Lead-Lag Live
Welcome to the Lead-Lag Live podcast, where we bring you live unscripted conversations with thought leaders in the world of finance, economics, and investing. Hosted through X Spaces by Michael A. Gayed, CFA, Publisher of The Lead-Lag Report (@leadlagreport), each episode dives deep into the minds of industry experts to discuss current market trends, investment strategies, and the global economic landscape.
In this exciting series, you'll have the rare opportunity to join Michael A. Gayed as he connects with prominent thought leaders for captivating discussions in real-time. The Lead-Lag Live podcast aims to provide valuable insights, analysis, and actionable advice for investors and financial professionals alike.
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Lead-Lag Live
Noel Smith on Hedge Fund Mastery, Multi-Strategy Approaches, and Interest Rate Futures Insights
Ready to uncover the secrets of hedge fund mastery? Join us as we sit down with Noel Smith, CIO of Convex Asset Management, who shares his incredible journey from the bustling floors of the CBOE to the upper echelons of hedge fund management. Noel's story exemplifies the importance of cross-asset analysis and the adaptability required to thrive amidst market volatility. We'll explore the sophisticated multi-strategy approaches used by industry giants like Millennium and Citadel and how these strategies can mitigate risks during market downturns.
Have you ever wondered what it takes to manage a multi-strategy hedge fund? Imagine it as orchestrating a diverse menu at The Cheesecake Factory, where different trading strategies shine under varying market conditions. In our conversation, Noel delves into the nuances of dispersion trading, high-frequency trading, and the moral responsibilities of handling client funds, using historical market events like September 11, 2001, as insightful case studies. We'll also examine current market opportunities and the critical importance of evaluating dispersion and relative value between stocks.
Our discussion then shifts to the complex world of trading interest rate futures and the pivotal role of the Federal Reserve. Noel sheds light on the intricate relationship between futures and Fed signals, the implications of the recent regime change in interest rates, and the indispensable role of options data in making trading decisions. As we navigate through the landscape of cross-asset volatility and variance futures, Noel emphasizes the need for constant adaptation in an ever-evolving market. Finally, we address the challenges of asset management, raising capital, and making profitable trades in today's unprecedented economic environment. This episode is a treasure trove of insights for anyone looking to deepen their understanding of hedge fund strategies and asset management.
The content in this program is for informational purposes only. You should not construe any information or other material as investment, financial, tax, or other advice. The views expressed by the participants are solely their own. A participant may have taken or recommended any investment position discussed, but may close such position or alter its recommendation at any time without notice. Nothing contained in this program constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in any jurisdiction. Please consult your own investment or financial advisor for advice related to all investment decisions.
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The idea that you're going to have volatility in a teacup and have it not really spill out into anything else is pretty rare. Going back to August 5th of last month, that's kind of what you saw and that's kind of why I said it on camera Faded. I think that this is a sell. It ended up working out. I didn't know that ahead of time. That was pretty much a real-time decision, but that was because cross-asset volatility wasn't going bananas everywhere. That was because cross-asset volatility wasn't going bananas everywhere. Yeah, the Nikkei was down. Yeah, everything was moving, but as a percentage of the reaction that you were getting relative to why and how. And if you look at the marketplace, in the options market, specifically the SPX, there's a lot of reasons to fade that. So if you are looking at cross-asset volatilities and I think everybody should for good reason that was a fake.
Speaker 2:This should be a good conversation with Mr Noel Smith, who I had on his spaces, I think, over a year ago. At this point. A bit of you watching this live want to interact and engage. Whether you're on LinkedIn, youtube or X, I could see your comments. Let's make this interactive as much as possible Makes my job and life easier, so I'm not constantly trying to figure out the next question to ask. This will be an edited podcast under lead lag live and all your favorite platforms. Please, folks, do me a favor and spread the word around lead lag live, given around Lead Lag Live, given how much effort and time I put into these conversations with thought leaders like Noel here. With all that said, my name is Michael Guyette, publisher of the Lead Lag Report. Joining me for the rough hour is Mr Noel Smith. Noel, for those who aren't familiar with you, introduce yourself. Who are you, what's your background, what have you done throughout your career and how many screens?
