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Odd Lots Podcast Episode Summary
Episode Title
This Is How Derivatives Trading Swallowed the Entire Market
Episode Overview In this episode of the Odd Lots podcast, hosts Joe Weisenthal and Tracy Alloway engage in a discussion about the rapid evolution of derivatives trading, particularly focusing on options, swaps, and their increasing mainstream adoption among both retail and institutional investors. The conversation features Benn Eifert, a partner at QVR Advisors, emphasizing the implications of this trend on markets and investing strategies.
Key Themes and Discussions
- Historical Context of Derivatives Trading
- Traditionally, derivatives trading was a niche area primarily used by professional investors for hedging.
- The onset of the pandemic and the Robinhood trading boom led to a surge in retail participation.
- Now, derivatives like options have become mainstream, with significant retail and institutional trading activity.
- Rise of Retail Investors and Influencers
- Retail investors are increasingly engaging in derivatives trading, often influenced by social media accounts promoting high-return options strategies.
- Common claims include the ability to generate substantial income by selling short-term options.
- Hosts express skepticism about these claims, highlighting the risks and misunderstandings associated with options trading.
- Market Dynamics and Institutional Adoption
- The episode discusses how institutions have moved from conservative investment strategies to incorporating high-risk derivatives into their portfolios.
- The hosts and Eifert analyze the current market landscape, where short-dated options comprise a significant volume of trading activity, specifically noting that 60% of S&P 500 options are shorter dated.
Key Concepts
- Options Trading: Selling short-dated options is promoted as a way to generate passive income, but the risks involved are often downplayed.
- Buffer ETFs: These new investment vehicles offer defined outcomes, providing some downside protection while sacrificing upside potential. They are marketed as low-cost, accessible alternatives for retail investors.
- Volatility and Market Risk: The conversation touches on volatility risk premiums and how they have changed over time, particularly since major market events like the 2018 Volmageddon and the 2020 market crash.
Notable Quotes
- "Selling options is pitched as a form of passive income, but it does not come without significant risks."
- "The option selling strategies that seem easy often mask the potential for significant losses."
Conclusion This episode of Odd Lots delves into the transformation of derivatives trading, the emergence of new investment products, and the implications of retail involvement in these markets. The conversation serves as a cautionary tale about the allure of high returns and the importance of understanding the risks associated with derivatives trading.
Additional Resources
- Reading Recommendations: For those interested in learning more about options trading, Eifert suggests starting with educational resources that explain the mechanics, risks, and strategies involved.
- Follow-up Episodes: The hosts express interest in future discussions with experts to further explore these evolving dynamics in the financial markets.
Call to Action Listeners are encouraged to engage with the Odd Lots community through their Discord channel and to subscribe for more insights and discussions about finance, markets, and economics.
For more content, visit the [Odd Lots page on Bloomberg](https://bloomberg.com/oddlots).
Written by AI. May contain mistakes. Listen to the episode to check what was said.
Transcript
Automatic transcript. May contain errors.0:00Your best restaurant location gets 5 star reviews. How do you make every location like your best location? Your best paper mill has been operating at peak productivity. How do you make every mill like your best mill? Your best data center has optimized every drop of water. How do you make every data center like your best data center? The answer is Ecolab. Better performance, better outcomes, better impact. Ecolab. Now every location is your best location. For enterprise organizations, managing all your food needs is a tall order. But with EasyCater, you get a single workplace food vendor with the tools and resources to make it easy.
0:40Giving teams across your organization an easy way to order from a huge variety of restaurants, all on one platform. All while consolidating your corporate food spend so you can control costs, streamline billing and payment, and simplify reporting. EasyCater, your business tool for food. To learn more, visit easycater.com slash podcast. Hey there, Odd Lots listeners. It's Tracy Alloway. And Jill Weisenthal. We are very excited to announce that Odd Lots is going to Washington. That's right. For the first time, we are going to do a live public Odd Lots recording in our nation's capital. That's going to be March 12th in Washington, D.C.
1:21at the Miracle Theater. And guests will be announced in the coming days. But in the meantime, you can find a ticket link at Bloomberg.com slash OddLots. Bloomberg Audio Studios. Podcasts. Radio. News.
