The Macro Trading Floor transcript – 23 August 2024

Alf: Buongiorno, everyone. Welcome back on the macro trading floor. Alf speaking and my good friend Brent with me. How are you doing, mate?

Brent: Buongiorno, Alfonso. I am good. I’m about to take my son back to school and I think you’re off next week too, right? So I guess we’re both off.

Alf: Well, we are both bold and sometimes we agree on macro and we’re both off next week, man. What’s going on?

Brent: The bold and the bold.

Alf: Bold macro calls. Okay, enough. Let’s talk about some serious stuff. So what should I say? So if you were off for the last month, 22nd of July. And then it showed up today, 22nd of August. Then you looked at a bunch of markets and you said, Oh, well, equity markets are you know, 1 percent off the highs where I left. Yeah, it’s okay.

And then you looked at other markets. You were like, what, what, what’s going on here? Like, why is the bond market rising a million bazillion cuts compared to a month ago, all front loaded. But then, but then the terminal rate is still like 3%. So it’s all like the Fed is in a hurry. We’re pricing the Fed in a hurry to cut rates, which we weren’t doing a month ago.

And then you would look at the facts and you’ll see like, Euro dollar one 11. And, and you know, the dollar is trading weak. And, and you would see, you would think something like massive, gigantic fed pivot, which is somehow sustaining equities and something along the line of that. Right. And you haven’t lived manic Monday.

You don’t know, right? You are on holiday. So, so let’s assume you were this guy, Brent, and then you look at this thing. So how would you, how would you position your portfolio? Just think about your risk that you need to take now.

Brent: Well, and so one really interesting thing there is don’t look at Mexican peso because that thing has absolutely collapsed in that same timeframe.

I mean, generally what I’ve been seeing in our business is. People are embracing this dollar selloff and honestly, at this point I call bullshit on the dollar selloff. Like mostly the dollar has been in a range. We’re getting close to the bottom of the range in a lot of major pairs. Usually what you need for a good, like sustained dollar selloff is you need synchronized global growth and a myriad of opportunities around the world and good places to put your money.

So like you saw that in, you know, Oh three, Oh four, Oh five, you saw it in 2018 synchronized, like no, no time ever in history was growth more synchronized than 2017, 2018. Basically every single economy was, was growing at trend in those two years.

And like, I just don’t see it. If you look at what Europe’s doing, what China’s doing, even Japan, like that was a good place to put money for, for a while. Like that Buffett trade obviously has worked out very well, but now given the volatility, I don’t see money flowing back as persistently into Japan either.

So to me, I think what this is, is just More a continuation of the range trade in the dollar and a little bit too much in the fed. So like, I guess we should talk about the fed, but why don’t you start and I’ll chip in as well.

Alf: Yeah. So, okay. From a month ago, let’s check the hard reality, right. Versus the market pricing.

It’s going to be a nice, interesting comparison there. So the hard reality says that we have had one payroll, which was above a hundred thousand, but not very strong, just, you know, mildly disappointing payroll number. Then we have had another friendly disinflation print, but nothing like, Whoa, it’s deflation.

And then we have had the payroll revisions, which we’re going to talk about for a bit, maybe, but you know, payroll revisions, mildly more dovish than the previous expectations, right? Okay. That’s the facts. That’s what we have had in terms of hard data. And then you look at the market pricing and it’s like, Oh, well well, let’s actually refresh it because just to make sure people are looking at the same thing.

So now we are recording on the 22nd of August and one year forward, a fed fund. So the fed funds priced a year from now is three and a half percent. And we are starting from a base of 525. So all of a sudden you’re looking at about 200 basis point of cuts, something along the line of that, in the next 12 months.

Okay, so that’s like quite aggressive as a pricing. If you look at the past recessions, the Fed has done on average between 200 and 300 basis points in the first 12 months. So 200 is on the shy side of recessionary cuts being priced. But, you know, it’s borderline between. Perfect soft landing and bordering on the recession side in terms of cuts that the Fed needs to deliver over the next 12 months.

So that’s where we are, Brent and the hard reality says still nothing about an impending recession as we speak. So, you know, the market’s just willing to bid for recessionary optionality much, much more than it was a month ago. That’s where we stand, I would say.

Brent: And I saw an interesting poll from Fred Goodwin at State Street that showed 65 percent of people think we’re either in recession or we’re entering a recession in the next two quarters.

