Tina Lindstrom is a Partner at First NY, where she manages an oil volatility portfolio.
She began her career at Susquehanna and eventually worked her way up to managing both the high cap equity index group and the commodity volatility group. This gives her the unique perspective to be able to compare and contrast how these two markets operate.
Tina explains what makes commodity markets unique, how the structure of markets has changed over time, how relative value trades might emerge, and what happens when you’re trading volatility and front-month futures go negative.
Please enjoy my conversation with Tina Lindstrom.
Corey Hoffstein 00:00
Okay 321 Let’s do it. Hello and welcome everyone. I’m Corey Hoffstein. And this is flirting with models, the podcast that pulls back the curtain to discover the human factor behind the quantitative strategies.
Corey Hoffstein Is the co founder and chief investment officer of new found research due to industry regulations. He will not discuss any of new found research funds on this podcast. All opinions expressed by podcast participants are solely their own opinion and do not reflect the opinion of newfound research. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of newfound research may maintain positions in securities discussed in this podcast for more information is it think newfound.com.
Corey Hoffstein 00:52
This season is sponsored by simplify ETFs simplify seeks to help you modernize your portfolio with its innovative set of options based strategies. Full disclosure prior to simplify sponsoring the season, we had incorporated some of simplifies ETFs into our ETF model mandates here at New Found. If you’re interested in reading a brief case study about why and how. Visit simplify.us/flirting with models and stick around after the episode for an ongoing conversation about markets and convexity with the convexity Maven himself simplifies own Harley Bassman. No Lindstrom is a partner at first New York, where she manages an oil volatility portfolio. She began her career at Susquehanna, and eventually worked her way up to managing both the high cap equity index group and the commodity volatility group. This gives her the unique perspective to be able to compare and contrast how these two markets operate. Tina explains what makes commodity markets unique, how the structure of markets has changed over time, how relative value trades might emerge. And what happens when you’re trading volatility and front month futures go negative. Please enjoy my conversation with Tina Lindstrom. Tina, welcome to the show. excited to have you here. Excited to get think a little bit of a different perspective on the show. We don’t get a lot of people trading commodities. And we definitely don’t get a lot of people trading volatility in the commodity space. So I think this is going to be a fun one for me and the listeners. I would love to start off I know you began your career as a trader at Susquehanna. Can you tell me a little bit about your path to becoming a trader?
Tina Lindstrom 02:38
Thanks for having me, Cory. Well, I was recruited right out of college, I went to the Ross School of Business at Michigan, and I was recruited for an internship. And after that summer, I was hired. So I had to be an assistant trader for a year shadowed some senior traders. And during the day when you were not clerking, they would explain trades that happened during the day, why they were good, why they were bad. And you can ask them as many questions as you want it to when they weren’t busy. It was very team oriented, a lot of mentorship at Susquehanna. And then after work, you would go, and I think two times a week, you would go to mock trading. And they would simulate a stock during mock trading. And you would compete against, let’s say, 10 to 15 of your classmates. And whoever did the best they would pick maybe six from each city, or year after about a year of clerking. And then you would take some mathematical tests, and then they would see who they wanted to promote from each city. And then you would go to falconwood, where you would learn during my time, they hired the head of mathematics from the University of Virginia. And that person gave us theoretical training during the day for a few hours, and then we would do mock trading. And then we would also play poker with each other. And after four o’clock, the partners would come and play poker with us. And other senior traders, it was pretty cool. You were playing poker with each other. And then 430 Jeff EOS would come and play poker with you. And that was how the educated you and that was how they learned about you and formed judgments about you and watched your decision making was was really pretty cool. Do you still play poker only day to day only only during market hours, only during market hours.