1:48Hello and welcome to another episode of the OddLots podcast. I'm Tracy Alloway. And I'm Joe Weisenthal. Joe, as part of my preparation for this episode, I have spent the morning on TikTok and Twitter slash X, Instagram, watching videos. Did you find any good techniques that you are going to employ for generating$200 ,000 a year on$250 ,000 in capital by selling short-term options? You know what? 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$1 ,000 is only nine doubles away from becoming a million.
2:36That's true. A million is only 10 doubles away from a billion. That's true, too. I think that sounds roughly right. Yeah. So what's the catch? You know, someone's got to do it. No catch, Joe. It's all good. We can all be billionaires. No, I think the thing about derivatives trading nowadays is when it started, it was very much a retail phenomenon. It was, you know, the guys on Wall Street bets, yoloing into some crazy derivatives trade, basically buying a lottery ticket on the market. But what's happened since then is derivatives have really gone mainstream in various ways. So, for instance, if you look at options like across the S &P 500 right now, something like 60 % of the volume is shorter dated options.
3:25So zero DTE or one DTE, which is kind of crazy. It's totally crazy. 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 actual institutional options trading research firm that came in and did this little mini seminar for some of the reporters on how to analyze options data. Do you remember doing that? 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 option sort of played this role as insurance for specific things.
4:16And 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 2025, that that craziness of 2021 would have been some sort of peak, right? There was a Robinhood era, meme stock era, et cetera. I would not have guessed the durability of it, especially with the Fed having hiked and everything that we've seen transpire since then. 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, right?
4:51Metastasizing. It's reversed. Okay. So options, derivatives, They're everywhere right now, and you have different groups of people, so institutional and retail using them. 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. Let's do it. And who do we call to talk about derivatives? The perfect guest. One man, the perfect guest. We have Ben Eifert, managing partner at QVR, back with us. Ben, thanks for coming back on. Tracy, Jo, it's so good to see you guys. I'm really excited about this.
5:27It's always so much fun talking to you. It's been a while, I have to say. Maybe just to start out with videos. Do you have a favorite? The one actually from a few days ago that I just absolutely loved. I'm going to 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 recently banned by the Indian government from doing what she's doing because she's sort of so controversial. but she's very intimidating. Like I like to kind of take on these option influencers and sort of say, look, you know, come on guys, this isn't right.
6:00I don't know, man. She's, she's just pound, you know, pounding the table about making a hundred percent in 10 minutes, you know, like guaranteed profits, intraday options trading over and over again. While like a band plays in the background and fireworks go off. It's like truly incredible stuff. I'm reading an article on live mint.com S E B I, which I guess is the Indian regulator, banning her from capital markets. But 100 % in 10 minutes sounds pretty good. It's really good. What's the catch? It turns out it's a lot better money for her than it is for you usually. Well, what is – okay, that's a very extreme example.
6:38But we've all seen these videos. The modal TikTok options influencer, what is the sort of – the gist of what they're telling viewers that they can do? Yeah, absolutely. I mean, the things that they say, you guys kind of joked a little bit about this earlier, but make$20 ,000 a month in passive income easily with only a$250 ,000 account. And what's the gist of that story? We all are very skeptical of these results, but what is the basic thing that they're saying that you can achieve that? The typical thing these days is they want you to sell short-term options, right? And there's various formats that might take.
7:14The 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 DTE puts, sort of daily puts over and over again. Could be selling covered calls or uncovered calls. Could be selling, you know, straddles or strangles or whatever it is. But the common idea are the kind of they'll pack all of these different hand wavy justifications into why this is free money or why this is really easy. You'll hear people say, oh, 90 percent of options expire out of the money. So it's just super easy. You just make money on all these trades, you know, and then and then anything that could go wrong, they explain away as how it's not really a problem.
7:53You 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 you get the stock for free and all of these things over and over again, where at the end of the day, look, 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.
8:19It's not free money, you know, but the justifications and explanations and persuasiveness that goes into this from these kind of influences is very powerful. Do we have any sense of what people are using these for? 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, you look at something on a subreddit or something like that, and people are just basically buying lottery tickets.
8:55Yeah, 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, you know, you should just do this all the time. This just makes sense. This is basically free money. It's really easy money. There's no accompanying strategy. There's no accompanying strategy of when and why might something like this make sense at what price?
