Joe Tigay, CTO of Equity Armor Investments, and Kaitlin Meyer, VP at MIAX Exchanges, join Steve Sosnick, Interactive Brokers’ chief strategist, for a wide ranging discussion about volatility. Topics include: whether volatility is indeed an asset class, will the current low-vol regime persist, and tools for expressing views about volatility, including MIAX’ suite of SPIKES products.
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Note: Any performance figures mentioned in this podcast are as of the date of recording (June 28, 2023).
Summary – IBKR Podcasts Ep. 90
The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.
Hi everybody, this is Steve Sosnick, Interactive Brokers’ chief strategist, and I want to welcome you all to this latest edition of the IBKR podcasts. Today we’re going to have a discussion about volatility. My guests today are Joe Tigay, CTO of Equity Armor Investments, and Kaitlin Meyer of VP at the MIAX exchanges. And we’re going to have hopefully a bit of a deep dive into volatility and some volatility products and some strategies that investors can use in light of the current low volatility environment and whether it is likely to remain that way. So, could each of you give a quick intro to the to the listeners? Please Kaitlin, you can go first.
Absolutely. Thanks, Steve, for having me on. First and foremost, it’s good to be here with you guys. As Steve said. I’m. VP of marketing and sales at MIAX. And my background has always been in the exchange space. You know, how do you look at products, how do you educate the end users on those, and specifically at MIAX, as we have grown just from one options exchange. We now have three options exchanges, one equities exchange, a futures exchange and an international exchange in Bermuda. There are a lot of things going on at MIAX and my focus is really educating the end-user on the products that we have. I know we’ll get into it here shortly. As Steve said, you know we’re talking about volatility, but SPIKES is an innovative product coming into the market and what that can signal for you today.
Thanks Kaitlin. Joe…
Thank you very much, Steve. My name is Joe Tigay. I am the portfolio manager at Equity Armor Investments. I am portfolio manager on two mutual funds, our Rational Equity Armor Fund and the Catalyst Hedged Equity Fund. And as a former options market maker on the Chicago Board Options Exchange, an early adapter, one of the first VIX options market makers and I was also a solo market maker in the S&P 500 pit. My background is in options and volatility trading, and I’m happy to share that knowledge with my current clients, which I do with portfolio management services and risk management for them. I’m happy to share that with you today.
Thanks Joe. Well, I’m going to start off with kind of an open question, but I think I’ll start with you, Joe. With apologies to Monty Python’s dead parrot, is volatility dead or is it simply resting?
I would say it’s simply resting. Volatility, it’s always there. It’s just a calculation. If you say it’s dead, it’s kind of a misunderstanding of what it’s measuring and what it’s doing. And to say that it’s dead would be like saying, you know, calculus is dead or something like that. It just doesn’t make sense to me. It’s simply a calculation on a series of options contracts. When you look at the SPDR ETF, you have a strip of all the options calculations. You can get a number back to you, and sometimes it’s higher, sometimes it’s lower, and it’s just basically, supply and demand. So, if you don’t like the price, you’re welcome out there to go out and buy volatility and you’re welcome to go out there to sell volatility if you think it’s high. Essentially, it’s just a free market and right now it happens to be low. It’s a summer month and people are just resting, but it’s just an indicator of low price movements expected for the next 30 days.
It’s funny, because when you said it’s like calculus, that it’s just there, I’ve described it as being like oxygen. It’s there, and you know when you have too much or too little of it. But for most of the time, it’s just sort of in the background and that’s why when people think of volatility as an asset it’s tricky, because you always have some exposure to volatility, just as there’s always exposure to the air that we breathe. And in all three of our businesses, volatility is to some extent the air that we breathe. I appreciate your thoughts on that by comparing it to calculus.
Yeah, I do think it’s an asset class. You actually go out and buy futures in it. It makes it a lot like a lot of other asset classes out there. But it’s different than most of the asset classes that we think of when you think of asset classes. I’m usually thinking of equities, real estate, gold, oil and currencies. These things you can hold, you can have. You can feel you can see most of the time. Bonds are another example. You expect these to go up over time. You can buy and hold them with a long-term positive appreciation expectation. It’s again, it’s just a calculation. And you can hold it in the future, but you can’t necessarily grab onto it. You can’t, like, put it in your pocket, but it doesn’t have a long-term positive expected value. The difference for volatility for me is that it’s mean reverting. Sometimes it’s low and I expect it to be higher later when it’s low, and sometimes it’s high when it’s high. I expect it to come back down.
Well, I think we’re along the same lines. That’s why when I picked a form of matter, I picked a gas because you can’t actually hold it, but it is in fact matter, and it’s pervasive. In terms of the mean reversion, where do you feel the mean is right now?