Corey Hoffstein 04:38
So I know you eventually ran cigs high cap equity index group and their commodity volatility group, which naively from the outside sound like just very different types of products to me. I’m curious how you would sort of compare the equity index versus the commodity derivatives markets,
Tina Lindstrom 04:59
the equity indices were very similar to equity style options, except then you had the correlation component. The skew was usually to the puts the fear was the downside to the upside the calls, it was negative call skew right? As we drifted higher, there’s less fear. The vol surfers was lower on the upside. So in commodities is almost the exact opposite. The fear is to the upside, if you you’re afraid when you run out of a commodity, that’s when you’re afraid when prices spike when you can’t get supplies. That’s when you’re afraid most of the people who are hedging are people who need the commodity for example, lumber, or ethanol corn for ethanol or crude oil or something like that. Incidentally, now crude oil vol is similar to equity solve all actually this year the ball surface because there’s a lot of hedgers from the macro space that come in and play and so the skew resembles an equity style skew until something happens when something happens, it will tend to flip and look like the typical commodity of last mile. So before
Corey Hoffstein 06:17
we go further diving into the things that make the commodity space unique, I was told that I have to ask you about the astrologist that was in the Russell options pit. So what’s the story there?
Tina Lindstrom 06:30
So there was a guy named que que his badge was Q k. And qk was an astrologist and he, as soon as you walk into the pit, he would ask you what your birthday was. And he had this book that matched the times when something happened astrologically between your birthday and his birthday, and he would go after people and trade with them. When the stars aligned.
Corey Hoffstein 06:56
He would like specifically choose a specialist based upon when the stars aligned.
Tina Lindstrom 07:01
So on the knife pit, it was an open outcry pit. So he knew everybody’s birthday. So he would go up to a random local market maker, a specialist, whoever, and trade with them at 221, on six months from his birthday, 200 days from your birthday, whatever his book said, was an advantageous time for him to enter a trade with you.
Corey Hoffstein 07:24
And so how long did he last in the pit for a long time,
Tina Lindstrom 07:27
he just he didn’t trade anything. He I think he was a dog walker, for living, but during the day, so I think he made money as a dog walker. And then he would just stand in the pit all day and wait for these times to trade with you.
Corey Hoffstein 07:43
One of the things that I’ve learned when talking to sick traders and ex sick traders throughout the years is that almost everyone at CIG seems to be trained in a relative value style of trading. And so to level set the rest of this conversation, I was hoping you might be able to walk us through what sort of a prototypical relative value trade might look like. Maybe specifically in the commodity space, the sort of things you’re looking for in the structures of the positions that you’re putting on.
Tina Lindstrom 08:13
So first, you would come and you would fit, let’s say your wall smile and all the different months and all the different SKU points to fit the market, then you would look for any kinks. So let’s say Vall was on the front 130, then 32, then it goes to 31, then back to 32. Then you wonder to yourself, Okay, why is the third month cheaper than the second month in the fourth month? And then you would say to yourself, Okay, is there a seasonality? Oh, there’s seasonality? Okay, move on. There’s no seasonality what is what is the reason for this kink? You would investigate further? And you would say, okay, oh, I heard that this macro fund decided to this macro tourists decided to that in three months that we were going to rally, so he decided to sell puts live to express his flat price view, then you think, oh, okay, that makes sense. And to me after I’ve investigated and found out why it was there, then I could put the trade off, then I could buy I could buy that month, the low month, saw the wall around it, and then wait until it gets fixed. Once he’s done with the order. Probably some other wall trader will come say, oh, that doesn’t make sense. And they’ll put it back into line. My style is not to sort of fix things. Mine is as little slippage as possible and entering these relative value trades to keep the expectancy there and I wait for somebody else to put into line.
Corey Hoffstein 09:50
You briefly alluded to seasonality effects. And I find at least in my research, there are seasonality effects in almost all markets but it does seem like particularly acute factor for commodities are things like weather patterns and harvest cycles are going to play a really important role. One that I hadn’t really given much thought to but you brought up in our prior conversation was around how different futures contracts may actually represent new versus old crops. So same futures in theory, but totally different commodities. I’m curious as to how that affects the underlying opportunity set for relative value trading.