And I don’t know that to me, that just seems very high. Like, I know things are slowing down, but they’re slowing down from a level of overheating. And to me, it’s more likely that we’re still in mid soft landing, maybe like going to like a mini, mini soft patch within the soft landing. But if you look at consumption We were supposed to be at the end of the excess savings.

So excess savings should have been drawn down by now, according to like a lot of the metrics. And then you would think then that if the jobs market’s weakening, which it is somewhat, but there’s some debate about how much, but if that’s happening, then you would think that spending would, would be falling as well.

And if you look at like target and Walmart or just retail sales, like the official data on retail sales. There’s just no evidence that the consumer’s retrenching at all. And people are making the argument that target and Walmart are like low end, but actually dollar tree and, and dollar general are not really doing that great.

So if everyone was going to a super low end, cause it was a recession, everyone was panicking. You wouldn’t think that target and Walmart and retail sales would be doing this well. And then again, like with the jobs market to me, initial claims. Sure. Like none of these figures are perfect, but initial claims is pretty good.

Like over the years. It usually leads, it’s, it’s relatively clean. And if anything, actually, there’s a residual seasonality that pushes claims up in the summer after COVID. So if anything, you can argue that claims are actually printing on the high side, like the non seasonally adjusted number that came out today is the lowest since April.

So to me, it just, the evidence doesn’t really stack up. And what I think it is, is that. There’s just this permanent bias to try to trade the recession. Like people just don’t want to miss it. That’s where like the big moves are going to come.

And the boring argument or like the boring thesis is we’re in a soft landing that will ebb and flow. And there’s like some soft patches and some periods of strength within that. That soft landing. And I don’t know, I still think that’s where we’re at now. The, I guess the critical thing more than normal. So for the last three years, it’s all been about CPI and inflation data, core PCE, and all that has really been like the main driver of policy.

And now we’ve transitioned and the baton has been passed where like, no one really cares about inflation data that much. Cause we know it’s. We’re on the glide path to two and a half, 2. 8 or whatever. No one really cares.

And now, excuse me, all the eyeballs are on, on jobs. So this next payrolls report, I think will be pretty Epic because the last one may be distorted by the hurricane and maybe not, but claims and everything else to me doesn’t point to anything all that nefarious in the jobs market. And if you get like a reasonable jobs number, like 4. 1 unemployment plus one 86 on the jobs number, I mean, this whole thing, a big chunk of what you’re describing in the pricing. is going to unwind.

Alf: We should Brent, I’ll make you pizza, I’ll fly to Canada personally and make you pizza if the next payroll is 186. All right. You, you have my word, man.

Brent: I mean, wager accepted.

Alf: Yes. Challenge accepted 186, 000 for Brent massive. But I guess, I mean, I completely agree, especially the boring versus exciting part.

I mean, if I speak to my clients hedge funds and all that, you know, our clients have the research, what they say is, look, if we are just patching through and it’s going to be soft lending, then fine. I have a set of trades for that. It’s a bit boring and I can try to figure out a bit of relative value here and there, a bit of well, let’s call it masqueraded short vol type of trades and I can try to manage that.

I’m a macro guy. So what if there is a recession and I don’t have anything on my book to actually show up for it. That’s where I’m expected to make money. And we are so late in the cycle that, you know, every time I, I need to have something right. And of course the urge always goes up when the price action is somehow suggesting that something bad is going on.

And we have, we have gone on with this behavior, I think for the last 18 months, then to figure out two months later that this recession optionality was way too expensive and you should have faded it instead. Right. So there is one thing here that I want to mention that has to do with the dollar. I know that’s your home turf, but it’s, it’s a very interesting finding. I’ve come up with my research recently.

So if you look at periods where, and you’re right, Brent, I agree, where growth becomes the main concern. So the market moves from inflation is a down deal pretty much. And now we are very, very scared about growth. When you look in the past, what happened is that generally the correlation between stocks and bonds turned back negative.

So the idea is, you know, well, if there is a recession, then the Fed is going to pivot very, very hard. And the fact that they pivot and the fact that they try to backstop the equity market allows bonds to be a negatively correlated asset. So if there is a drawdown in growth or in stock market or in something that suggests to the Fed, something’s going wrong, they’ll step in.

And so bonds serve again as a hedge because the inflation picture is solved in the meantime. When you look at that, you think immediately, well, well, well, if the Fed is super dovish, or there is a risk of recession, I don’t want to be long dollar, right? And it’s first thought that comes to mind. You don’t want to be long dollar when the Fed is pivoting dovish or the U. S. growth is coming down.

