Record Dispersion Explained: Options Mechanics — Full Breakdown & Transcript

[00:01] the surface, the indexes are pinned here. Uh you know, from your view, thinking about the risk map moving forward, looking at a period where volatility could be rising around the corner that

[00:15] think are moving idiosyncratically, asynchronously, move asynchronously, rather, which would become the problem. how do you adjust your time horizon around this particular information?

[00:29] >> Yeah, I mean, I think uh I think it remains important to, I don't know, just said, put put hedges are very cheap, especially right now. And uh you know, times over the last few weeks and in much less eloquent terms than Jim, it

[00:43] does feel like we we are in this this holding pattern. I'd be interested to been saying this just feels exactly like October of last year to March of this year. It just where we we test the same level over and over. It was 7,000 in

[00:55] that window, it's 7,600 this time, but it's just that we just don't seem to through the surface. As it pertains to your question specifically, Chris, if if we are expecting vol expansion in the coming weeks, I do think that that would

[01:08] asynchronous nature of things, but we are in I mean, today is sort of a a perfect example of what happens if we're in the the perfect environment compressed, where it feels like we're we're ripping higher and higher. And I

[01:23] come right back down tomorrow. The momentum just doesn't seem to be there. us to put in additional legs to the upside. We're seeing the capital rotation happen now. The macro environment continues to weaken or trust

[01:36] continues to deteriorate in in the news and this administration. I do I do think a scary picture. It's something that everybody should should certainly be thing as infinite growth, but in this administration, uh it's it's it's tough

[01:50] continuous growth for for more than a, you know, two two month insane rally to the new level before we just we stagnated or to or to hold these >> Chris, I want to add something here. So, the dispersion that you're talking about

[02:04] Right? When you have index ball the index itself is pinned and you have plenty of implied volatility uh you know, structured products are just selling ball to dealers.

[02:17] definition, most people don't understand this. This is very very important. It it forces cuz there's idiosyncratic risk, right? Some new news comes out, If the index can't move, let's just say we lock the index because of index ball

[02:33] By definition, that means something else has to go down. And so, what you've seen, if you go look through 2017 and you look at a hundred years of history, correlation is in a very tight band.

[02:46] But, starting in 2017, you see correlation break out to records and like, "Oh, this is a this is a one-time thing." This summer, for example, is the highest dispersion we've ever ever seen in 125

[02:59] >> Right, yeah. >> That is not a coincidence. That people I always I always start with fundamentals. So, they say, "Oh, it's cuz all these crazy macro changes are happening and that's driving different

[03:11] No. That's not the reason. The reason is the index level and that forces actually a higher realized ball at the single list constituent level.

[03:26] at the single list constituent level. By definition, by mark by by arbitrage constraints, if I hold the index in place, you're going to have higher You're going to have higher volatility the the constituents. This is

[03:39] like, "Well, the ball's compressed. Look at what's happening. This is crazy." It's not crazy. It's actually because ball is compressed. Um and so and to such an extent, we were in May

[03:55] vocally, aggressively talking about how expect the biggest dispersion ever this summer because of the wall compression before it happened. And not just that, we said expect the crazy move in momentum

[04:10] to turn and that to be the primary you know, entity that gets hurt in this You're like, how did you call that? It's not because of macro, it's not because of that anything really changed at the

[04:22] at the memory level or whatever. People will put a narrative on it. But it's because all the call positioning in that momentum area had you had record call positioning, record implied walls, it had just run 50%.

[04:39] The bar at which that would have to keep running in order to make those calls, you know, work for those customers, was not likely to be there. And guess what? All the dealers are short those calls and long stock or things that look

[04:54] like stock against it. And as the index compresses, right? And it has the opposite positioning, short put, long call for dealers at the index level, that part started to

[05:07] get selling pressure. We know this is also the the driving force because as you went into June OPEX, as you went into July OPEX, you start to areas. Right? And the greatest relative wall

[05:21] pinning at the index level. So, you, you know, we we were able to really map out outcomes just as a function of the summer flows and the positioning in the market. And now these things can reflexively

[05:35] start to have bigger effects, right? Because what happens if momentum keeps Right? Then it can as wall becomes uncompressed at the index level. Now, it can cause greater stress and greater issues. But my point here is

[05:49] the dispersion that you're talking about uh the kind of scratching of head, why are these things moving in such a crazy way while the index doesn't move are are actually a feature of the whole vol compression.