Tina Lindstrom 10:30
So an equity is, it’s more interest minus dividend, you can calculate the basis, you can’t really use that model in commodities, if you try to interpolate one month, unless they so there’s options months based on one future, there’ll be two or three on one future, you can trade those against each other. But if you were trading options on one future versus options on another future, that where there could be some kind of very different seasonality very hurricane season versus non hurricane season, freeze versus drought season, you could be in a lot of trouble. So you would never and a case that we talked about before where you would just butterfly it, you can kind of do that after adjusting for seasonality. But if you do something like that in orange juice, or coffee or cotton, you can get in a lot of trouble. So you really have to be you really have to know what you’re doing. And explore all those things before you put on time spreads.
Corey Hoffstein 11:30
Commodities is a space that’s changed a lot over the last 20 years. In the early 2000s. There was this really big uptick in the use of commodities as a passive asset class. And then after 2008, there was a huge inflow of capital into CTA style strategies. How is this sort of structural change in market participants flowed through into how the related volatility markets behave.
Tina Lindstrom 11:56
Most of the people who trade options are hedgers or specks who have been in the market, whatnot, and a lot of people who trade trade on fundamentals. But sometimes you have to watch out for a macro unwinds or some macro guy with maybe it’s not a whole macro sell off event, maybe he has a problem. And then they have to sell a sizable amount or buy a sizable amount of the book to cover. And then you trigger signals from technicals that trigger a CTA selling or buying, then it triggers other stops. There’s a lot of stops used in commodities. And you’ll have a nonsensical move where it’s you would think it’s a one or two standard deviation, but then it’s like, how could this be that’s like a five standard deviation move? We were trading 1% up or down ranges for two weeks, and all of a sudden, we traded a five standard deviation move for no reason why Oh, CTAs got liquidated? Okay. It’s fundamentally bullish still. But we just had this huge move down why CTAs? So I would think that it brings sort of a y factor, I guess, some outlier event that you can’t really price that you really have to have in the back of your mind.
Corey Hoffstein 13:16
How has that affected the way you think about managing risk in your portfolio?
Tina Lindstrom 13:21
You definitely always have to have your wrist tied off. So if you think okay, 95% chance, I’m right, I think volume is too high. And let’s say you get shorts, on some vol, you have to take part of your money. And you have to spend it on some wings, just to stop the risk from getting out of control if something you didn’t expect happened.
Corey Hoffstein 13:43
So you’re now a partner at first New York, where you manage an oil volatility fund specifically, what do you see as being the biggest difference in this role versus when you were operating as a market maker?
Tina Lindstrom 13:56
I think the market making business is extremely hard because you take the other side of a trade that somebody has thought about somebody has spent time researching and thinking about what trade to put on, and then they put it into the market. And then you have to take the other side. If you’re a market maker, you have to price the slippage of volatility well, and how much am I making to take the other side of the trade and maybe try to get out of it after fees and in time to scrape some money. Whereas a prop trader, I’m a prop trader now and so I decide when to enter a trade. I decide what kind of structure to put on and what the Greeks and the risk reward looks like. So I’m the one now who has sat there beforehand and thought about what I want to put on. I think it’s very different. I like this side better than being a market maker.
Corey Hoffstein 14:51
Do you think your experience as a market maker has made you better on this side of the table, either your direct experience or your internal reaction with clients from the other side.
Tina Lindstrom 15:03
I definitely think so because you know how a market maker thinks, you know, they’re trying to game you they’re trying to maximize, they’re expecting to see. And from my side, a lot of the alpha is net of execution costs. Its net of execution costs, and one, the largest execution costs is bad execution. So if I’m pricing something myself, and I asked for a quote, I know if they’re failing me, if they’re making markets too high thinking, I’m a buyer or whatever. So I definitely think I execute my own trades better with my experience.
Corey Hoffstein 15:39
So when I was talking to you at first about coming on the podcast, I think you very adamantly told me five or six times that you are not a quant? You’re not a quant? You shouldn’t be on a quant podcast. I I personally, very strongly disagree. I think anyone who operates in the field of derivatives has a very strong quantitative background. I think probably what you more meant was that you’re more discretionary, less systematic, doesn’t mean you’re not a quant. But so with that in mind, what I do want to know is what is your process for generating discretionary trade ideas?