And then you do research and you figure out that if you hold a long dollar position for a couple of years, so we’re talking like long term macro investing here, okay? But if you hold a long dollar position for two years after, The stock bond correlation has turned negative and it has stayed negative ever since.

So it means it’s like a pretty big correlation sign flip. Something has gone wrong or the Fed has pivoted dovish massively. You actually make money by being long dollar versus a bunch of currencies for the remaining two years. Which is quite interesting.

Brent: What periods are those? Like, do you back there–

Alf: it’s like four periods, wait, I should have the chart in front of me.

Yeah. It’s April 2000. So quite earlier. So the market went going for, for a lot of time before the recession of 2001. So April 2000, February 07. So again, quite early. February of seven, April, 2000 and December 13. So two of them were followed by a recession, right? 2001 and 2008, but 2013 wasn’t at all.

So 2014 and 15, the two subsequent years were okay. So there the coalition flipped because, well, inflation wasn’t a problem anymore. And the Fed had turned aggressively dovish trying to, you know, run the economy hot. This was the jargon back then. Okay. And so defend against any drawdown in stock markets or in growth and, you know, accommodate policy and all that beautiful stuff.

And if you have held the dollar long for two years, when the correlation turned negative between stock and bonds, so either the Fed pivoted dovish or there was some problem with growth, you would actually have made money and a bunch of money specifically in long dollar versus high beta currencies, long dollar versus Aussie dollar, Canadian dollar sterling, and all this beautiful stuff.

And I find that quite fascinating. What’s your take, Brent?

Brent: Yeah. I mean, that’s interesting because If the US cycle’s turning, then you would think that more pro-cyclical, commodity driven countries would have an even worse time . I remember the 2000, 2002 period because the theory then, much like it has been a lot of the time now, is that all the money flowing into the Nasdaq bubble in 90, whatever, 96 to 99 to 2000 would then have to unwind.

So people were very bearish dollar when the Fed pivoted. And it just didn’t work. Like eventually the dollar started selling off into like at the end of 2002, but you had really another, like two years of dollar strength. So I do remember that time and it was very confusing for people. So, I mean, if the, if we got the same thing now, then again, it’ll probably be pretty confusing.

And the, so we’ve been talking about like what we think about, you know, payrolls and fed and whatever. But then if you listen to the fed. They’re not talking about 50 basis points either. They’re talking about like similar to Powell’s speech in 2018, where he basically said, gradualism is the way unless there’s an emergency.

So unless basically there’s a economic emergency or inflation expectations are unhinged. Those are the two times that you would cut more than 25 or hike more than 25. And history has shown those are the times when they did it. And so if you look at like Schmidt from the fed, he’s pretty hawkish generally.

But he’s still talking about like, we need more data before supporting a rate cut. Daily’s talking about gradualism. I mean, to me, it’s risky talking about this because we’re talking about it the day before Jackson hole. So, you know, he might come out and telegraph 50 tomorrow, but I don’t think he will.

So I’m willing to take the chance of looking stupid. I think that they really don’t have any desire or Or plan to go 50 in September. I think gradualism is what’s going to happen. Just given that the day, I mean, inflation is still above target. Yes, obviously it’s falling and, and they’re forward looking.

The jobs market is okay. And then the biggest thing is just, they don’t really know what neutral is. So like the market or the fed can say three or three and a half, but you know, they’ve never would have thought that hiking to here would have done so little, so obviously there’s a lot of finger in the air involved there.

So. I don’t think the Fed wants to go 50. And so I just don’t think they’re going to go 50 based on the data and based on what they’ve been saying.

Alf: So as we discuss, I also think they are not going to go 50 unless the next payroll is horrible. If it is horrible, they might say, well, that wasn’t a coincidence.

Things are slowing down a lot. So basically we should do 50 just to be, to, to make up for the missed July cut. 25 all in one go. But if the next payroll is okay, they’re going to do 25. The market, by the way, is at one cut and a 25 percent odds of 50. So that means that 25 is by far the base case right now.

50 basis points was the base case during manic Monday and the day after that, but the market has normalized to think that it’s going to be 25. It’s going to be 25. And what it has done, Brent, is that it’s basically blown up the amount of cuts that are priced between now and the end of 2025 by assuming the Fed is going to rush back to neutral.

