25 Sayings on Vol and Risk…Part 4 of 5

[00:00:00] Hello, this is Dean Kurnutt and welcome to the Alpha Exchange, where we explore topics

[00:00:07] in financial markets associated with managing risk, generating return, and the deployment

[00:00:12] of capital in the alternative investment industry.

[00:00:20] What a week last week was in equity markets.

[00:00:22] The S&P had its first 2 day of 2004 mattered quite a bit. My son, Aiden, was born.

[00:01:41] He's now 20, nearly six foot six,

[00:01:43] and loving it out in the Arizona desert.

[00:01:45] Man, to be a, enjoy the here and now. How about world events in 2004? In sports, the nearly 100-year curse of the Bambino was broken as the Red Sox beat the Yankees in the World Series. MySpace, yeah, remember that, reached 1 million users., makes more money. Brilliantly crafted to describe the virtues of compound interest, let's consider how powerful this can be. Remember the old rule of 72. Take 72 and divide by the interest rate and you get a good approximation

[00:04:20] of how long it takes to double your money.

[00:04:23] At 4%, our initial stack left untouched is twice as large in 18 years. doing my best to support the logic of the trade construction. He listened politely, but ultimately said, Dean, I need trades that make money today. I understood, especially as a new manager, you've got to put up numbers early on. Speaking of carry and the likelihood of successful outcomes, I'm reminded a bit of the good fellas seen in which Frenchie pitches Henry Hill and Jimmy Conway on the air, Franz Heist.

[00:05:44] Asked about the risk of execution, grinning fear of missing out, but focused on the fund manager equivalent. ROMO reflects the call optionality that defines the compensation structure for the asset management industry. Underperformance in bull markets presents a bigger business risk than experiencing large negative returns. We can quickly refer back to the new manager I mentioned and the need to

[00:07:02] produce an early, steady stream of positive returns. Howard Marks' reference to benchmark hugging speaks to a feature of our industry. In Billy Joel's Goodnight Saigon, we will all go down

[00:08:22] together. The risk of missing out speaks, the equal weighted version of the S&P, was 13.2%. The S&P itself? Just about doubled that at 26%. In 2024 New Century had already gone down, as had the Bear Stearns hedge funds. BNP would suspend redemptions on a money market fund in August 2007. But I read his words as a statement about being a price taker, not a price maker. If the broad standards of credit evaluation have sufficiently eroded, you must decide, as a

[00:11:03] lender, whether you want to play ball or not. They aren't your risk on assets are short vol. The second set of securities, the risk off category, are haven assets that tend to rally during market vol episodes. We can include treasury securities, gold sometimes, and of course, vol itself in this category. Certain FX crosses have had especially good

[00:12:21] VIX-like properties at different points in time.

[00:12:24] The yen was for years, nothing to see here. I had Harry Markopolos as the fourth guest of the Alpha Exchange back in 2018. It was the 10-year anniversary of the uncovering of the Madoff Ponzi. Harry said this, quote, and so I knew it wasn't front-running. I knew it had to be a Ponzi because his returns were basically up at a 45-degree angle. And we don't have

[00:13:44] 45-degree angles in finance. They exist in trigonometry and geometry. They might exist linkage between risk on and risk off as well. The best opportunities in markets result from price impairments that are driven by forced selling. There's blood in the water, let's go kill someone. Former Morgan Stanley CEO, John Mack reportedly said, I can't help but mention the September 2006 interaction between Amrit Nat Gas guru, Brian Hunter

[00:15:02] and John Arnold who ran Centaurus.

[00:15:04] We learn about the rise and fall of Hunter

[00:15:06] through the book, Hedgehogs. a single 2% down move in the S&P. That's an accident-free regime and one in which the profit-seeking mechanism of capitalism is going to embolden the sellers of insurance. Competing with each other for the incremental dollar, the insurers drive premiums lower. Now might be a good time to talk about the option characteristics of parking tickets,

[00:16:20] don't you think?

[00:16:21] Let's frame out the risk considerations.

[00:16:23] First, for the most part, a ticket is a good thing. In forestry, they say that the small fire prevents the big one. I've wondered mostly for amusement, but occasionally with some degree of seriousness, if the Fed's third mandate should be managing the VIX in a collar between 15 and 25. Call it financial stability or crowd control. Imagine the derivative salesperson getting that call.

[00:17:42] It's an order from Powell through the Fed's open market desk. mechanical fashion lost 24%. The next year this product lost 73%. This year, in two short months, it's down 10%. We absolutely suck, the CFO said to the CEO. If Nvidia's Jensen Wang is worth $70 billion, what is the VXX CEO worth? I forgot, no one actually runs

[00:19:01] this robotic construction. Stay with me. If, as I've declared earlier, successful trades vol now of just 22.5%. That puts it in the 10th percentile over the last five years, a slice of time that includes 2019 before the pandemic. While that vol tells you most of what you need to know about this option's price, there's something else going on, and that's a one-year Treasury rate of around 5%. Puts and calls are priced off forwards.

[00:20:22] In the case of an equity index like the S&P is just 30%. Well, that's a zero with percentile to be sure. Hard to remember as it may be, there surely is a scenario in which stocks experience a correlated decline.

[00:21:40] That's in fact more than norm than the exception

[00:21:43] when it comes to risk off.

[00:21:45] So this one year deep out of the money put spending some time evaluating. And this, my friends, brings us to number 20 of our 25 sayings on Vol and Risk, and that is that, quote, price is the only fundamental. Sometimes attributed to Soros, but I cannot verify. It certainly jives with his theory of reflexivity in which market prices condition behavior

[00:23:00] as they create or destroy wealth.

[00:23:03] Feedback loops result. First, the obvious one is Roaring Kitty's stampede of Reddit bros, engorging on gamma. But there's a second corporate finance angle here. The stock goes up to unimaginable levels and it actually creates real space for the company itself to maneuver. For a brief period, the market cap of GME exceeded $20 billion. To be sure, there are various restrictions and considerations, but my goodness, monetize

[00:24:24] the living daylight out of be the Democratic nominee. He was at 86 and is now down to 73.

[00:25:41] Ticker symbol is P-R-I-T-U-S-D-B on Bloomberg.

[00:25:46] Now you'd expect on first thought that a sell-off in Biden unlikely idea that Biden must be replaced. It could also lead Biden to make a hard turn on policy. Polling results are pretty powerful agents of how we make decisions. I've reached the magical 4,000 word count. And with the confidence of Joe Cassano, I can't see within any realm of reason how I didn't get you in and out of here in under 30 minutes.

[00:27:01] We've completed sayings one through 20, five more left.

[00:27:04] I hope this has been useful to you and I've succeeded in giving you some

[00:27:08] things to consider in the world of risk.