00:20:03 · Tracy Alloway, Alex Micalizzi, Joe Weisenthal
[00:20:03] S3: Can I ask really quickly, who do you actually sell that vega to? [00:20:07] S2: Yeah. We generally use the broker or listed market. So we will go to the S & P market makers in this case, and we will go there. We'll either do it on screens or via the broker market. It's generally what we do in this case. With the trend, we'll go to the trend a little bit later because I think it's important to understand why it's an imperfect hedge and what disruption that causes and how dealers, my colleagues have changed some of the trading methodologies as well. [00:20:44] S1: Let's talk a little bit about the action that we're seeing these days. And I guess to understand maybe the action, these days markets have gotten a little bit, like I said, it feels like the plane is like rumbling a little bit or something at high speeds. But before maybe we understand right now, let's maybe start and go back to the start of the year. Let's start, okay, we're talking about We're talking to you at the beginning of 2026, or maybe March 2026, three months ago or whatever. What are popular things that you're selling and what are the popular thing to clients? And then what are the popular trades you're putting on to hedge those trades?
00:21:20 · Alex Micalizzi
[00:21:20] S2: Yeah. So I would say it's bifurcated. There's an index side. So US registered stuff, we talked about the 300 billion run rate. And then there's the single stocks stuff, which is a very similar concept, but It's the, when we talk about maturities and we talk about these knockout dates, it's basically shrunk to a level that's creating a different dynamic. Let's start at the beginning of the year. So markets are going up. This product is effectively on the single stock side, on the index side is knocking out the single stock side is a lot faster because we observe it instead of every three months. Some of this stuff we observe every day. And so this stuff is churning a lot and In terms of hedges, there's less hedges because there's less vega because the product isn't extending because markets are going up. So this is a pretty virtuous cycle because it trades out, one comes in, and your day one hedges are working and you don't have to think too much about it. And then it's all hunky dory, as we say, until we hit some turbulence and certain stocks go down. And indices go down and that hedge, which isn't static and needs to be dynamic, changes. And the participant, the value of where I can hedge in terms of that implied volatility has also changed because a lot of people need to hedge at the same time. And some of the counterparties that were used outside of the listed market and IDB are pulling back because of turbulence. And so you have this concurrent effect of a lot of dealers have to now sell more optionality as markets are coming off. And a lot of the, I guess the demand for it is also fading come August.
00:23:14 · Tracy Alloway, Alex Micalizzi
[00:23:14] S3: So just to be clear, you're left in a situation where the dealers or the issuers have a lot more Vega that they need to offload at the same time that I guess primarily the market makers are a lot more reluctant to take on that Vega. [00:23:29] S2: That is very well described. Yes. And again, that's because what was disappearing or knocking out every three months now seems to be having an extended maturity. because the spot prices come down. And I think the market makers are seeing all the supply come as these indices and stocks are coming off and going, well, what's happened? Like the last nine or the last seven to eight months, we didn't see this. Now we're seeing it. There's a yin and yang to this though. And we've seen it on a lot of V-shaped recoveries. It's, hey, I've got this product and I think in all fairness, if we look at the worst of three, it's generally three to five years. So that's where the, that's where, and with say an expected life, we call it when we expect that maturity to knock out of about two years, we see dealers hedging more and more of that as the markets come off. But all of a sudden, if these indices start to rally again, we could have a situation where this product knocks out in three months. And I am left just with my short hedges in the market and the supply is not yet there from my auto callable. So there's a situation where dealers can be left short, a lot of vaguer on the street. just on a small rally. And in all fairness, we're not too far from all-time highs as it is.
00:23:29 · Alex Micalizzi, Joe Weisenthal
[00:23:29] S2: That is very well described. Yes. And again, that's because what was disappearing or knocking out every three months now seems to be having an extended maturity. because the spot prices come down. And I think the market makers are seeing all the supply come as these indices and stocks are coming off and going, well, what's happened? Like the last nine or the last seven to eight months, we didn't see this. Now we're seeing it. There's a yin and yang to this though. And we've seen it on a lot of V-shaped recoveries. It's, hey, I've got this product and I think in all fairness, if we look at the worst of three, it's generally three to five years. So that's where the, that's where, and with say an expected life, we call it when we expect that maturity to knock out of about two years, we see dealers hedging more and more of that as the markets come off. But all of a sudden, if these indices start to rally again, we could have a situation where this product knocks out in three months. And I am left just with my short hedges in the market and the supply is not yet there from my auto callable. So there's a situation where dealers can be left short, a lot of vaguer on the street. just on a small rally. And in all fairness, we're not too far from all-time highs as it is. [00:25:01] S1: It's the funny thing. It's just the funny thing. We do these things like, oh my God, the volatility, et cetera. And we're like, we're like one and a half percent, I don't know, from an all-time high. It's kind of, the stock market's doing fine.
00:25:01 · Joe Weisenthal, Tracy Alloway, Tracy Alloway
[00:25:01] S1: It's the funny thing. It's just the funny thing. We do these things like, oh my God, the volatility, et cetera. And we're like, we're like one and a half percent, I don't know, from an all-time high. It's kind of, the stock market's doing fine. [00:25:15] S3: Well, is this part of the, your colleague at Nomura, who's been on the show a number of times, Charlie McElligot, he calls. [00:25:21] S0: This the spot up, vol up. regime, right? [00:25:24] S3: Is this like part of why we're getting that situation?
00:25:27 · Alex Micalizzi
[00:25:27] S2: Yes. I would say it's even more prevalent on the single stock side, but on the index side, we are definitely seeing that just because of the growth of the worst of and the growth of the US SEC registered notes. We're seeing that dynamic in the longer dated and there's just been, I guess, less capital committed to that vaguer or Less understanding of what's driving it. And it's basically this that's driving it. This factor that we just have more of this stuff in this bucket. On the shorter dated stuff, when we look at single stock, it's been driven by the same product, but the product complexity, it goes to another level. So when we talked about how do we get a higher yield and we said, hey, let's put these auto calls in there. There are other things we can do to get a higher yield as well. So we can put contingent coupons. So that basically means that I won't pay you this coupon if the stock or the worst of has fallen too much. So that's another thing we can do. We can also, instead of having the observation every three months, we can have it daily. And so that means any rally, this thing's gone. And if you look at something like that, It becomes very, very binary. Generally in this type of structure, it's on single stock name, worst of three. We let the stocks breathe, for want of a better term, for a month. And then we start observations on a daily basis. And these things typically go from six months to 18 months, maybe two years. So on every day, I might be left with no option, no vega, no put. Or if one of these stocks goes down, I'm left with a lot of put value in that one year timeframe. So either I have vol here or I don't, and I'm now observing it every single day. So it's creating this on off type of market in, in the single stock names.