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.
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?