Tina Lindstrom 16:12
What is my process? Okay, so basically, because I’m a vowel trader, I study the ball surface every one and a half minutes, I study the ball surface and how it moves every one and a half minutes real time. So I can see the kinks in the portfolio. And then I go through the process. What am I missing wises kink here? Okay, this guy is betting on this thing. Okay? He’s expressing it wrong. He’s, he’s a Delta guy. He’s a guy who’s betting on crude oil going up. He’s a guy who’s betting on crude oil going down. Okay, I have an axe, I think that I want to sell vol. Okay, I want to sell ball. So this guy, these calls are too high, because somebody’s betting on futures going up. Okay, I think futures are also going up. So I’m going to sell the same calls hedged. Or maybe I’ll over hedge it, what kind of turbo Am I using? How am I adjusting my price, fall correlation, stuff like that. So that’s sort of my process, I’m more opportunistic relative value. And then I’ll say, okay, and this other product, because I do trade the whole entire barrel of oil, I’ll say, okay, and this product is expensive, but maybe I can buy this against somewhere else and hold it in my portfolio, and just reduce my variance little bit.
Corey Hoffstein 17:29
So because you brought it up, you mentioned you do trade the entire barrel. For those of us who maybe aren’t as well versed in the different parts of the barrel, can you explain what those different parts are? And then I’d like to know, how does the market structure of those different products differ in terms of how the markets operate? Or the vol surfaces look? And how does that present different opportunities to you in sort of a relative asset basis?
Tina Lindstrom 17:57
Okay, so I trade Brent and WTI crude oils, I trade gas oil, which is what barges are run off of. And I trade heating oil, which is very similar to jet fuel. So airlines will come in, and hedged air and our Bob gasoline. So in the crude oils, you have producers, hedging producers, could be an oil company could be a sovereign country like Mexico, or Brazil. And they come in and they hedge their oil production. But in Arbab, and heating oil, you have sort of opposite flow, because you have consumers who also hedge. So in crude oil, you would have put buyers call sellers. In heating oil, you could have call spread versus put sellers, they buy the call spread, sell the put same thing with Arbab. So they’re different. They have different kinds of flows, but they have different risks, too. So our Bob, if you didn’t know any better, you would get sort of enticed into selling August, September, October Arbab evolve. That would be a very big mistake. It looks very expensive, relative to heat, and even crude. But then if you sell it, and then all of a sudden it’s hurricane season, and something hits the Gulf of Mexico, you’re in big trouble because it’s very, very liquid and nobody will let you out. So those are sort of the things you have to be cognizant of when you’re trading that stuff.
Corey Hoffstein 19:29
How do you think about position size both at the outset of a trade and managing it over its lifetime?
Tina Lindstrom 19:36
I would say because of my Susquehanna training. Okay, so first you would enter a trade. If the higher edge you think you’re getting to what you think it’s worth, the more you would put on and also you have to adjust that for the volleyball. So, for example, last year, during March and April today happens to be is the one year anniversary of the low print in crude oil history. So if I was ever trading 300 500,000 up, I was not trading that size. During those days, you have to pick and choose okay. But back then, of course, markets were wider. So you had more wiggle room. But definitely you did not want to be short gamma, you can’t get that back. So you have to size appropriately that you know that you’re going to be able to get out and know how much money is that going to cost you? So I would say now during a normal environment, it’s how much do I know what’s going on? Why is it trading here? How much edge do I think I’m getting? What levels? And sizing? Should I scale into it? Because I know if something happens, and it doesn’t go as planned, how much will it cost me to get out how much liquidity behind this is there?
Corey Hoffstein 20:54
Because he brought it up, you know, we have to go there and talk about when front month oil futures traded, I think the low print was like a negative $37 per barrel or something like that. And April 2020. And negative prices are going to break a very traditional volatility model. And so I’d love to know sort of how your day went, if you can recall what it was like April, I think was April 20 2020, the one year anniversary, how you navigated this event, how to flow through to your models, how to flow through to your portfolio and how you manage the risk.