So maybe they’re going to do 25, but they’re going to rush meeting back to back, almost back to back meetings, cuts all the way down to 3%.

Brent: Right. And very often we’ve talked about the 1995 analogy where like they cut 25, three times. So I mean, that should be part of, part of the playbook too. I would think.

Alf: Yeah. Okay, let’s switch gears for a second, because in this episode, we really want to talk about framework. We often do that, and the feedback we get is that people enjoy that. So, Brian, do you have something else macro to talk about, or do you want to talk trading framework for a second?

Brent: Yeah, trading frameworks is good, but I wanted to actually just pick up on one thing you said earlier about just quickly, you want, you were saying that a lot of your fund clients and people are saying, well, we’re so late in the cycle, so I want to be, I’m going to have FOMO for the recession trade.

Like, if you think about how long the cycles have been, you know, you had 2000 to 2008, you had 2010 to 2020. Are we late in the cycle? Like this is, we’re in year three. Yeah. I mean, I actually can’t think of a cycle that was less than five years. I mean, there probably was one, but like off the top of my head, most of the cycles are like six to 10 years and we’re in year three.

So maybe we’re not late, late in the cycle. I don’t know.

Alf: Yeah. But the feeling is that as the Fed hiked to 525, it must cause, basically this is the thinking, right. And, and also what they’re looking at. And I think it’s, it’s not necessarily a bad framework is, well, if I look at the moment where it took a lot of time for Fed acts to feed into the economy until something broke. So 2006 2007, it took a tremendous amount of time between that fed in. Well, then if, even if I look at the longest attempt ever, then now I’m matching those timelines. So, you know, people are always wary, I think, in the macro community to say, Oh, this time is different.

They’re rather looking at parallels. It’s more comforting, I would say, Brent, to look at parallels.

Brent: I mean, actually that’s reasonable too, I guess, if you look at what the Fed’s done. Sure.

Alf: So that’s, that’s, but of course, there are many different things in 2007, the government was almost having surpluses.

Seriously. Right. Yeah. So now that’s a slightly different, I would say. A couple of different things going on there. Yeah. Yeah. Yeah. Okay. So trading framework, and we’re doing this guys because we receive a lot of feedback that you enjoy Brent and I talking about how do we try not to lose money, which I think is, is, is rule number one, two, and three of trying to be a macro investor or a trader.

So let’s talk about it. And today Brent proposed before the show, a topic, which I love because. In the hedge fund I’m launching, this is something I reflected upon a lot. So Brent, put up the topic out there and let’s talk about this.

Brent: Sure. So the reason it came to mind was I had an intern in here yesterday and I was just talking about trading and structuring and all that kind of stuff.

And then we started talking about linear versus options, like cash versus options. And two and a half hours later, I still wasn’t done talking about it. And I was Kind of just a reminder of how big of a topic it is and how important. And I feel like it was a big part of my development as a trader, because as a spot market maker, I mean, your job is just to trade cash and you trade cash.

And my PNL, like my really big PNL sometimes in the future, but like, as I had developed came a lot more from options. But then what ends up happening is then you sort of get addicted to options because of the lotto ticket kind of mentality. And then what a really good framework, in my opinion, should be is agnostic and flexible between linear and nonlinear expressions.

And there’s just, I mean, there’s so many factors that go into it, obviously where vol is, is one of them, but then, you know, many, many other things. So like, for example, some of the things where options work better is, is the path, right? Like you avoid getting stopped out by doing options. So once you buy in the option, you’re, you’re in the position until the option expires, but in cash, you can get stopped out after two days and then the thing rips your way and you know, you were right and you lost money.

And there’s a lot of other things. I mean, we can go into them. Like you, you obviously can get more leverage from options. Although sometimes it’s phantom leverage because. People tend to trade out of when, once the position gets really big, people tend to trade out of it. So you actually don’t always get the leverage that you thought ex ante, because it’s too scary to have such a big position.

And then another thing options are good for is like in FX. You can almost put on any size position. So like, say, say you have a decent amount of capital and you want to be short, like 300 million Aussie, that can be kind of difficult in cash simply because like, if you use stop losses and stuff, it gets difficult to strap that on, but then, you know, you can put on a billion Aussie of puts and have a Delta of 300 million and then just sit there and if you’re right, you’re going to make money and then kind of similar to the stop loss thing when you’re in cash, you always have to, well, depending on what you’re trading, but most things you have to worry about gap risks.