9:28How 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 unlock. The infinite money cheat code. It's an infinite money cheat code that lets you unlock sort of spectacular returns. One day, Tracy, we're going to do an episode on the cheat code that I did find in markets, which I think I've hinted at. Wait, you found one and you're still here? well it's the short version is i did find a cheat code in 1999 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 couldn't talk about it some other time i did briefly find a cheat code uh in the markets and i thought i was like you know and he didn't tell any of us yeah i didn't i didn't i was like oh this is kind of cool i made $10 ,000.
10:17We talk about volatility, right? And so just very crudely, maybe higher vol opportunities present good times because you're getting a large premium or whatever for some of the options trading, et cetera. People who walk into these extremely naive strategies, oh, 90 % of the time options expire out of the money. What does the payoff look like for them? How many pennies can they pick up before they get steamrolled. Yeah, totally. I mean, these kinds 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 &P, 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.
11:05And then once every three years or five years, you'll kind of get wiped out and end up down. So you just start getting into it the day after the wipeout. Exactly. And actually, there is something to that. 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 in 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 or two years or something like that.
11:36So 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 favor of buffer ETFs. What are buffer ETFs? Yep. So this is 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 we're trying to do is give you equity exposure, but your protection, you have a buffer down to say 10 or 15 % where you're not going to lose money as the market goes down.
12:24And 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 where you sell a call to buy a put spread. That is for many, many years and decades, by far the most popular thing 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.
13:00So if you're an aggressive salesman, you call that like a free hedge or a zero cost hedge. Of course, you're giving up upside. So you can it can be very cost. You pay for it, but only implicitly by some notional gains that you're not thinking about. That's exactly right. And there's three legs to the trade. So there's lots of bid 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 70 basis points management fee or whatever it is, instead of having to, you know, be involved with Wall Street banks or doing trading themselves.
13:34People love that. There are very famous mutual funds like the JP Morgan one that everybody talks about. It's$22 billion of assets or something like that. And now there's, I think, something like$90 billion of buffer ETFs doing the same kind of thing. And they're all doing something very, very similar, which is, again, they're selling, call it an 8 % or 10 % out of the money call or 7 % out of the money call, they're buying an at the money or slightly downside put and then selling out another like a 10 % down or 15 % down put to kind of give yourself this buffer on the way down, you're giving up upside on the way up.
14:05One 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? So this is exactly the right question. So the first thing that 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? 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 spread caller against that, you buy a put spread, you sell a call, you're probably going to take that one - Sorry, what's a put spread as opposed to a put?
14:41A put spread would be you buy, say, the at-the-money put, but then you sell a 10 % of the money put. So that's going to give you protection only for 10%. And so if you do that kind of a trade, you might take your one delta option down to like a 0.6, down to a 60 delta. So now you're only participating kind of 60 % in the movements of the market. And if you look at how these kind of trades perform over long periods of time, they actually act a whole lot just like having sort of 60 % as much stock. 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.
15:18And if you were just to take the counterfactual, which is why don't I just own 60 % as much stock and put 40 % 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 underperforming.
15:39Thank you.
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16:50EasyCater, your business tool for food. To learn more, visit easycater.com slash podcast. Are there institutions, you know, Tracy mentioned the University of Connecticut. You know, institutions have sometimes very specific needs. They need to have like a guaranteed return, very long term. They may not be optimizing for maximum returns. They have to dole out a certain amount for student aid, whatever it is. Are there certain types of institutions where whether we're talking about the buffer ETFs specifically or analogs to that strategy, that this is, in your view, in alignment with the institutional mandate?
17:31Right. So 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 disbursement that has to be made at some future date and they want to lock in for sure the fact that they can make that disbursement. 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 collar is you've only got like this, say, 10 % buffer of protection. And what if the market crashes? So if the stock falls or if the market falls 25%, which does happen, you're actually not protected against all of that.
18:02Yeah, exactly. So this stuff really doesn't like lock in defined outcomes to the downside. It just gives you kind of some buffer of protection in exchange for some upside that you're losing. 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 here. 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?
18:37This isn't like micro cap stocks. This is S &P or something. So, 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$22 billion fund that once a quarter is rolling this 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 for this trade that you're going to do. This is what happened during fall of the GEDDN as well, right? Yes, very much so. When you have a big trade 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.