Speaker 1:do you have behind you? Well, not counting the one I have in front of me, I think it's like seven or eight.
Speaker 1:So, I'm Noel Smith. I am the CIO of Convex Asset Management. We are a hedge fund and I started out on the floor of the CBO in 1996. And I was a clerk back then. My job was to get coffee, make tacos and things like that. Eventually I kind of became a pet trader, a market maker, and then something around 2000, 2001, I was kind of leading the main efforts of the firm from the upstairs and kind of lording over a handful of guys on the floor and then from there we went to guys at the Amex, the Comex, the Nymex, the Merck, the Board of Trade, etc.
Speaker 1:Kind of like a body in every place that we thought there was something to do, and I ran a prop firm for a long time, but we were involved in high frequency trading as well and had dreams of launching a hedge fund a long time ago and in the recent few years did launch a hedge fund. So experience in the hedge fund space, in the prop trading space, in the high frequency space and in the getting coffee for others at the request space I'm going to guess that getting coffee was the most interesting part of that.
Speaker 2:Now, coffee for others at the request space. I'm going to guess that getting coffee was the most interesting part of that. Now let's talk about the different types of hedge funds that you have some experience with. Which ones, from a strategy perspective, were most interesting? Which ones are most boring? Which ones do you wish worked better today? Well, that is such a broad question, and it's a good one.
Speaker 1:Nobody's ever asked me that, so I only have a deep experience with my hedge.
Speaker 1:It's not like I've ever worked at Bridgewater or Citadel or whatever else, but I do know people that work at these firms not Bridgewater so I have a probably better than casual understanding of what goes on at them. And this is kind of like you know, not talking my book, but this is kind of why I launched my fund because we don't have a strategy and neither does the same millennium, they are a multi-strategy, but us say millennium, they are multi-strategy, but the point of that is that every dog has its day and sometimes that same dog has no day, no sunshine, for a long time. So I think that, like a long short equity book or convertible arbitrage, something like that, it can have extended periods of drought and we are a multi-strategy hedge fund and much like I think what are the best breed hedge funds, like a millennium or Citadel. They are multi-strategies because they always have something they can kind of look to if things get boring, or P&L just doesn't go the way they expect All right.
Speaker 2:So let's get into that, because multi-strategy sounds like a fancy term, but obviously there's nuances right to what those strategies are. What are some of the strategies that you like to employ on your hedge fund and which strategies are perhaps old in the tooth, meaning old in the cycle, meaning maybe a lot of the alpha has been arbitraged away?
Speaker 1:in general, so what does multi-strategy mean? Think you know a cheesecake factory? Right, they're a multi-dish restaurant. They're not just a pizza place. They're not just a coffee place. They have a lot of things to offer. So multi-strategy hedge funds simply means they have a lot of different ideas with different people kind of running them In terms of strategies that have worked, no longer work or are old.
Speaker 2:I think everything kind of has its like, like in the movie the Matrix everything that was old is new again in some period of time.
Speaker 1:I'll give you a specific example that I'm going to have to talk out of the side of my neck on is dispersion. I ran a dispersion book 20 years ago and, for whatever reasons, it kind of dried up and the P&L became pretty flat and there wasn't a whole lot to do. We hired another guy that came from a big dispersion firm and he came to us, said something to the effect of hey, I can improve your strategy, I can add some alphas to it and we can make it better. So he did, and he eventually ended up leaving without much of a P&L, so that we were kind of settled with the book, like it or not, and then this strategy couldn't lose money for five years after he exited the firm.
Speaker 1:And it really dawned on me something that we all kind of know, which is it's not always the strategy, it's the time and the place and just the opportunity set. So, using dispersion and the skin cut and paste to a lot of different ideas, there isn't always a time that it works Really. Of all the harebrained schemes I've been pitching, the only thing that I think is truly unique and different, which isn't even that. Truly unique and different is high-frequency trading. High-frequency trading is just an electronification of some of the best practices from pitch trading, but using new tools, and I thought that was genuinely unique at the time and still is on some levels.
Speaker 2:Is it easier or harder to manage hedge funds and manage a multi-strategy approach? In largely large cap cycles, right when it's a passive type of FOMO, momentum type of environment, it's always different.