Since COVID it’s been higher. It’s been higher than it had been before. Historically, we’re on the lower end of the side right now. We have SPIKES under 14 — actually under 13 1/2. So, it’s very low. It’s a more than a three-year low for volatility. That is, it’s lower than the mean. I usually look at the 252-day, like the one-year trading average, for my mean and typically it wants to trend back to the mean for that. So right now, we are decidedly on the low end of the mean for me.
And by bringing up SPIKES that leads into one that that I wanted to address to Kaitlin. Tell us more about SPIKES, about that complex and some of the use cases that our listeners might find for them.
Joe has been talking, so I’ll give him a plug for some of the content that he’s writing. SPIKES is just another indicator, not so different from some of the indexes out there. You can’t trade those. SPIKES itself is a 30-day expected measure of volatility in the S&P 500. You have VIX out there, many people are familiar with that product. SPIKES was developed by a guy named Simon Ho from T3 indexes. It’s basically what he and I think is a better way to measure volatility.
We have VIX that uses SPX options. SPIKES uses SPY options. When you look at the two indices side by side, you know they’re measuring the exact same things. As you start to look at the products, they’re 99% correlated, but some key differences. I know we’ll get into those. I do want to say, for those that look up these indices, obviously those aren’t tradeable. So, on the SPIKES index you have a complex as Steve talked about. You’ve got options that you can trade. You have futures. There’s ETFs: SPKX, SPKY. And these just give you a way to know, like Joe’s point earlier, what’s your view on volatility. So now you have tradable products that you’re able to do that with.
The key differences if you look between them are… Everyone that you know can pull up VIX. You look at options, futures. Again, you have those on SPIKES as well, but with the index itself, there are key differences. SPX is the input for VIX, but SPY options — which are traded on all exchanges — those are the inputs that are used for SPIKES. And one of the key reasons why we think that that’s a better index is that you’re using a lot more inputs from all the different exchanges. That helps with any differences, particularly in key events, like FOMC meetings when there might be less pricing going on, but as in SPX there’s a price dragging methodology used in SPIKES that will kind of mitigate any of those kinds of erratic differences that can come into play.
And we will get into some of the compare and contrast a little bit later on in the episode. But I was reading the Wall Street Journal the other day. And so everybody knows we’re taping this on June 28th. This probably comes out a little bit later because of internal production and stuff like that. But they had a big article that the stock market isn’t as calm as it seems. And to me, one of the most interesting points in that article was correlations within stocks haven’t been this low since late 2017 and early 2018. For those of us who’ve been in the options market for a while, those are very auspicious dates because we all remember what happened in February of 2018. Which was “Volmageddon.” Two questions, and I’ll throw this out to either of you, which you can answer in any way you want. Number one, do you feel that that that we’re sort of setting up for the potential for a big move in volatility, not necessarily Volmageddon by any means — I don’t want to be alarmist — but do you feel like we’re setting up for a big move? Do you feel like we’re setting up for just a continuation of this? And secondly, if we do get a Volmageddon event, will it be made better, worse or no different by the popularity of 0DTE options? There’s a lot in that question and I have my opinions, but I want to get both of your opinions on these.
I’ll start with the first one, Joe, and I think it goes back to what you said earlier. You know, is volatility dead? No, I don’t think it is. So, as you think, is there something brewing or not? As you know, with volatility, you can never predict the future, but it is mean reverting when looking at history. You see what happens. You have spikes and then it comes back down. No plug on SPIKES there, but yeah. You’ll see it’s very low. You look going back to February of 2020. So, if we go back to history, you know there is going to be an increase at some point. What that is, I don’t think any of us on this knows, nor does the market. But with the amount of increase into 0DTE options, which seems to be such a hot topic lately, has that changed things that people are looking at? There’s a lot, I think, to unpack, you know? We’re still going through potentially new interest rates coming out. Stuff is happening that will take time for the market. As you’ll see in the data in that article that you mentioned, Steve, there’s something about the call options going on and volatility products, so I think people are starting to assume that there will be an increase at some point. When? I don’t, I don’t think any of us know. Obviously, if we know the answer to that we can be a lot richer than we are.
And one thing that before I throw it over to Joe, I just want to remind everybody that just as February 2018 was a very auspicious date, so was February 2020, because we all know what happened in March of that year and yet at that point in February of 2020, there were rumors of a — more than rumors, news stories — of a of a virus that was taking root in in China. So, markets don’t always see what’s about to hit them. Sorry Joe, I didn’t mean to steal that point.
No, no problem. That was really good information. Yeah, I remember February 2018 very well as a long volatility trader. We had a book of futures back then and that was a very memorable day for us, February 5th, 2018. Remember. Remember the 5th of “Febvember?” Yeah. We wound up having to sell $60 million notional on the close of futures, which was just one of the most fantastic feelings. But it was similar to 2020 actually, because there were the stories of the virus in 2020 there were stories about there’s record short interest in some of these ETNs in 2018. There was record positioning going on here. So that was very interesting.