19:07And especially in a poor liquidity environment, you know, that's going to really hurt you. Like markets can, you know, markets can move very significantly as market makers and arbitrageurs 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 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 it filled.
19:38And they put it up way over the offer side of where the market really should be. Are there funds that claim to do something more sophisticated? Because it does sound obvious. It's like all the rules are out there, the prospectus, the mechanics, the timing, etc. 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? Yeah, I mean, certainly there are 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.
20:11And 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 in very smart ways and try to kind of get mid-market execution and have nobody know what we're doing. So the competitive advantage is really on the execution side rather than the actual design of the product. Yeah, there's probably some of both. I mean, 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.
20:43and generally be trying to achieve the client's objectives, 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, that's a kind of a strategy design aspect. And then there's just an execution implementation aspect that's, you know, 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 about distribution and very, and, you know, implementation details are very secondary, right?
21:18The people who've been really successful are marketers and distributors hitting the street hard. They're not, you know, vol traders who are designing these things. All the influencers. I'm just going to throw out random derivatives products and if you could just define them. What is the wheel and why does it have an ETF named after it? Yes, this is, this is fantastic. So it kind of goes back a little bit to the meme stock options craze. What's the ticker? Is it W-E-H-E-L? It's just wheel, isn't it? I think it's four letters. I think it's W-E-E-L. No, I think it's W-E-E-L. Oh, W-E-E-L. Yes, W-E-E-L.
21:53Peerless option wheel. Peerless option income wheel. I like that they put peerless. Yes, totally peerless. Tell us about the wheel. So a lot of the original meme stock option traders who made a bunch of money in GME and AMC back in the day, some of them sort of migrated from that into getting really interested in option selling. And in particular, kind of a strategy called the wheel, where the idea is you're going to sell against short dated options, you're going to start out selling cash secured puts. So you're going to sell some puts on the S &P or on your favorite stocks. And then you're going to keep doing that unless the market goes down enough that you get assigned on that put and you take a loss.
22:30Then you're going to long that stock. And then you're going to 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 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. And you're sort of, you keep moving with the market, right? And the one thing you know is the market's going to move probably.
22:58It seems like there's some assumed mean reversion here or assumed the cycle of life. Yes, there's very much like a cycle of life. There's this idea that no matter what scenario, 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, same thing. And ultimately, what's not described in these pitches is how it's a short volatility trade. What you're 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.
23:30Because what happens is stock goes down a lot, you're going to lose money on your short put. Now you're going to 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 a call. And you're just getting chopped up by this volatility, right? So people love to pitch options trades in ways that don't have anything to do with volatility. When they're inherently volatility trades. 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 a stock really cheap, but you get paid for it.
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24:10So it has nothing to do with the price, has nothing to do with if this is like a good risk reward, 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. 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. Yeah, totally. If you look at benchmark indices for things like call overwriting or cash secured put selling, those have been around for a very long time and they 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.
24:49And what you see there is it actually tells a really nice story, which is from about 1990. Line going up. Mm-hmm. Yeah, lines going up. And you want to compare that to just the S &P. So from 1990 to about 2012, they look pretty good. They kind of keep up on average with the S &P, but on somewhat lower volatility with a little bit lower drawdowns. And that was really the pitch that investment consultants and pension fund consultants started making after the credit crisis to their clients. Wasn't this what Madoff claimed to be doing some sort of like put right? He was claiming to be doing like conversions and like diagonal spreads and stuff.
25:28So 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 looked decent in this sort of back test. But the whole point is, you know, very much like any back test in finance, option selling looked good when nobody was doing it in size, right? There were, it was not, you know, option markets were a 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,$200 billion pension funds doing like option selling. And then those pension fund consultants started writing white papers and they started pitching to their clients' boards.
26:01And by like 2011, 2012, 2013, they started to get some traction and you started to have, you know, giant$200 billion pension funds saying, sure, we'll put 10 % 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 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 &P where they sort of had very similar risk, but much less return.
26:45And that was like, how does this actually look once real money goes into these strategies? Because at the end of the day, derivatives markets are big and deep and liquid, but they're not primary markets, right? They're derivatives markets. They're not designed for like global asset allocation for 20 % of all the money in the world to go into selling them, right? But this is the big debate, right? To what extent is this kind of options trading or derivatives trading actually affecting the underlying, which would be the market or, you know, something like the VIX? And you hear different sides to the story.
