00:12:30 · Joe Weisenthal, Alex Micalizzi, Tracy Alloway
[00:12:30] S1: No, no. So this is great. So I give you $ 100. You are going to give me some coupon that is presumably higher than I could get just by paying a treasury. And in return, essentially what I am giving up is some participation in this upward move of the stock market. [00:12:47] S2: Some participation. And in a lot of cases, you are taking a downside risk, which isn't linear to the S & P performance. There's generally a buffer, some protection. And there's variations of what that protection is. So if we say, we'll take a typical example of a knock input and we'll put a 60% strike. All right. [00:13:08] S1: Let's talk about what that means. [00:13:09] S2: So that means that if S & P, you start day one at a hundred dollars and it's a one year, say it's a one year trade and we observe it every three months on the auto call ability. If S & P is down 20%, you still have protection until you hit down 40%. [00:13:27] S3: Okay.
00:13:27 · Tracy Alloway, Alex Micalizzi, Tracy Alloway
[00:13:27] S3: Okay. [00:13:28] S2: At which this will treat, in this example of a knock input, you will get the same equity participation as of earning S & P. So you get all the downside as if from $ 100, but it has to be below 60. That's a general structure. Other structures are you just sell a vanilla put there. So your put payoff comes in at that 60% point. But there's a lot of variations, bells and whistles on that. And that creates a digital exposure, which we'll talk about because that drives a lot of what we're seeing in the market. And the more... risk you take, for example, take the example of the 60% knock-in at a hundred from 60% down to zero, I basically have a hundred percent risk. So basically if I go down to zero, I've lost a hundred dollars. And so I can expect to get more premium for that as opposed to just selling a vanilla put where the most I can lose is 40%. And that changes the coupon as well. [00:14:41] S3: You mentioned worst of auto callables before. When did those become a thing? Because the idea of like tying a product to the single worst performing stock seems kind of risky to me. [00:14:53] S0: And yet they seem to have become more popular.
00:14:55 · Alex Micalizzi
[00:14:55] S2: Yeah, I'd say they've, so historically they've always been there. Like I can't remember a time not having a worst of. It comes down to the yield factor. So what is a worst of? Instead, in the example we just had now, We had S & P and it's down 40%. We take a typical structure in the market that has S & P, NASDAQ and Russell and the worst of, we now observe the worst performer. So you could have two of these indices up 20% and you could have, you know, the main street, wall street sort of trade. And one of these indices really underperform, you could end up with that put. And so it's, going to derive more premium, more premium from just selling a one index, which gives you a high yield. And it's also going to create additional risk factors for us because we have to model how these three things are moving together. And also it means that there are cases where what's the best, what's a great outcome for someone who has this yield and say it was done during a time of turbulence and the yield is very high. The best sort of outcome is two of these stocks rally and one of the stocks is marginally down and just stays there and the volatility on this thing does nothing and it goes sideways. You have now, I wouldn't say locked in, but you now have a relatively higher yield than just doing S & P that's gone up, right? That complexity of trying to monitor the worst one and being able to hedge it, is, I think, a segue to what's trading in the market and why it's creating this market dynamic, or why it's grown, sorry. And so you look at the three assets, the Russell, S & P, and NASDAQ trade, you basically have had all three of these indices and Russell over the last year. Russell was effectively sideways for many years. It's now performed a lot better. And so think about this. What drives volumes in an order call is a knockout. I can have a five-year trade, but if these three indices or three stocks or whatever go up every three months, I can do a five-year trade now has the same notion of every three months. So that volume goes up considerably.
00:17:17 · Tracy Alloway, Alex Micalizzi, Joe Weisenthal, Tracy Alloway
[00:17:17] S3: Just before we get more into the market impact of all of these, talk to us about what's happening, I guess, on your side of the desk when you actually issue one of these products. So you mentioned having to model the correlation between three indices just then. What's the first thing you do when you sell one of these? [00:17:33] S2: Okay. So the first thing we do is we eliminate the delta. So we hedge the delta. That's the simplest thing. We're not taking a directional view. [00:17:41] S1: Is that some Greek letter? [00:17:43] S2: Yes, it is a Greek letter. [00:17:44] S1: What does it mean again? [00:17:45] S0: I said there'd be Greek letters. [00:17:46] S2: I don't know. [00:17:47] S1: What's the delta again? [00:17:48] S2: The delta is the relationship between the price of this product and the spot price of a stock. [00:17:56] S1: Okay. [00:17:57] S3: Right. [00:17:57] S2: Excellent. [00:17:58] S1: Keep going. Right. [00:17:59] S2: So this product is bullish in nature. So as the market goes down, we went through that 6,100 thing. [00:18:06] S1: Yeah.
00:18:06 · Joe Weisenthal, Alex Micalizzi
[00:18:06] S1: Yeah. [00:18:07] S2: I'm on the other side of it. So I have a short delta position. I'm short the market. The first thing we do is we hedge that out. Now we're left with more interesting Greeks. And so at a headline level, what have we got? And let's take the example of the one year single S & P example, and let's take the auto call. The maximum maturity of this thing is one year. And I own some sort of put on that one year trade with the risk of this thing not existing every three, six, nine, 12 months. So I've got Vega on this put, and what's Vega? [00:18:46] S1: Thank you.
00:18:46 · Joe Weisenthal, Alex Micalizzi, Tracy Alloway
[00:18:46] S1: Thank you. [00:18:48] S2: Vega is the put sensitivity to the implied volatility. I've got Vega there, and I've got these quarterly knockout features. So what are they? What is a knockout? A knockout is a fancy way of saying a digital and a less fancy way of saying it's a call spread. I've got three call spreads there. that I look at. And so that, that is a lot of options in that phase. And so what do we do? What, what do we have headline Greeks? So we look at our Vega and a lot of my exotic brethren will probably go, well, that's not technically correct, but the way we generally look at it is when do we expect, how long do we expect this thing to last? And it's probably gonna, we can model that sort of, and just say in this example, we say it's going to last six months. We will assign the vega of this put at the six month level, and we'll go to the listed market and we'll sell some sort of downside because it's related to that 60% strike and sell that out there. That's not really what's in this product. [00:20:03] S3: Can I ask really quickly, who do you actually sell that vega to?