So like if you went short zoom into earnings in 2021 you know, you were probably wishing that, that you didn’t do it in cash because you, you would have blown up and even in FX, you get these weekend gaps, like they were much more prevalent during the Eurozone crisis and, and other times, but still, I mean, you still do get gaps.

And then of course, like options, you can do much more complicated things with the path. Like, I think it’s going to sit around for a month, but then it’s going to go up after earnings. So I’m going to do a calendar spread, or I’m going to short the front and long the back or whatever. Obviously there’s a lot more complicated things, nonlinear things you can do with options.

But I guess the main point for me. To anyone like who’s new ish or new ish to trading or investing is you really should be agnostic and flexible about it. You don’t always want to be long cash. You don’t always want to be, you know, short options or long options. There’s just different, different things work in different environments.

And you should be thoughtful about the path of the security that, that, you know, obviously the, the target. Is like the end end result, but then what’s the path going to be on the way there. If you can forecast that, including the time and volatility along that time. And then, you know, what are the, what are the economics of doing it through options?

Alf: So now I should go home because I have nothing to add. Just kidding, just kidding. Well, not really kidding, I have two things to add. But you said a lot of good things there. So effectively the thing you get with options that is very different from linear is you’re trading through at least two more dimensions.

At least. The first is the dimension of time. And If you have a linear trade, unless you decide to be stopped out by yourself, nobody’s going to stop you out. If you have a future contract with an expiry, you can roll that. So in principle, you can, the dimension of time is not something that constrains you in a linear trade.

In an option, yes, it does. Yes, it does. So you not only need to be, let’s say you’re trading options for linear exposure. So you’re trading it for directional exposure. Okay. There, you not only need to be right about the direction. But you also need to be right about the time. And in some cases, you need to be right about the path to get there.

So basically, what is the realized volatility to get there where you want to be when it’s pay off time? So it is a lot of dimensions more. OK, that’s a plus. And that’s a minus, because people like to say, well, I can buy options so I can never get stopped out and then I can sleep. Yes. That is true if you’re long options, but a few things I would highlight.

First you’re normally charged for that, my friend, you’re not going to go there and somebody’s going to offer you a free convexity and free sleep at night. There is no such a thing. You’re generally charged for that. I would say although there are rare occasions when you’re not, but generally you’re charged.

And then the second thing is it’s beautiful not to be stopped out. But the other thing is that contrary to a linear trade, you have a time timeframe where you must be right, or to be more precise, where you must have the probability distribution shift your way. Terminally, you can be still wrong, but as long as during the time of your option, a few people will believe that they need to reprice the scenarios your, your way, of course, you can make money.

But time is quite a dimension when you’re wrong optionality that is.

Brent: Yeah. And you were saying about you get charged for the privilege of not having a stop. So when this intern was here yesterday, we were looking at NVIDIA options because the earnings are coming out on the 28th and.

Like, so just for context, like Amazon options are like 25 vols. NVIDIA could be like 50 when nothing’s going on… the one week or the August 30 expiry is trading at 87 balls, which is just absolutely like chaotic pricing. Like if you price up, say like it’s, it’s trading at one 30. So you price up something like 10 percent out of the money. And you know, this thing’s expiring in a week and two days.

And like, You barely make money if the thing moves 10%, it’s crazy. So like, that’s the thing with options is it’s just like, it’s the ultimate way to be right and lose money. Like you, you have to know kind of like, essentially the thing too, is that like events and obvious catalysts just tend to be overpriced.

So like, they’re not even priced in there. They’re actually overpriced because. Market makers generally don’t really, and some do, but generally market makers don’t love being short, especially short dated options through events. They’re just harder to hedge. And like, they like to be short them out at the right price, but not at like some basic vanilla kind of price.

So events tend to be overpriced. And one that leads to one really good setup is when you believe you have an edge on an event, like you have a divergent view on volatility or on like the event premium. So like, sometimes that’ll happen with like, say a speech by someone at the bank of Canada or like the RBNZ or something where people aren’t like super focused on it.

And It’s not like non farm payrolls is not going to catch anyone by surprise, but something like an RBNZ deputy governor speech, that’s really on point. And it’s like a key moment in monetary policy for New Zealand and the currency is right at a major level. And so if that level breaks, you think that volatility will accelerate and those kinds of things are not priced into the options market.