27:15So you have some people arguing that actually one of the key reasons the VIX has been kind of subdued recently is because of all the short dated trading. Then you have 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. Yeah, the size of short-dated option selling is very, very large. It's very, very one way. Again, 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 25 delta put wing to call wing, the overwhelming end user of that product is selling it for income or for, you know, for a asset allocation type of strategy.
28:08And what that means is 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. So go ahead, Joe. No, this is sort of where I was going to follow on to Tracy's question. I mean, if we were having this conversation in 2019, 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 retail and now institutional money flowing into this space?
28:51And I presume to some extent the reason you have a business is because there are these fingerprints. What do they look like? Yeah, absolutely. So taking this example of short dated option selling, for instance, the first thing you want to look at is the relative price. And what is that in the world of options and volatility? It's the term structure of volatility, which means where is implied volatility for the S &P, for example, which is one of the biggest parts of this ecosystem for 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?
29:26Yeah. Right. Let's get into this. And what you'll find is really in the evolution that you've had in that post 2012 regime has been the volatility term structure getting steeper and steeper and steeper. So lower 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 arbitrageurs, then have to go further out the curve to hedge. You see that very distinctly. Another thing you can look at is volatility risk premium, which is something you kind of have to estimate and look at empirically.
30:05It's not just the shape of a volatility term structure. But 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 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 2012, 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 to one point or a half a point.
30:43And then kind of to Joe's point, that'll blow out a little bit after a major market crash for a little while. And then you dive in. Exactly. Okay, one other thing. I thought you said that you die. That's actually what I heard first. You either die or you dive in. Okay, one other thing I wanted 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? Mm-hmm.
31:24Krishna 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. 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?
31:59And so there's this idea that, gosh, 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? And so you're incentivized to do negatively skewed things. Now, the multi-strats have very good risk management. They know this. They're not silly. So they're not going to just let you go sell a whole of options naked and put a bunch of puts and see 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 their risk systems a little bit better, at least in some size.
32:32Dispersion 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, 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 dispersion is 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 all know about doing dispersion.
33:08That shrunk very dramatically because P &L has been relatively poor. It's very cyclical. Multistrats are a fascinating thing in that regard. 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 stop out of PM. But it comes with a lot of weird incentives. An episode that I'd love to do that we'll probably never do is talk to a multi-strat PM essentially about how they game the risk parameters that are imposed on them by their manager. Maybe we could talk to a risk manager and talk about it. Maybe there's a retired PM out there.
33:42Yeah, and how they sort of try to find pennies in front of steamroller strategies that'll work for a year 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 MicroStrategy, which is an exotic wrapper of Bitcoin in some way, are extremely volatile. We all know that, and that's part of 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 3X micro strategy ETF. Who is the like customer for like, you know what, micro strategy, just not volatile enough for me.
34:25Not enough daily, not enough daily swings here or like, like what's good. It reminds me of, remember the like multi-blade razor commercial? And why stop at three? It's like, we have three blades, and we have four blades. We have six. Yeah, why not have a 10X MicroStrategy ETF? Why stop at three? Absolutely. No, it's really fascinating. My best sense from watching Twitter and people asking me questions is there's a community of people and kind of a voice for, hey, look, I've only got$20 ,000. 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 $20 ,000.
35:03And how are you going to do that? you need as much leverage as you can possibly imagine, right? So crypto is an attractive space because of this, because some of the things in crypto that you can do get 100 times leverage or something, right? So if that's your benchmark, actually 3x MSTR is relatively tame. It's a boomer. Exactly. It's pretty boomer. But yeah, these ETFs exist. And they're really fascinating, because normally the way that a leveraged ETF works is that the ETF issuer will do a swap with a bank and get 2x leverage or get 3x leverage. And it's a fairly simple and clean thing. But no bank is going to give you 3x leverage on microstrategy, right?
35:38Because the wipeout risk possibility is very real. The collateral is not going to cover a massive move down in microstrategy. And so what you would think of as vanilla things, it's just a leveraged ETF. 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 some of these underlyings. And MicroStrategy can go up a bunch and this huge ETF, 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 roll and buy a ton more of call options on MicroStrategy when there's very little appetite from the dealer community to provide liquidity on that.