Now going back to the first part of your question, that article, the correlations and volatility correlations are very, very tied together. Remember, these volatility indexes are tied with equity indexes. When you have low correlations, you can have days when one part of the market is up, one part is down and then the market is flat. We’re seeing a lot of that lately. That’s correlated with low volatility. One of the reasons why the market [volatility] is so low is that we’re getting rotations. We’re getting into value, into growth, back in and out. There’s a week when regional banks get hammered, then the next week the regional banks take off again. So, to me, one of the risks I see with that is that most of the rally in 2023 is in the top seven or so S&P 500 names. They are maybe forming a little bit of a bubble some might say. It’s not necessarily for me to say that, because sometimes the market can remain irrational longer than the short sellers can remain solvent, so that’s one component of it. But to me, that sets up a little bit of a risk when you see that concentration. And then getting back to the 0DTE, is that setting up a Volmaggedon? I don’t think it’s necessarily similar. And I do think the risks for a big pop in the VIX or SPIKES is significantly higher when it’s lower for starters. We’re kind of at that point, but to get a Volmageddon type of event you need a kind of a trip line, like there was on some of these ETNs. I don’t think they exist in the same way with 0DTE. It does, however, set up things that are similar to me, more like a flash crash or something like that, where there is a potential catalyst where we reach a set a level and then you can get it unwinding. So, there are more parallels to me to a flash crash event where volatility might not go unhinged, but you might see some big market moves.
I tend to agree because we’ve seen this before, where volatility indices can lay low for a long period of time. And I remember in 2018 having a discussion with a long-term options guy – long-term meaning his career — and he was telling me why he was shorting VIX at like 11. Why Vol was a sale with VIX at 11 or something like that and I basically said, “You’re insane.” When we were options market makers, we tended to be the odd ones in that we traded from a long volatility point of view. So, I too have somewhat fond memories involved. They say markets take the stairs to the attic and the elevator to the basement. But volatility tends to do the opposite, so it tends to take the stairs to the basement and the elevator to the roof and that’s kind of the problem you have. If you think you’re going to jump in and catch volatility correctly, it’s very hard to do. Think about early May, which was essentially not a particularly interesting time. Then there was an FOMC meeting. We started the week at 15 1/2 and we were at 21 ½ by Thursday. Things move quickly, then it all settles back down.
The other thing from the systemic risk point of view is that the people who use the term Volmageddon when worrying about the systemic risk from 0DTE options are sort of inversely proportional to their time spent as a professional options market maker, risk manager, clearer clearing person, exchange, person, etc. You know, like both of you. I’ve compared 0DTE options to a casino opening up a new table. You know, we’ve always had the $10 tables, now we’ve opened the $5 tables, but there’s really nothing fundamentally different in the risks or the games that have been played. We’ve had 0DTE options for as long as we’ve had options because every option is eventually a 0DTE option. And I know that some of the folks at OCC, who have spent a lifetime in the clearing of options and risk management of options, generally share this viewpoint. Do you both feel I’m barking up the wrong tree here, or do you think I’m sort of in the right place?
I think you’re 100% right. Like every expiration Friday, for as long as options have been around have been has been a 0DTE and then there’s been weeklies for a very long time. So, yeah, 100% right, I think I love that analogy of opening up another table. It’s another spot for traders. I’m sure day traders like it because they have more options available to them, no pun intended. So, I think that’s 100% right. I don’t think it does create any new systemic risk. Yeah, it’s just more trading, more volumes, the exchanges like it, yeah.
Yeah, I would just add I 100% agree. Just more education though too. I think we saw it during the pandemic of new people coming into our markets. The accessibility. We all have phones, we all trade off of them. So now you just have more. More optionality when you can trade, so making sure for all those that are interested that you’re educated on how they work. Because if there is some type of huge volatility event, making sure that you understand the implications of those. But you know, both of you are correct. We’ve had these forever. That’s what everyone’s been saying. There’s not a change from that standpoint. It’s just now you have a lot more to think about it, and to trade every day.
Yeah, new tools. You know, speaking of tools, Kaitlin, can you compare and contrast some of the tools that are available? You referenced the futures, you referenced the options, you referenced the ETFs. In full disclosure, I happen to be long SPKX right now, because as you could tell from this discussion, I think I’d rather be long vol than short vol and that’s one of the ways I’ve expressed it. Not a big position by the way, but I’ve wanted to dip my toe in and try them out. Can you go through some of the rationale behind these products? And let me state very clearly these are not ETNs. I’ve written about this before. ETNs are credit instruments. They’re a bond. They’re issued by a creditor. They’re not issued by a clearing house. They’re centrally cleared, but they’re very different and so let me just start by saying these are not the type of ETNs that Joe was referring to that got people into trouble.