Speaker 1:So is it easier for me to drive my car like crazy or borrow your car, assuming I like you and don't want to crash it and then drive your car? So there's a certain just moral responsibility that you feel just to always do right by people that choose to interface with you on a professional level. So it's harder. I'll give you a specific example and this is timely as of yesterday, september 11th. On September 11th 2001, I was running a firm and it was in Chicago and New York and I didn't know if we were out of business that day, just not even to speak of the human aspect of it, because that's not what this channel is about. But from a business standpoint, I didn't know if we were blown out that day. If I had to guess, I would say yes, we probably were.
Speaker 1:The old folklore of trading airline puts before September 11th. Well, I can verify with 100% accuracy that that happened because I was doing it, I was short a bunch of airline puts and fast forward to after the event and after the market reopened and whatever else, we were back to positive P&L by something like mid-November. So my point is that things ebb and flow and I don't know that I would have taken those same risks with somebody else's money as I do with my own money, because I knew that the opportunity set was so great coming out of September 11 that we really leaned into it to the point where we actually made money by the end of the year. And running a hedge fund, you have to be so much more risk averse, sometimes to the detriment of the fund.
Speaker 2:Let's talk about that opportunity set point. You can make, I think, a very bearish argument around the majority of stocks. You can make a very bullish argument around the majority of stocks because the majority of stocks have not participated as much as the large cap tech end, as you know. How do you think about the opportunity set here for the longs versus the shorts? It's a funny question because, as we were already, talking about.
Speaker 1:We're talking about dispersion, so dispersion. So if NVIDIA goes up a billion percent and Exxon Mobil, that's a bad example, but Abercrombie Fitch goes nowhere, right? So does that really mean I care about Abercrombie and Fitch or I care about NVIDIA? Well, I don't. I care about the difference between them, I care about the dispersion in the marketplace. So for people that do what I do, the opportunity set is good. That doesn't mean I have to own Microsoft and NVIDIA or Apple. I can own the spread difference between them and profit from that spread, irrespective of the lunacy revolving around Nvidia.
Speaker 1:I don't want to pick on Nvidia because I thought the same thing with Tesla. I think Tesla cars are cool. I don't know what the value of the stock is. I always thought it was very high, but I knew a lot of guys that lost a lot of money being short that stock. It was a very difficult thing to do, and similar valuations are being placed on NVIDIA. Valuations have always been something I have no real opinion on because I'm not good at it Amazon for years wasn't making any money.
Speaker 1:Everyone's like, ah, this thing isn't making any money. Guess what it went up. Same thing could be said for Google at Infinitum. So, in terms of valuations, do I think that NVIDIA is high relative to Chevron, texaco or whatever? I really don't know, but I do know that there is a statistical and mathematical difference between them, and that creates a different opportunity set that may be more nuanced for other people to capitalize on.
Speaker 2:I think the old school hedge funds used to care about valuations. I mean, I don't know if that's the case anymore. I mean, you mentioned higher frequency trading. Are we in a permanent world where valuations really just don't matter? It's either based on options trading or structural things and the way things trade. It's just a different type of way of thinking about investing.
Speaker 1:Well, I've always thought that because I come from the market making background. So the problem is, there's the reality of the world that we live in. If you're a hedge fund manager, say, you're running a billion-dollar book and you don't perform because the valuation on the stock has just got to work the way you think it is, and maybe you're totally right. Or even more to the point, we've all seen short theses that don't work out for a long time, like Herbalife. When Bill Ackman started talking about Herbalife he was totally right. It took him years to make money on that thing. Or even Valiant Valiant was a great short thesis and it took a long time for that to work out.
Speaker 1:My point is that you can know exactly all of the best information that is to be had and still be wrong for long periods of time, and if you are wrong for any substantial period of time, you get fired. So then that forces the people that you know follow you to fall into smaller and smaller tranches of time, and it kind of forces people into. You know what have you done for me lately? And you know valuations be damned. With that said, you know if the valuations are so compelling, you know there will be long short funds that sponsor the stock or the stocks and things actually will work out. But that can take a long period of time. Sometimes people just don't have that much time at their discretion.