36:23And it's a big mess. Are there options on the 3X MicroStrategy ETF? I would actually have to check. Some of the levered ETFs actually do. And yeah, it's kind of a running joke, right? You've got like the triple levered ETF on the thing. You've got the covered call selling ETF on that thing. You've got people running the wheel strategy on that. Just in sort of an infinite recursion of option selling abyss. Amazing.
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37:49The 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.
38:28Brokerage 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. Just going back to options influencers. So one thing that you see a lot 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. How do you make money in options by selling? I get the sense that it's not just you buy a put.
38:59It's something else. You're exactly right. So normally the way a derivatives trader would think about a 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 influence. It's this idea of this cheat code in markets where people just don't know this one cool trick. and I'm going to show you for only$99 a month. And the typical pitch, again, is you're just going to be doing some combination. 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.
39:34And 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$200 ,000 a year on a$250 ,000 account. but obviously that's not your profit from the trades you're just doing trades and you're selling that premium but you might lose money on those trades yeah right you're not that's not income and you know i 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 30 on your income thing right like it's you know these are trades but this community is not expressing what is this trade why is it good when is it good What's the price?
40:12What's going on? It's just saying, look, you can just sell these options and this is income, right? Which is totally crazy. So people come to you from time to time. You're a voice of reason. When we had you back on a few years ago, you know, people would 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 S &P 500 index ETF, don't do it. But then finally, 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?
40:48And like, you know, I do know most of the time you're like, just buy an ETF and live your life. That's a perfect analogy, Joe. Well, thank you. Well, where would you say, we're going to get DMs after this? Like, I want to learn more about how to do it right. Is there a way to start to learn to do it right? Yeah, absolutely. Usually the first thing that I do is I send people kind of 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.
41:17So 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 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 all say, look, if you have some kind of fundamentally driven or tactically driven process for coming up with a view on stocks, and you have a timing view, then sure, could you use a call spread or a put spread to express that view? You say, oh, I really like earnings on Tesla next week.
41:50Could 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 you're risking. 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, 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 50 % leverage or, you know, or something like that.
42:22And 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 to think about the risk reward 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. What's your favorite options blow up or derivatives blow up? And I'll say I'm partial to Volmageddon in 2018 because I wrote a lot about it. And I'm still traumatized by the reaction of VolTwit when I said it was going to blow up when the VIX was going up.
42:56But what's your favorite? Well, VolMageddon is a great one. You know, you've talked about that. Everybody else has two. So I'll give you something else. I mean, I think possibly my favorite was Allianz Structured Alpha, which blew up in 2020 in March. And the reason was, you know, Allianz is a huge sort of safe conservative firm that everybody would look and say, oh, they would never be doing something kind of crazy. because they're very buttoned up. They're very serious people. They own Pimco. But they had these French kind of option traders. And Joe laughs because it's always the French. It's always the French.
43:30There's just something in the DNA. And 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 put. They'd do a few other things. Think of that as the core thing they were doing, right? And that's kind of safe-ish, right? You're getting some credit, you're earning some premium, but like you're supposed to know how much you can lose. Yeah. And then, but the returns were pretty good. They actually kind of kept up with equity markets, which doesn'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, or they were buying it back, but like way, way, way lower strike than they said that they were buying it back, right?
44:07So that's obviously one way to make more money kind of. That sounds really bad. Yeah, that was really bad. And 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 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.
44:38Then they have a Word document with 18 points on how to do all of the lying and number fudging for all their analysts to be able to follow. And instructions on how to not hover your mouse. How do you fudge the numbers? Allian Structured Alpha, Greg Turant. And it's like, don't hover your mouse over a formula. It's supposed to be a formula, but it's hard coded because the investor might see that. Stuff like that. And with very detailed emails on all this kind of how to lie kind of stuff. the fund. And then what happened was, you know, obviously in March of 2020, 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.
45:15And 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 then when everything comes back, we'll just make that money back and We won't have to tell anybody we lost money. This SEC complaint is amazing. Defendants reduced losses under a market crash scenario in one risk report sent to investors from negative 42.15057489755747 % to negative 4.150. They just removed a number. Yes, that's right.
