00:27:33 · Joe Weisenthal, Alex Micalizzi
[00:27:33] S1: Just to be clear, if I'm one of these high net worth investors and I buy one of these nodes, what do I typically want to happen? I want it to last the entire lifetime and just keep clipping the max coupon possible. Like what is the sort of ideal market regime for me as the buyer? [00:27:52] S2: As the buyer, the market regime, things are very volatile. So my yield from this put selling is very high and things quieten down and markets have drifted lower. Not in a volatile way, but they've just drifted lower and the world has become nice again and I'm left with this really high coupon for as long as possible. That is the outcome. [00:28:16] S1: So if it goes up too fast, Then the note is over and I don't get all my coupons. If the market plunges, then I'm actually potentially in the red because I'm outside of this buffer zone and I'm actually exposed. But we get this nice little quiet thing, maybe a little bit lower, et cetera. Then I get that coupon. It lasts for a very long time and I'm not picking up any downside. [00:28:36] S2: Exactly. That's what you want. And so when we get those drift downs, it's when we generally get this fold dynamic. And it's happening in the skew. So when I said knockouts and coupon contingent, Again, digitals, fancy words for put spreads and call spreads. [00:28:51] S1: Why is it called digitals?
00:28:51 · Joe Weisenthal, Alex Micalizzi, Tracy Alloway
[00:28:51] S1: Why is it called digitals? [00:28:53] S2: Because it's binary. It's binary, right. And so it's either zero or one. And so if we think of these things as put spreads and call spreads, we're now going into another dynamic, which is skew. So we can look at volatility and say, hey, at the money volatility is 30. But what really matters in these type of products is how steep or not steep the skew is because we really have this clump of put spreads and call spreads on rather than just this outright Vega. And I guess the question you would ask, I think is, Hey, you told me you just sell one put. [00:29:29] S1: Yeah. [00:29:30] S2: Why are you doing that when you've got like these? [00:29:32] S3: I was just about to say exactly that, exactly that question. [00:29:35] S1: Keep going. [00:29:36] S2: Because to replicate those put spreads in the notion or the dollar somewhere trading, it's just not conceivable. There's too many of these things we have to do. There's, in a lot of cases, especially single stock, which is changing, there's not daily option markets. The bid-offer spread would just be too high to try to even contemplate doing this.
00:29:36 · Alex Micalizzi, Tracy Alloway
[00:29:36] S2: Because to replicate those put spreads in the notion or the dollar somewhere trading, it's just not conceivable. There's too many of these things we have to do. There's, in a lot of cases, especially single stock, which is changing, there's not daily option markets. The bid-offer spread would just be too high to try to even contemplate doing this. [00:29:59] S3: Actually, this reminds me of something I wanted to ask you, which is correlation is one of the trickiest things in all of finance to model. And I'm very curious how often the models disagree, I guess, internally on a potential outcome. And if there is disagreement or if there is uncertainty... Where does that actually get priced? Does it get priced in the coupon that you're paying out to the investor? Or do you, I don't know, add an additional reserve or something like that?
00:30:28 · Alex Micalizzi
[00:30:28] S2: Combination of all those things. So I guess the modeling component, we think of finance as this risk-neutral world. And so if you look at that empirically and the returns on equities, it's not risk-neutral to start with. We also have liked to look at markets in terms of, so basically markets have gone higher than what a risk neutral rate would suggest. Right. And so a lot of these products they're based on the expected knockout date, because a big component of this is the funding. You gave me, you gave the issuer a hundred dollars. How long is that going to invest for? Right. And so we base it on risk neutral. So that in and of itself is a constraint, but also. what can we observe? The selling the put, we can observe implied volatility in the listed market. And so we can build a volatility surface on that, a local vol surface. But if you look at this actual trade and we look at the, let's go back to that simple three month quarterly knockout and the knockout again, is that put spread? I've got a series of these put spreads that are forward starting. All right. So I've got a, you know, in three months time, Am I going to have to do something in that next three month bucket? So you've got forward starting risk. And when we look at local vol and the construction of local vol, it really, really underestimates the relationship between these dates going forward. So to cut a long story short, there's modeling assumptions that we use and we look at stochastic volatility to try to take that into account. And that's just, again, some of this stuff is opaque. because one of the components of stochastic volatility is vol of vol, and you can't really observe vol of vol outside of maybe VIX options. And so on a single stock name, you can't do that, especially when you get to these daily nuggets.
00:32:42 · Joe Weisenthal, Alex Micalizzi, Tracy Alloway, Tracy Alloway
[00:32:42] S1: With the single stock structured notes, what are the popular ones that we're talking about here? [00:32:50] S2: NVIDIA? [00:32:51] S1: Apple? Meta? What are people buying? [00:32:54] S2: Semis. Okay. You've got the hyperscalers. [00:32:58] S1: Are there ones for the neoclouds? Are there people buying? [00:33:01] S3: There's a CoreWeave one in Asia. [00:33:04] S0: There's probably some in the U.S. [00:33:05] S2: Too. [00:33:06] S3: But our colleague at Bloomberg, Shuli Ren, wrote a really good column about it. 40% annualized yield. [00:33:11] S1: That's pretty sick. So actually, I was going to thank you for bringing that up. Just to be clear, when you're talking about, you said $ 300 billion market this year? [00:33:20] S2: And that's predominantly on, that's just U.S. registered. [00:33:25] S1: So this is U.S. money? [00:33:26] S2: Yes, this is U.S. registered money. [00:33:28] S1: Okay. Because my understanding is for as much as like people talk about it here, this is like really big in. [00:33:35] S3: Asia, right? [00:33:36] S2: Yeah. [00:33:37] S3: One of my favorite headlines that I ever wrote was, I think it was when there was drama in the Chinese UN and a bunch of structured products in Asia got knocked out. [00:33:46] S0: And I called it the tarf barf. [00:33:48] S1: Oh, that's good. [00:33:48] S0: Thank you. Thank you. [00:33:50] S1: But can you explain what it is about high net worth in the US versus high net worth in Asia such that there is a maybe more naturally economic reason why these products are so popular in Asia? [00:34:04] S3: Yeah.
00:34:04 · Tracy Alloway, Alex Micalizzi, Joe Weisenthal
[00:34:04] S3: Yeah. [00:34:04] S2: I would say just because it's been around longer in Asia. [00:34:09] S1: Is there a reason for that? [00:34:11] S2: I would say it probably started with Japan when interest rates went to zero. And the concept of Uridashi started where, hey, how can I enhance this? And then you get a coupon. Hey, how can I make that coupon higher? And you add certain factors to it. And in markets, I guess... This market, the US market is more used to participation because just. [00:34:38] S1: Of how it's done. Yeah, I get it. [00:34:39] S2: I get it. And other markets have had different sideways down, whatever. And so having something that protects you a little bit on the downside and gives you a yield when maybe the equity performance hasn't been there starts to look more attractive. [00:34:55] S1: Now, these days we're talking about, you're going to get some pretty fat, pretty juicy yields in the United States these days. We're in this sort of weird situation. In which, and it's kind of a rare situation historically in which stocks have done quite, quite well. And also rates have been going up and also spreads have been going up, particularly on many of the stocks that have been going well. It's a very strange environment. Does that lessen at all some of the appetite for structured notes when I don't have to get particularly exotic if I just want a coupon? Yeah.