Tina Lindstrom 21:29
So that’s funny, because most of the market, we use an out of the box model that’s been around for years very popular. I’m not going to call it out, but it broke. Why log normal models did not work when prices could go negative. So the exchanges listed negative prices, negative strikes in oil, and this skew the term structure and the skew the wall surface you could not it was unmodifiable. I mean, the numbers made no sense at all. I’ve never seen numbers like this before, and basically broke, I would look at the model and I would say okay, using Black Scholes it was giving me if I bought puts, I would get long futures, something outrageous. So working with the company that made the model, they said well, okay, the only way to fix this and it’s not a great fix is to use a CSR model, Calendar Spread model, where calendar spreads in commodities, because it can be backward dated, or contango, the front month can be over a second month, or vice versa. It can be positive or negative. So that’s the only model that you can use. So everybody flipped over to a CSO model to price this event. So it was very dicey. And because of that, markets became very, very, very wide. And there was good opportunity there.
Corey Hoffstein 23:02
So it makes me think that when the market gets dicey and typical liquidity providers have their models break, or the models start being a garbage in garbage out scenario, there’s sort of two responses. One is to go in and trade it with your intuition. The other is to just step away and not trade at all. Do you think that part of the dysfunction in the market that day was largely because of number two, that many participants just felt unable to trade the markets and so they disappeared?
Tina Lindstrom 23:34
Well, they didn’t really know what things were worth. And I would say in a lot of the market making companies, it’s a whole team, there’s one or two senior traders, and then there’s three to five less senior traders, you can make a mistake, you can make a big, big, big mistake and blow your company out. So I think the risk was there. And I think people, companies, a heads of companies, everybody had to have a discussion. What do we want to do here? Do we want to put chips in or do we want to take chips out? And I think if you didn’t see sort of this thing coming, and you didn’t have the bullets, you couldn’t trade? If you weren’t selling out a long convexity at a great price. You weren’t selling it short.
Corey Hoffstein 24:20
Equity markets have mostly gone electronic at this point. But the same isn’t necessarily true for commodity volatility markets. How do you think the efficiency of a market changes when trades are still largely done via hoot and holler or instant messages?
Tina Lindstrom 24:40
I think there are electronic markets and these commodities markets, but they’re definitely jumpier than equity markets, because there’s so much different risk that you could not be sure of. It could be Oh, is a producer trading with me? Is this producer natural hedging and they’re not making any kind of assumption or statement about the vol surface or skew they just want to hedge? Or is this somebody who knows? Is this Marathon Oil? Do they see a hurricane coming? And I don’t know about a year. So it’s, I would say, it’s like trading a higher vol stock. And I would say those probably are wider on the screen electronically and equity options as well.
Corey Hoffstein 25:30
How much more or less important to relationships become when you’re trading hoot and holler and via instant messenger? I mean, do you have to know the people on the other side to feel like you’re gonna get a good fill or accurate information?
Tina Lindstrom 25:42
I think you really do it relationships matter a lot, I think in all businesses, right? I think with equity options, if you’re the top two or three equity options shows you get the best information. And brokers I think, in general, on every market, they want to know, you’re an upstanding person, you’re not going to do anything manipulative, to run the stock on them, where they can’t get filled, you have mutual respect, where you know, they’re not lying to you. And they’re showing you their hand if it’s 200. But it’s 2000, you’re not going to trust them anymore. So if we have mutual respect, it goes a long way plus the voice broker stuff. I’m committing millions of dollars 1000s of barrels of oil, every trade, if I wasn’t a good person, I don’t know the trade. That’s not, that’s not what I meant. I don’t know what No, you know what I mean by that price. Whereas if you were trading electronically, then it would be up to the exchange, then you can play into the exchange, they would be the arbiter here, it’s like the market almost couldn’t function if you didn’t have mutual trust, and he didn’t know the other person didn’t have a relationship with them.
