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.
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?