00:34:55 · Joe Weisenthal, Alex Micalizzi
[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. [00:35:28] S2: So in the U S if we actually look at the size of the market historically, versus what the coupon or that yield has been, it's not as big as the total return. So what that's telling me is that people, the US, in the register space at least, are taking some of that return and using it as investment income, as a dividend per se. And so the market structure in the US is different because this is a participation trade and this is something that diversifies and gives some protection to the downside. [00:36:06] S1: All right. [00:36:07] S2: And I think it's being used like that in, in the U S whereas in other markets, it's more about how can I get the highest return and the duration, like the maturities are less. And also the, the idea of reinvestment is higher as well in terms of taking this and doing it again. Hmm.
00:36:07 · Alex Micalizzi, Tracy Alloway, Tracy Alloway
[00:36:07] S2: And I think it's being used like that in, in the U S whereas in other markets, it's more about how can I get the highest return and the duration, like the maturities are less. And also the, the idea of reinvestment is higher as well in terms of taking this and doing it again. Hmm. [00:36:26] S3: You know, you mentioned less capital available in the, I guess, financial ecosystem for absorbing some of this flow. I don't want you to name specific counterparties or anything like that, but what is going on here exactly? Is this like a restrictive balance sheet thing or are people nervous about actually like expressing particular views? [00:36:47] S0: What's going on? [00:36:48] S2: I don't think it was views. I suspect that to protect portfolios, call options were being bought in the market. And as those portfolios changed and maybe shrank, the need for that went away. And so a large buyer that elevated option premium disappeared at the same time. Well, I guess it's all related as markets were coming off as well. And that definitely changed some of the dynamics in the market. [00:37:16] S3: So what does that actually mean for issuance of structured products? If you can't offload the vega to someone else, if you can't properly hedge, are you naturally limited in what you can do?
00:37:27 · Alex Micalizzi
[00:37:27] S2: Yes and no. I think there is still a market. There is way more liquidity in the US capital markets than anywhere else. And looking at this from the lens of trading in Hong Kong and Australia, there are real two, three, five year equity markets that are hedgeable. I would say ultimately what drives issuance is the direction of the market. I would say if we do go sideways and there's less order callables or we go down, you're just not going to get the demand for more or historically demand tails off. And that does also create a very interesting dynamic in the market. So the example of, I think we moved it from a one year trade to a five year trade. So the dynamic that we're seeing in the market is we've got typically with the US registered, we've got three to five year maturities with expected life of two years, you're selling two years. If the market goes down or the worst of goes down, the chance that this goes to five years becomes a real thing, right? And so all the vegas there. So that dynamic will mean there's no new issuance, but I'm now short this two year trade and I never had Vega there. I used that position as a proxy for the 5U. And so that term structure also changes where you can get the stuff that's depressed in the market having a higher value because you've just got your short hedge on and now you've got exposure to the 5U. And again, conversely, we get markets go back to all-time highs. I'm just left short the 2U and that's another reason it can go up. And when we look at this stuff and we model it, we call it, you know, peak Vega.
00:39:15 · Joe Weisenthal, Alex Micalizzi
[00:39:15] S1: So what happens if like, all right, people, you know, again, we're in this bow of like, oh, it's the AI, boom, is it coming to an end or something like that? What happens if we really get some real, I mean, these moves aren't that big yet. Semiconductor ETF, I guess it's down, I don't know, maybe 10% from its peak or something like that. It's not that big. What happens if we're like, wow, you know what? We're really going to reprice the AI trade in a meaningful way for some theory, the ROI is up there, whatever. What happens to these products if we're like, all right, we got some moves here? [00:39:50] S2: So if we get really large moves in terms of, again, the client has, in effect, there is a directional component to this trade, right? They are short of put. So in extreme situations, in these cases, there's $ 100 potentially at risk. And there's a point where, depending on the type of put or how it was structured, that the dealer can be on Instead of being long gamma because of this put, it's really a put spread. I'm on the other side of the spread because it's gone too far. Now that's another Greek word just introduced. I'm now short gamma, which means that I'm more susceptible to market moves and I exacerbate the market moves. I have to buy when market goes up and sell when market goes down. That's gamma. Big short.
00:39:50 · Alex Micalizzi, Joe Weisenthal, Tracy Alloway
[00:39:50] S2: So if we get really large moves in terms of, again, the client has, in effect, there is a directional component to this trade, right? They are short of put. So in extreme situations, in these cases, there's $ 100 potentially at risk. And there's a point where, depending on the type of put or how it was structured, that the dealer can be on Instead of being long gamma because of this put, it's really a put spread. I'm on the other side of the spread because it's gone too far. Now that's another Greek word just introduced. I'm now short gamma, which means that I'm more susceptible to market moves and I exacerbate the market moves. I have to buy when market goes up and sell when market goes down. That's gamma. Big short. [00:40:37] S1: Do you see like, all right, let's say a bunch of people bought these notes that don't take any hit until they're 40% down or something like that. Are there things that you see in the market when like a bunch of these things are 38% down and they're getting close to that barrier or whatever? Are there fingerprints on the market? It's like, wow, it looks like a bunch of structured notes. We're getting close to some of these levels. What would I expect to start to see happening? [00:41:06] S2: In all fairness, we haven't really seen a down market where those books have been there. We see it on the knockouts more. Because that's probably, it happens once every three months rather than once every five years. But the concept is the same. So it's a digital, it's a call spread. [00:41:22] S0: Yeah.
00:41:22 · Tracy Alloway, Alex Micalizzi, Tracy Alloway
[00:41:22] S0: Yeah. [00:41:22] S2: And either this product is going to survive and go on for at least another three months or it's not. So the fact that it's a put spread or a call spread, it depends what side I'm on, whether or not I'm long or short gamma. So the same thing on the put, if it's a knock-in put especially. Depending on which side I'm on or approaching it, you get a gamma profile that can be short. That you being the dealer. Yeah. And so- What that means is you can get exacerbated moves around those levels as a result of being close to those levels and having this binary outcome near those levels. So we see it often on the knockouts just because there's more of them and we face them more. But yes, in a period of these things are down wherever the strike is, I think we said 40%. As we approach it, you'll start to deal a short gamma. And then when we're on the other side of it, you'll get the same sort of aspect. [00:42:20] S3: Which is more painful, the slow decline or the big overnight fall?