Yeah, that’s a great point, Steve. I think of volatility as an asset class itself, and as Joe talked about it’s something that has been taking off in the marketplace overall. As often as I say, as you could be trading, you know, gold or crude, you know this is just another tool in kind of your toolkit, if you would think about volatility products overall, so diversification. And for many of us that are trading equities, maybe you have SPY, this gives you a way to hedge. Say you know, at some point there could be a change and we no longer have a fully up market, SPIKES or other volatility products, because they are inversely related to the S&P, allow you to kind of hedge that perspective. I know Joe was going to talk about some strategies here in a second, but I think that’s an important point to call out as why people look at SPIKES. Or volatility just in addition to what else they’re trading. And to that point you know as you think about SPIKES, again, a measure of the S&P 500 volatility, it does use SPY options. So that’s why we’ve seen a lot of traders looking at this product because they are trading SPY and then it just allows them to hedge in another manner and functionality of different products. Some people like options. Some people are trading futures. Having ETFs on this index allows you the choice. That’s why I’m passionate about SPIKES providing the marketplace choice in terms of another product when they’re looking to trade volatility. Lower exchange fees, which is often something important that we look at, but it also gives you the choice of the type of product that you’re trading, whether you want to be trading ETFs like the SPKX which is the 1X measure, or the 1.5X in SPKY.
You gave Mr. Tigay a perfect segue. Sorry to torture that rhyme. But, Joe, how are some of the ways that you’re utilizing volatility products in your trading and your portfolio management?
This is a strategy that my team and I developed as options market makers in the VIX pit. And we identified that most people think of options, and they think of volatility futures — SPIKES futures, VIX futures — they think, “That’s super risky. I don’t want anything to do with that.” Well, there’s actually two sides to that coin. They can make things riskier. They can also make things less risky. That’s where we step into volatility trading. We use it to make investing in the market less risky. And we hold expressly long volatility. We hold long volatility with the goal of getting market returns on a smoother path. So, we use the exact way that I described the VIX before. I expect it sometimes it’ll be cheap, sometimes it will not be. And it will not always trade as a very highly negatively correlated trade against the market. Meaning when the market is lower, volatility is higher; when the market’s higher volatility is lower. So, we hold two components to a portfolio and then we rebalance daily. So, we have an equity component. And that can be either tech stocks like we have in our Catalyst Hedged Equity Fund, or we can have just a large-cap portfolio like we have in our Rational Fund and then we can daily rebalance. It’s essentially a long/short but they’re both long: long stocks, long volatility, where we’re getting the benefit of that appreciation over time which I expect with the equities. We have that long-term bias there and then we’re getting that smoothing out of that. And we’re getting the benefit of while these stocks are going higher over time, there’s going to be volatility events, there’s going to be corrections in the market. So, in an event like 2020, when there’s a big pop in volatility, we’re going to have a much lower drawdown, which obviously is what we achieved. And we’re able to capitalize on that gain in volatility. We can sell volatility when it’s high and then we can use those proceeds and buy stocks back which are cheaper. It’s very important to trade it that way. It’s kind of like using futures, but kind of gamma trading it. If any of your listeners are familiar with gamma trading, we’re able to have like a free gamma trade by just holding two components to our portfolio. We’re trading the volatility back and forth and holding our equities to get that long-term appreciation.
That is a very simple and elegant strategy in a way, and clearly, our listeners and I are not the first people you’ve explained this to, but that is a very elegant way of thinking about it. I really appreciate it. You know, keep a little timer here. We managed to blow through the time allotted to us. There is no real set time limit, but boy, we covered a lot of ground in what seemed to me to be a short period of time. Any final thoughts before we wrap up from either or both of you? Kaitlin, you can go first.
I appreciate being on with you both. I think it’ll be interesting to see, as we look at where volatility is now, I’d love us to see what it is in a month if we connect again, so I’ll let Joe give us give his guess on that.
[Laughs] Well, right now it’s low, so historically it says it’ll be higher than where it is today in a month, but I think you and I’ll improve my chances if we say maybe three months from now. Looking forward to that fourth quarter, it usually is higher in that fourth quarter. But yeah, it’s not going to change how I trade. I’m going to expect the market to be higher if you give me a long period of time. And while the market’s going higher, I’m going to expect there to be volatility spikes and volatility.
What an awesome way to end. I’m not going to attempt to top those. So let me leave it at that. I want to thank once again my guests, Joe Tigay, CTO of Equity Armor Investments, Kaitlin Meyer, VP of Marketing at MIAX, and Steve Sosnick, chief strategist at Interactive Brokers. Thank you once again. You can find all our podcasts at ibkrpodcasts.com and wherever you find your podcasts, whether it’s Apple, Google, etc. And thanks once again to my guests and thanks once again to all of you listeners for sticking through with this. Take care everybody.
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