Those are the kind of trades that I find where essentially you have a divergent view or you have like an edge or like a real view on like, this thing is underpriced because of X, Y, Z, as opposed to like, I think, you know, NVIDIA is going up, so I’m going to buy calls. That’s just like a horrible way to trade options because you’re ignoring the price of the thing.

And then another big thing with options versus cash I mean, this is very, very true in FX, but it’s true in everything is that you not only like is vol overpriced a lot of the time just generally realized tends to be under implied. That’s just the nature of options but then also the bid offers is much wider in options.

So like, If you want to buy a hundred million euros, you’re, you’re, you’re going to cross the spread of like two basis points or something like that. But a lot of times like a three day euro dollar option might be trading, like, you know, you might buy it at 15 and if you want to sell it two seconds later, you’d be selling it at 12 and a half.

So in terms of bid offer options, even in equities tend to be just, you’re paying a lot more, a lot more for, for that. Now, the one good thing actually that I found about that is that. It makes you overtrade less because like, if I think Ozzy’s going up and I buy Ozzy and then some flickery headline happens and I’m like I get nervous and I get out, you don’t really do that in options as much because you’re paying such a big bid offer, the bar to exit is higher.

So if you tend to overtrade. And you compare like linear to options and everything kind of looks equal or fair, then sometimes the option will just give you more staying power because it’s, it’s not like one click and you’re out, you’re, you’re going to pay a huge tax when you get out, which on the surface is bad, but actually can be good because it might Like, keep you from doing some suboptimal behaviors.

Alf: All this is correct. And I would add now that we have bashed options for five more minutes, so why don’t we talk about when options are good to use? So I’m gonna do that. Okay. In the hedge fund I’m launching, I’m gonna be using options for mainly. Two reasons. The first is when I want to isolate a specific payoff in the distribution or over time of an asset, which you cannot do linearly.

So linearly, you’re basically forced to not be able to isolate time. You can’t do that ex ante. You can just wait for the events to happen while you are in the trade. And second, you cannot identify a certain payoff. If you want to buy the, the, the probability that the Fed is going to cut rates by 100 basis points between now and year end, linearly, it’s very hard to structure a trade that only pays you if that outcome happens.

In options, yes it is. It’s very, very easy to identify payoffs. And sometimes you have a specific view, Brent on a certain payoff. You know, you say, I don’t think the probability of that specific part of the distribution is correct. I have a, a divergent opinion and so you can isolate that. So basically I’m saying when your subjective probability of a certain specific outcome payoff is divergent from option markets, you can not only measure these probabilities correctly, but you can also implement specifically that idea.

So options are very good for that. And then the second thing is we have built something with my team. It’s called the option monitor. So what we do there is look, often options are priced quite quite well, I would say. So you are not massively overcharged, for sure, not undercharged for convexity, you are, as Brent said, slightly overcharged. It’s the nature of options. If you want to be long options, it means you’re getting longer insurance, long vol, and for being long vol, you’re going to get slightly charged. That’s generally the nature, but sometimes, sometimes these of all convexity and probabilities basically that are priced in options cannot be optimal.

It means investors are overpaying or underpaying for specific tails. Okay. So in this case right now, the option monitor says people are overpaying for Japanese yen upside. Okay. So what, what it means is that if you look at the probabilities price for certain very large moves in Japanese yen over the next month or three months today, people are willing to bid up these calls that capture these big moves in a massive way relative to the actual probability that such a move will happen.

So if you look in the past, like a 5 percent yen rally over a month has happened, I don’t know. 7 percent of the times. So you would expect that option markets would price you something like 7 to 10 percent as a price to get in, in that optionality. And instead people now are willing to pay 20 percent as a probability.

Why? Well, because they’ve just seen the yen ripping. And so they really don’t want to miss it, right? So they’re all bidding up the yen and they’re like, you know, now I need to get this thing on my book. It’s a recession optionality or whatever they’re thinking. Okay. So when you screen these deviations, basically you have a better expected value possibility of, you know, identifying situations where these options are particularly overpriced.

People are very optimistic about the tail, very pessimistic about the tail. So that’s more of a systematic way of approaching option, but more a probability way of doing that.

Brent: And then something else that that made me think of is, I don’t know if this really happens in equities, but in FX, it definitely happens where, so the black Shoals or whatever model assumes some kind of distribution with some tails or whatever that the skew prices, the tails, but it doesn’t really take into factor or into account sometimes more nuanced things.