Corey Hoffstein 26:51
Oil is an incredibly political asset class at this point, which seems like it introduces a very unique risk factor, compared to maybe some other like agricultural products. For example. How do you think this affects how oil behaves? And what does it ultimately mean to you in terms of how you’ve to think about managing the portfolio?
Tina Lindstrom 27:15
I would say before I traded oil when I was trading eggs, you pay attention mostly to property portraits, whether now I’m on Twitter, looking for aircraft movement. I’m following Arab Twitter. I’m following Israeli Twitter. I’m seeing what terrorist attacks are happening. I want to see breaking news, I want to know if there’s a reshuffling of the oil minister. Okay. What does this mean? Who is this guy? More bold up? Is he good? Is he coming to the oil market? Or is he going to increase volatility? How does the new president get along with Saudi Arabia? Okay, what’s going to happen? When the Khashoggi report comes out? Are they going to call Saudi Arabia out? What’s that going to happen? Oh, they’re doing it right before the OPEC meeting. Why are they doing that? Okay? How does that affect the optionality of the options month with that gamma, all of these things? How are the talks going with Saudi Arabia and Iran, you have to study all of that you have to understand the players. And it’s Saudi Arabia, it’s Iran is UAE, it’s Israel. It’s the US, it’s Russia. I have to pay attention to all these things that I’ve never had to before. So it’s quite different.
Corey Hoffstein 28:29
One of the things that it seems to imply to me is that because oil is so political, you ended up getting a lot of macro tourists who enter the space and start speculating from a macro political perspective. What do you think they get wrong about the market when they come in naively,
Tina Lindstrom 28:50
sometimes they overpay a lot of macro tourists, the way they like to express their views is by buying options. Now, instead of buying futures, they buy options, why their downside is capped. They can say to an investor, okay, I spent 1% of AUM on this strategy, it worked out or it didn’t work out. If it didn’t work out, I lost 1% For worked out on making 5% They could quantify risk reward to their investors. Now, sometimes I’ve seen fund managers be very right about direction, but they were wrong on the vol level they were paying to express the view let’s say they want to buy 20,000 calls. Well that 20,000 calls. Let’s say you go and a lot of macro guys go electronically. They hide it on the screen, okay, but they don’t hide it that well, and people can sniff them out and they execute poorly. If you give it to a broker, he comes up with maybe a wider price, but he gets you going out one price better than if I had 20,000 options to buy and I was buying it 1000 at a time and people saw me come Make up raising the price club raising the price. Because now when the macro tourist is right and is trying to get out, Oh, this guy, this strike, oh, he picked this strike Oh, okay, he’s on the screen. Let me lower my balls on the screen. Okay, let me lower my balls a little bit more. And there’ll be 1,000% right on the flat price move, but made very little money if at all because they expressed it wrong, and they execute it wrong.
Corey Hoffstein 30:26
You told me a funny story before we started recording about someone who came in and bought option contracts on the wrong futures contract. Do you mind retelling that story?
Tina Lindstrom 30:37
It was uh, maybe it was like five to seven years ago. And I forget the exact thing but I think they moved the OPEC meeting or something. And so on the screen, I think it was a July contract. They moved it to July. Okay, they moved it from June or July or something. And the July options contract for crude oil just went ballistic. Somebody was betting on a bullish results. During that OPEC meeting. We really didn’t understand it because options on commodities expired different expirations than then equity options. And I think it expired either a month or month and a half before the OPEC meeting. So they bought the wrong month. So it took maybe two or three days, for me to at least realize this is a major sale. Initially, I didn’t understand what was going on. Because I had the time spread on right. I looked into it. And then it was really going against me. And I’m like, What is going on. And I was like, oh my god, this is a macro person who didn’t realize the expiration dates, and turned out to be a super trade.
