A Volatility Arbitrage Trader On What Markets Are Saying Right Now

Tracy Alloway (0:11)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

Joe Weisenthal (0:16)

And I'm Joe Weisenthal.

Tracy Alloway (0:18)

Joe.

Joe Weisenthal (0:18)

Yes.

Tracy Alloway (0:19)

Did you know, did you know that the VIX futures-

Joe Weisenthal (0:24)

This is super dramatic.

Tracy Alloway (0:26)

It's not that interesting. Did you know that the VIX futures curve has been inverted or kind of inverted for, I think like six months now, basically since February.

Joe Weisenthal (0:39)

I didn't realize it was then, or I didn't realize it had been six months. So basically that means that investors are hedging again, just higher volatility out in the future than they are right now or the other way around?

Tracy Alloway (0:55)

The other way around. So it means people are paying more for volatility protection in the near term than they are in the future, but that's unusual, or at least it's counter to how the VIX curve normally looks.

Normally the VIX curve is upward sloping because there's more uncertainty further out into the future and so you pay more for that volatility insurance. So it's kind of unusual to have the VIX curve downward sloping for this long. And I guess it's one of those things that tells you that we're in an interesting place when it comes to markets at the moment.

Joe Weisenthal (1:30)

Yeah, I mean, it makes sense that people are paying up more for short term hedging right now, because we obviously are just in extraordinary times. You know, you look out a little ways, one year, two years, you could sort of envision a return to normal, but it feels like we're in a period where anything could happen tomorrow, whether it's policy, whether it's related to the virus, et cetera.

And so, yes, sort of intuitive that people want hedges in the here and now.

Tracy Alloway (1:59)

Yeah, and of course the big event risk on-

Joe Weisenthal (2:02)

But can I say something though?

Tracy Alloway (2:04)

Go on.

Joe Weisenthal (2:05)

No, this is something that's always bothered me, and maybe we'll get into this with our guest today. But I don't understand why it's not always like that, because I understand that most of the time, people want to pay out for some protection because the future seems like less certain than the present, so I get that in theory. But on the other hand, one of the central sort of like dogmas of finance is that, over the long term, things go up, the economy improves, stocks go up, et cetera. So it always seems to be like it should actually be the other way around, where it's like in the short term, anything can happen, but in the long term, things are smooth.

So I've never really understood the premise of why VIX futures curves slope upward in the first place, but anyway, we can get into that later.

Tracy Alloway (2:50)

Yeah, I mean, there are dozens and dozens of exchange traded products whose very existence is predicated on the VIX curve sloping upwards in normal times.

But yes, we should ask the question, I guess. All right, well, you've already sort of given it away, but in this episode, we're going to be talking about the current volatility regime. And I was about to mention that there is a very big event risk coming up on the horizon, which is the US elections. And we've seen a lot of talk about volatility hedging ahead of that. We're going to get into that. And we're also going to talk about some of the longer term changes in volatility market structure, including maybe even why the VIX futures curve is normally upward sloping.

Joe Weisenthal (3:36)

Now, I'm super excited about this one. I mean, it's obviously been an extraordinary year, I think, due to the rise of these sort of discrete events, whether it's the virus itself, the big thing that's coming up on November 3rd of this year, which could be producing extraordinary amount of uncertainty.

There's been so much interest in what volatility futures or vic futures curves on all sorts of asset classes are sort of anticipating on how wild things could get. We also, as we spoke about with Ben Eifert a few weeks ago, there's the emergence of this whole class of sort of retail derivatives buyers, call options buyers, also sort of breaking historical patterns potentially in terms of how hedging markets look. So this is an extraordinary rich topic to dive into. And although we've hit it in some ways in the past, it doesn't feel like we can ever really talk about it enough.

Tracy Alloway (4:33)