45:50They just took off a decimal place. They just took off a decimal place. That's right. It was all just hard-coded. That's incredible. They didn't have some sophisticated methodology for this. They literally just typed the numbers into the spreadsheet. Sometimes, and this gets to the, I mean, to be honest, you don't really even need to be French to do this. No, you don't. That's right. I could have come up with this one. I don't need to go to Ecole Polytechnique to come up with this. You just go to cell C6 and you just overwrite the number. Some people do screw up math. Even sophisticated traders, sometimes math is tough at this level.
46:25But 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 VIX futures at about 25. And then the front month VIX futures went to 85. And so they were liquidated middle of March in a huge catastrophic explosion that people like us were shown the auction and everything. And they drove the relative price of the VIX options and futures to twice as high as it had ever been relative to S &P in this sort of spectacular implosion. They went to zero. They lost billions and billions of dollars for teachers' pensions and all this kind of stuff in just total and utter fraud.
47:05Again, at a very big buttoned up place. And actually, one of the funny takeaways from it was in all of the lawsuits, Allianz stepped up and settled lots of lawsuits and paid investors back all this money. And it 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. It was just that you could sue them and they would pay you. 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 bonds type fund.
47:41Burgers and bonds. 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's like euro dollar futures and swaps, things like that. But 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? 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?
48:14And my choices were Bill Gross of PIMCO, Warren Buffett. Who else was it? Oh, Yas of Susquehanna. and Jim Simons of Renaissance. And everybody was really confused because they're like, none of these people are derivative. Well, Jeff Yass is a derivatives trader, 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 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, with tens of billions of dollars of P &L.
48:50People 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, funky thing. You don't really have listed options that people can sell as easily. But, you know, big institutions have been involved in this stuff for a very long time. I guess it's probably coming.
49:16If it makes people money, I'm sure there's going to be a product invented. You could tickerize it. Yes, absolutely. They made a VIX for fixed income called Move, M-O-V-E. Oh, yeah. Oh, 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, come back. Yeah, we'll definitely be calling Ben the next time there's a blow up. That's actually a recurring theme in our stuff, 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.
49:45Listeners, consider this a warning. Can I just ask one more quick question? Of course. Why? Like you lay out these with the buffer ETFs 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 not much cash. Why is it so big elsewhere? 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.
50:21So 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. And then they put on the trade. They put it on with a couple managers that they like and they go out to dinner with them once a year. It's a footnote in a long report on performance. And as long as it's just kind of modestly 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 big institutions are doing. Yeah, retail is different.
50:50But, you know, call overwriting, you know, unlevered call overwriting doesn't blow up. It just underperforms and underperforms. It's going to take them 10 years to never decide to stop. All right, Ben Eifert, until the next blow up, I guess. Wonderful, guys. Really fun.
51:15Joe, that was fun. I love talking to Ben because he's a funny, fun guy and also just explains things really well. I'm wondering, should we get the she-wolf of Indian options on together with Ben to fight it out? Yeah, let's just do just a rigorous one-on-one debate about whether you can really earn 100 % in 10 minutes. It's really funny that they actually, as a regulator, they're like, you have to stop this, that you have to get out of the market. 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.
51:57And options fit perfectly into that, right? Like, why wait 10 years to make a decent, reliable return when you can buy zero DTE options and make a bunch of money in a day? You know, 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 flip of the Super Bowl and stuff. Or you see like Robin Hood selling futures on who's going to win a Super Bowl football game or whatever.
52:38the 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. Yeah. Well, shall we leave it there? Let's leave it there. This has been another episode of the All Thoughts Podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway. And I'm Jill Weisenthal. You can follow me at The Stalwart. Follow our guest, Ben Eifert. He's back on Twitter after a hiatus. He's at Ben P. Eifert. Follow our producers, Carmen Rodriguez at Carmen Armin, Dash O 'Bennett at Dashbot, and Kale Brooks at Kale Brooks.
53:13For more OddLots content, go to Bloomberg.com slash OddLots, where we have a newsletter and a blog. And you can check out all of these topics 24-7 in our Discord, discord.gg slash OddLots. And if you enjoy OddLots, if you like it when we reminisce about volatility blowups, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad-free. All you need to do is find the Bloomberg channel on Apple Podcasts and follow the instructions there. Thanks for listening.
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From the publisher
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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