Speaker 2:Is there anything that would suggest that, depending upon where you are in the valuation cycle, certain hedge fund strategies tend to perform better than others? Because I would think that, to the extent that there's a link around volatility, overvaluation tends to be volatile. Undervaluation tends to be volatile in the middle, not so much. Talk about that, because I think having an understanding of the cycle could maybe determine which strategy to lean more into.
Speaker 1:You know, unintentionally, you're kind of getting into our alpha. What we really do is try to figure out. We trade interest rates. Okay, interest rates are the price of money. We all know this. If we're looking at the volatility surface within the 10-year notes all day, every day, which we are it is impossible to not have some kind of opinion on interest rates. And if you are trading interest rates all the time, it's impossible to not have an opinion on how that affects the things that are affected by interest rates, which, at some level or another, everything is. But let's just be more specific, like finance stocks, real estate stocks, things that are the low fruit, and then you can apportion your risk where you think that's going to be.
Speaker 1:You know a lot of the alpha that is generated by big hedge funds. You know one of the biggest in 2022, you know their best trade was basically this is not the trade, but like long down short arc. Again, that was not the trade. But if you were to just dumb it down by several levels, that is kind of what they did. And they had a banner in 2022, which almost nobody did. So being able to see these macro trends I'm not a macro guy, but being able to see macro trends and not fight them or have some kind of intuitive feel for them, either it would be from the options market or from your research. There is definitely off with them.
Speaker 2:You said that you're trading interest rates right.
Speaker 1:I trade futures on interest rates. I'm not really trading rates Futures on okay.
Speaker 2:So futures on rates Okay. So what does that mean for the audience? What exactly is the kind of activity you're doing?
Speaker 1:Futures is just a future agreement between two people that decide to trade. So if you and I decide to trade futures on a cup of coffee, well, I think it's going to be worth something in the future and you think it's worth a different something, so we decide to make a decision. If you're looking at futures interest rates and I focus on ZN futures, which is the future, on the CME, on the 10-year note, specifically their options why? Well, because there's a lot of paper there. So if I'm right or wrong, it's kind of easy to get out and get in without too much friction and that's where a lot of just activity coalesces.
Speaker 1:So the projected future interest rates I don't have any more information than anybody else. I see the same CPI that everybody that would be listening to me sees. There's no information to be had. But the options market is the place where a lot of people go for the most leverage and therefore it is typically some of the most informed flow that you will see, and it's informed because of the leverage. So if you are either really informed or really cheaty or whatever else, you tend to stop at the options market and see what you can do there first, and then I see that information and as an artifact of being a participant, I can structure my trades to benefit from that information. And, as an artifact of being a participant, I can structure my trades to benefit from that flow.
Speaker 2:It sounds to me like, if you're going to be trading futures on rates, all you care about is the Fed, or maybe not. Maybe the Fed cares about the futures more than the other way around. That's a good question. I don't know.
Speaker 1:I don't know if the Fed follows a two-year or two year follows the Fed and there's been plenty of charts that I've read that are compelling to both sides of that. You know that is something that I just don't know. Sometimes you can see where there's an extra grind with an individual player, like, for instance, some firms will have a position in you know, 45 days out in the ZN futures or the ZN futures options, and then they go to cover that.
Speaker 1:Well, you know that's not really going to affect the curve per se, or their opinion on the curve isn't going to change as a result of that trade. That is their individual fingerprint, which doesn't really mean anything. So sometimes there is meaning to be divined from movement within the options in the futures, and sometimes there's just not. Sometimes it's somebody just spilled their coffee and they want to do their own thing, and that is the art of the business, which is trying to figure out who's doing what and what's the rationale behind it.
Speaker 2:All right, let's talk about how futures have been acting here. I mean they've been, I think you can argue, largely been acting a little bit more normal. Normal in the sense that you're starting to see more of the inverse behavior with rates when markets go down, meaning yeah, markets go down, rates fall, price rises. On the 10-year note side of things, Do you think we're in a regime change? Are things now different than the last several years, where it was largely duration correlated type of dynamic?
