, the fix got to 65. Yeah. 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.

9:54The difference this time around is that since the election, right, Donald Trump is the personification of a gamma agent. You are the only person I know who describes Trump as a gamma agent. Everyone has their terms. A living personification of gamma. And I think, look, his mandate is to break status quo. Right. And we talked that last August shock about the idea that the concept of a carry trade, because we were being asked about how the 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.

10:41The 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. Oh, you're just never going to get that risk buildup. Well, in this case, starting November, you know, when it really took shape, and I think the market had been sensing certainly since kind of the summer, skew was seepening. Skew matters, right, just as a relative measure of kind of demand for downside versus demand for upside.

11:14But put skew, which is like deep out of the money downside relative to an at-the-money put, was jacked 90-something percentile because of all of the potential chaos agent. So, vol is getting more expensive. So, vol was already quite expensive going into this scenario, even if maybe the macro catalyst went wrong way. And I think there's two big things that happened. So, let's talk about this past week or really was past three weeks. Yeah. 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, your longs and your shorts in aggregate, still kind of 90-something percentile, was 100 percentile.

11:59Coming 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.

12:10Thank you.

12:40The answer is Ecolab. Better performance, better outcomes, better impact. Ecolab. Now every location is your best location. How many vendors does it take to meet all your organization's food needs? Just one. EasyCater, the workplace food platform that lets teams order from a huge variety of restaurants, over 100 ,000 nationwide, all through a single vendor. In addition to all that variety, EasyCater also gives you full visibility of your organization's food spend with invoicing, centralized reporting, and seamless integration with expense management systems, all on one platform. EasyCater, your business tool for food.

13:22To learn more, visit easycater.com slash podcast. You're thoughtful about where your money goes. You've got your core holdings, some recurring crypto buys, maybe even a few strategic options plays on the side. The point is, you're engaged with your investments, and Public gets that. That's why they built an investing platform for those who take it seriously. On Public, you can put together a multi-asset portfolio for the long haul. Stocks, bonds, options, crypto, it's all there. plus an industry-leading 3.8 % APY high-yield cash account. Switch to the platform built for those who take investing seriously.

14:03Go to public.com and earn an uncapped 1 % bonus when you transfer your portfolio. That's public.com. Paid for by Public Investing. All investing involves the risk of loss, including loss of principal. Brokerage services for U.S.-listed registered securities, options and bonds, and a self-directed account are offered by Public Investing, Inc., member FINRA and SIPC. Crypto trading provided by Backed Crypto Solutions, LLC. Complete disclosures available at public.com slash disclosures. Give us like a little zoom out, basically from mid-November to, as you said, about three weeks ago, it started turning.

14:35I think the peak on this, and it was February 19th or something like that. Yes. But talk to us just about that sort of kind of an upcrash in the wake of the election, people loading into everything risky from crypto to Tesla and everything. False narratives. Yeah. What was going on there? And then how extreme did that get? 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.

15:09The rates 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 had 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 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 DREG, with tax cuts, and these other stimulative measures completely had the market thinking about a further extension of U.S.

15:52exceptionalism, 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 U.S. 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 U.S. exceptionalism. And part of U.S. 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.

16:26The last 15 years. It 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 stock market last year, like MAG-7, MAG-8, 35 % of the S &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 U.S. 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 when I started 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.

17:18And that spread, that time spread, 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 can even say. The other shock that's lost in the wash here, and this wasn't just a Trump gross scare, right? We already gross scare every Q1 into Q2. That's an artifact of the post-COVID economic world. That's right. We had a good piece from Neil about that. Anyway, keep going. Yeah, so that matters, right? You know, that was part of my thesis.

17:53Like, look and see the trajectory. We have these overheated animal spirits, Q1 numbers, and then the seasonal adjustments kick in and we have a gross scare in Q2 or into Q3. But the other element here was the deep seek 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.

18:27And 80 % of those assets happen to be concentrated in kind of like concentric tech disruption circles. So you add in this massive rethink on what had been the perpetual motion machine of AI CapEx and that deep seek shock and NVIDIA trades down 17 % kind of after that realization that weekend of what we were looking at. All of a sudden, a massive valuation shock and an earnings repricing effectively. Tracy, did you see this from Eric Belkunis yesterday? Vista shares filing for an Animal Spirits ETF, ANIM, and a 2X Animal Spirits ETF, WILD, which will hold the five fastest growing 2X single stock ETFs at any given time.

19:11Isn't that just called momentum? Yeah, but that momentum isn't enough. 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. Yeah, isn't that weird? Like, why are we crashing economic growth to boost economic growth? Well, because I think in this case, like, there is something credible to the idea that the deficit spending was a market concern, right?

19:50I 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 U.S.

20:22dollar assets and use our currency. So guess what? 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 the source. So it's a real regime shift. 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 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.

21:14Right. 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.

21:33How many vendors does it take to meet all your organization's food needs? Just one. EasyCater, the workplace food platform that lets teams order from a huge variety of restaurants, over 100 ,000 nationwide, all through a single vendor. In addition to all that variety, EasyCater also gives you full visibility of your organization's food spend with invoicing, centralized reporting, and seamless integration with expense management systems, all on one platform. EasyCater, your business tool for food. To learn more, visit easycater.com slash podcast. You're thoughtful about where your money goes. You've got your core holdings, some recurring crypto buys, maybe even a few strategic options plays on the side.

22:19The point is, you're engaged with your investments, and Public gets that. That's why they built an investing platform for those who take it seriously. On Public, you can put together a multi-asset portfolio for the long haul. Stocks, bonds, options, crypto, it's all there. plus an industry-leading 3.8 % APY high-yield cash account. Switch to the platform built for those who take investing seriously. Go to public.com and earn an uncapped 1 % bonus when you transfer your portfolio. That's public.com. Paid for by Public Investing. All investing involves the risk of loss, including loss of principal.

22:58Brokerage services for U.S.-listed registered securities, options and bonds, and a self-directed account are offered by Public Investing, Inc., member FINRA and SIPC. Crypto trading provided by Backed Crypto Solutions, LLC. Complete disclosures available at public.com slash disclosure. Introducing the all-new Adobe Acrobat Studio, now with AI-powered PDF spaces. Do more with PDFs than you ever thought possible. Need AI to turn 100 pages of market research into five insights with a click? Do that with Acrobat. Need templates for a sales proposal that'll close that deal? Do that with Acrobat. Need an AI specialist to tailor the tone of your market report to sound real smart in real time?

23:33Do that with the all-new Adobe Acrobat Studio. Learn more at adobe.com slash do that with Acrobat. Okay, so we had a wild but not disorderly sell-off. 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 over-performers underperforming and the underperformers suddenly overperforming. How was it? Give us some like market color. 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?

24:19So 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 with leveraged ETFs. Leverage on leverage.

24:52And vault 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 or 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 ads and deletes. Well, they were 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.

25:23So 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 or five type years in places 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've had worst month or in the start of March was also, going the wrong way too, but you're not going existential here. So that actually speaks to the model working.