Corey Hoffstein 31:47
So this whole commodity volatility space is unique, arguably pretty esoteric, as we just sort of reviewed, and it’s not an asset class, or derivative space that most allocators are going to be intimately familiar with. And so what I want to know is if I flip the table on you, and you’re doing due diligence on yourself, I thought you’re skipping this question. Now, this is one I got to ask you want to skip the last time? No, I gotta ask, what question are you going to ask yourself and why?
Tina Lindstrom 32:20
So I think, perhaps the years of experience somebody has at running that particular strategy. And also, one thing you’ve already touched on how important relationships are? And how much of that does that particular manager have? I think that’s super important.
Corey Hoffstein 32:40
So the world seems to be opening back up. People are getting vaccines. A lot of people I know at least are starting to plan travel in the summer fall pretty hopefully. So keeping the fingers crossed that the world maybe gets back to some semblance of normalcy later this year. What are you most looking forward to?
Tina Lindstrom 32:59
So I used to go into the office every day. And I’m friends with a lot of the brokers in the market. I’m friends with a lot of them, and I would see them about twice a week. And I would say, let’s skip the John George. Let’s go boxing. Let’s go work out. That was my thing. Let’s go to Barry’s together. Let’s go to rumble. And rumble has been closed for a long time. So I am looking forward to going to rumble twice a week or SoulCycle with my friends and just the Hangout.
Corey Hoffstein 33:31
Well, Tina, thank you so much for joining me, this has been a great conversation.
Tina Lindstrom 33:35
Thank you so much for having me.
Corey Hoffstein 33:40
If you’re enjoying the season, please consider heading over to your favorite podcast platform and leaving us a rating or review and sharing us with friends or on social media. It helps new people find us and helps us grow. Finally, if you’d like to learn more about newfound research, our investment mandates mutual funds or associated ETFs. Please visit think newfound.com. And now welcome back to my ongoing conversation with Harley Bassman. Harley, you’re known as the convexity Maven. And you very frequently write about long convexity trades. I’m curious in your opinion, when does it make sense to be short convexity?
Harley Bassman 34:21
It depends if you’re selling to maturity to expiry, or you’re selling over a horizon where you plan on buying back. The big options sellers that we see the institutional options sellers tend to sell options every day, one to three month options. And then they go in they do a we call delta hedge but they do some kind of trade also every day to manage that risk. And they in general win on these short dated options because implied volatility generally trades eight to 12% Over realized volatility on liquid instruments. So if you’re in basic equities, basic bonds, basic commodities, basic currencies, if you sell one through five options, and hedge them every day, you will tend to make money. The reason why it trades, let’s say 10%, over realized is once again, risk preference, people are not risk neutral, and therefore they’re scared. And these losses can be very magnified with short optionality. So people demand a little bit of extra premium. And so that’s one way of doing it. That is not for anybody watching this call, that’s just where the options come from. Number two would be a sell to maturity. So most often, for me, I’m selling a put on some asset, I would like to own at a certain price, if a targeted by as long as I have the cash in the bank to buy that asset. And I’m still confident I want to own that asset at a given point, I’m happy to sell that option. Assuming that the matrix of where the market is now, where the strike is how much money I’m taking in. If a stocks trading at 50, they sell the 40 put for $1. That doesn’t work for me. If I liked the stock that much, I mean, I think it’s fine to go higher than 51. That’s probably a bad idea. You want to take in enough money so that it covers the opportunity cost of the stock never going down but going up a lot, you missed it with trade, the other one would be a covered call, which mathematically is functionally the same as a short put long a stock, short the call, put call parity, Black Scholes equals the put. So once again, if given a high enough volatility, and a profile, and it’s I own a stock at 50, I would sell it at 60. If it got there, that’s my target, and someone will pay me three or four points for that 60 Strike. Well, I’ll pick it up another three points on what I already have. And I’m happy to sell at 60. That is a fine thing to do. Of course, the risk is you better be confident that the stocks gonna stay where it is you go a little higher in stocks get dropped by 20 points. And clearly you should have just sold the stock because it was slow on the call. So that’s what I’m going to be comfortable. I very, very rarely sell long dated options, except for one time. We might talk about that in a different podcast.