Speaker 1:There's a lot of small questions embedded within that. Oh yeah, bring it. So, yes, we're in a regime change. There is obviously going to be some kind of movement or disappointment of movement. Right now we're pricing more than 100% chance of an interest rate declination in September. More than 100% what does that mean? That means that we're trying to debate between 50 and 25 basis points. It used to be closer to zero. So that is a much different floor in which to bump up against than something with a two or three handle. So with a two or three handle you can still go down two or three points and you can certainly go up, you know whatever 10 points.
Speaker 1:And because of that uncertainty around interest rates and some kind of soon slowing between Asia and the United States, there is more wiggle room for things to move. So the spread for things to move is wider and that does create opportunity and opportunity sets like what we previously discussed, like a dispersion trade. A dispersion trade starts to get boring when rates have reached their new steady state and aren't going to change for the foreseeable future. Then things just kind of bump around. Maybe you can make some money maybe. But if that new steady state is two or three handle there is still opportunity there and rotation within sectors so that you can have on energy one minute and then you can have short energy the next minute for whatever logical reason. So there is still opportunity, even though there is a regime change. There's just a different set of information. It's not a better or worse set, it's just a different set.
Speaker 2:It doesn't sound to me like you're necessarily making a quote, a call on the interest rate, futures, right? I mean, you're doing it based on well, maybe that's the question. What is it that you're determining as far as, or using to determine how to trade futures?
Speaker 1:I use the options information. Okay, let's get into that.
Speaker 1:So that is to me a why do I trade options? The answer is simple. So I think I can make more money trading options. I mean, all of this is dead simple. So I think that predicting interest rates and trying to get a guy in the Fed or talk to Nick Timoros or whatever else is a million times harder.
Speaker 1:And if you gave me every macro number with like an hour or a day ahead of time and you gave me permission from God and permission from the SEC and all this other stuff to make it morally and ethically square, I still don't know what I would do most of the time unless it's a very aberrant number.
Speaker 1:So I mean, there's been all kinds of times where I thought the market would do something. Look, yesterday we came in ever so slightly hot maybe and the market went down 1.6% and then ripped right back up, so a total move of like 2.7%. I had no idea that was going to happen. My point is that making a call on interest rates to me is difficult and even if I'm occasionally right, the chance of me being out of consensus with the entire macro community and continuously being right over two decades man, that's a tough bar. Or I can look at what the options are doing. I can see where people are structuring their trades and try to figure out a way to profit from the other participants in the marketplace and, frankly, I just feel like that's an easier trade?
Speaker 2:Is that entirely subjective, qualitative, or are you using any kind of quant work as part of?
Speaker 1:that there's a small amount of subjectivity to it, when you think somebody is doing something, but unless they call you, you don't know. But say there's a guy out there that bought 85 you know 85,000 options and making some studies in there trying to sell 85,000 options. Of course that could be a coincidence, but it might not also be a?
Speaker 1:coincidence that it might actually be the same participant unwinding their trade. That is the subjective part of it. Now there are definitely quantitative aspects of the business, and most of our business is quantitative in nature. But there are some things that are difficult to. I haven't figured out how to quantify them yet, so they're so qualitative and, frankly, if everything's quantitative, then there'd be no need for me, the guys behind me. Right now, the computers can do all the work and there would be nothing else to do. And, frankly, if that was the case, then somebody with a bigger, faster computer could arm that out. Then my computer would be worthless in six days or six weeks or six years. So I think it's a continuous cycle of people figuring out where the trade is making money, other people figuring out what that is, and then the trade goes away.
Speaker 2:Do you look at other asset classes? I mean, do you look at stocks? Do you look at interest rate sets of sectors? Is there anything else that you're looking at outside of the options to inform any of the trades?
Speaker 1:So, I look at everything. No, that's not true. Okay, do I look at you? Know the yen carrier trade anymore? So then, like Jim Bianco would tell me, no.
Speaker 2:Remember that yen carrier trade? I kind of remember that was so long ago, man.
Speaker 1:Barely, but that's a good example. We can talk about that in a minute, but everything is relevant on some other level. So if oil is going crazy, which it kind of is lately, what does that mean? Why is oil going crazy? What does that mean for recessionary scares? What does that mean for inflation?