Like, If Euro Swiss goes to 92, the Swiss national bank will probably get a lot more dovish and they might even intervene in the, in Euro Swiss because inflation is very low. There’s a lot of pass through between the Swiss franc and inflation. So if you think of like, so say Euro Swiss is at 95. And a normal model would say, like, it can go to 90 or it can go to 100 or anything in between.

It’s actually not necessarily true that those, all those paths will be the same because sometimes specific securities like FX can trigger feedback loops or can create new policy adjustments that will then factor in, like, you could also argue inequities to like, You know, the odds of going, I would argue the odds of equity is going down.

Like 10 to 20 percent are so much higher than them going down 25 to 30, simply because of the way the fed reaction function is. So there’s a point around 20 percent where the fed tends to react and like, okay. Trading all that is, is a whole other thing, but sometimes you can think of, okay, the path of this thing is not just brownian random motion in both directions, there could actually be responses to the thing moving in different directions.

And if you have that in your, in your model, and sometimes people even just use simple, like technical analysis, like if this, you know, if dollar Canada is at the bottom of the range, like it is right now, then the odds of it bouncing are higher than the odds of it continuing based on, you know ideally like a fundamental view overlaid on top of that.

So. I think if you can figure out any kind of edge on, like, the path is not just a normal, like, equal probabilities in all directions, then sometimes you can kind of find nifty option strategies based on that as well.

Alf: So now I’m wondering, Brent, if you really said Brownian motion. Did you say Brownian motion?

Brent: I, I did, but I didn’t mean it.

Alf: Okay. Otherwise, sorry, man. I don’t want to have a podcast with you anymore. Okay. So guys, I hope that after this conversation, you have a little bit of thoughts you want to bring home on when to use options and when instead to prefer linear. I think it’s an important topic.

I think options are often oversimplified, overused maybe but they can be very, very useful in specific situations. Few announcements, I would say, because now we’ve drilled on options and linear for 40 minutes. I think the first one is very simple and it’s the easy announcement. I think both Brent and I are actually off next week.

So because you asked us to tell you when there is no show, like you, you’re, you’re addict. So yes, there is no show next week. We’re coming back on the first week of September with the non farm payrolls and all that beautiful stuff. So we can we can debate how wrong we were and a recession is coming and all that beautiful stuff.

And that was the first announcement. And then I have a second, a very easy one, but Brent, both to you first. Want to say something?

Brent: No, I think that’s good. I appreciate all the feedback on the podcast. I think this has been a pretty fun experience and we’re getting like more, a little bit more laid back, but hopefully not unprofessional as time goes on.

But I’ve really enjoyed doing this so far. So I’m looking forward to Coming back in September, I do find the September, October period tends to be one of the best times to trade. Also, it’s one of the best times just to be in the industry on Wall Street because people are just pumped up. They’re motivated, they’re engaged after July and August where people are a little bit less engaged.

So I’m stoked to come back and get going on September 2nd.

Alf: And it’s not 40 Celsius in the south of Italy either. So that’s that’s good news. Okay. Then the small announcement from my side is that when I come back on the 2nd of September, I’m opening a window for a two weeks free trial to my institutional research.

So shoot at me guys, there’s going to be a form in the comment section of the comment. What do I say in the well below part of the podcast, the description of the podcast. So you can just fill the form. And it’s a few questions like who the hell are you? And You know, do you, do you have a Bloomberg stuff like that?

Two minutes, you fill it up and then I’m going to sign you up for a free trial.

Brent: And I will say that this obviously is going to sound biased, but before we started doing this podcast, when I didn’t really know Alf that well, I did subscribe and I still subscribe to his professional service. And it’s excellent.

I mean, I read his stuff every day. I’m in the chat with him and you know, we discuss a lot of stuff. So. It’s a good product.

Alf: Thank you, Brent. Solid guy. I mean, I have a happy client, at least one happy client, at least one, at least one. And it’s beautiful. When I talk about hedge funds, clients saying stuff, I’m not talking about Brent, but sometimes I might talk about him and he doesn’t know.

Anyway, guys also sign up to Brent’s newsletter. Read that every day. If you don’t, you’re crazy. It’s on a spectra markets. com. Is it? Good. I got it right. And also that link will be below in the description enough with publicity but still do go and check the links below and we will talk to you in two weeks now, I guess.

Brent: All right. Awesome. Thanks everybody for listening. See you in September.

Alf: Ciao guys.

Brent: Ciao.