Speaker 1:So if the idea that China is slowing on an economic basis because they consume more oil than we do and therefore there's less demand for oil and therefore oil is going down it's not right now but whatever Therefore it will affect future inflation rates and that affects the bond prices, and people who see that same information will be in the bond futures options market.
Speaker 1:So I see that all of that and everything is connected to everything else At some level. The earlobe is connected to the big toe and if your earlobe gets cancer, eventually your big toe is going to get cancer. So there is some kind of a connection with almost everything. And if you stare at markets all day, every day, for the last portion of 30 years, eventually you start to just hear things, figure things out or have some kind of a sense of how much does this oil move really affect interest rate projections in the future and how does that really affect your JP Morgan stock or whatever? That stuff is difficult to quantify but we can get, I think, more efficient work done by looking at the options market than we can by just hiring an army of researchers to crunch the balance sheets.
Speaker 2:I've never really found that to be useful to me in the short term, Talking about options on the interest rate futures side, drawing on the bond side. I don't hear much about zero DTE there. I don't even know if there's zero DTE when it comes to that.
Speaker 1:But I wonder if.
Speaker 2:Well, first of all, is there zero DTE when it comes to futures on rates? No, okay. Does that make it then conceivably more signal than noise, versus if somebody were trying to look at options to figure out what?
Speaker 1:to do with equities. Yeah, I think there's definitely more signal to noise there because it's more exotic. You have to have a different level of expertise.
Speaker 1:And I traded equity options for 15 years before I even looked at a ZN option. So it is definitely more nuanced. There's more information, it's crazy liquid, a lot of size and it's a more sophisticated product. So the nuances of Tesla stock versus Elon Musk's tweets is nowhere near as relevant. Right, because there's such a giant amount of money in the interest rate marketplace, you're going in there with your 100 lot or whatever else is absolutely invisible. Nobody cares Even a 50,000 lot.
Speaker 1:Yeah, people will notice it, but they'll barely turn their heads. It's just you have to be so big to really move that.
Speaker 2:So if it is moving.
Speaker 1:It's virtually impossible for you not to notice, and then see how that reverberates to the rest of your book or the marketplace.
Speaker 2:Let's talk about volatility when it comes to fixed income. There's the index, like the move index. You had a recent segment with Arlie Bassman, the creator of it. But I want to talk about volatility and equities as it relates to volatility in the interest rate future side of things. Again, it kind of goes back a little bit to the flight to safety dynamic. But do you look at volatility from a cross-asset perspective? How do you think about volatility in terms of how do you trade through it?
Speaker 1:Absolutely. I do look at volatility from a cross-asset perspective, Again using my analogy of earlobes and big toes, because that's the thing I can see on the camera and my big toe is the farthest thing away from my earlobe.
Speaker 1:The idea that you're going to have volatility in a teacup and have it not really spill out into anything else is pretty rare. Going back to August 5th of last month, that's kind of what you saw and that's kind of why I said on camera fade it. I think that this is a sell. It ended up working out. I didn't know that ahead of time. That was pretty much a real-time decision, but that was because cross-asset volatility wasn't going bananas everywhere. Yeah, the Nikkei was down. Yeah, everything was moving, but as a percentage of the reaction that you were getting, relative to why and how, and if you look at the marketplace, in the options market, specifically SPX, there's a lot of reasons to fade that. So if you are looking at cross-asset volatilities and I think everybody should for good reason that was a fade.
Speaker 1:That was the genesis of my decision to fade that market.
Speaker 2:Is being a hedge fund manager. In fact, by the way, seeing it as sexy as it used to be, I mean, we've seen that, we've seen these. There's that Bloomberg cover from a while ago of perception versus reality when it came to hedge funds, right, they were a strong virile I'm not going to say straight up from a certain part of the body, right, and then it was a little bit more on the let's call it flaccid side. In that cover from Bloomberg. I'll see if I can find it has a lot of the alpha, just in general, separate from what you're doing you think, been wrung out from the hedge fund community.
Speaker 2:It's hard to know because you don't really know what everybody else's book is.
Speaker 1:So you know, if you have a dispersion book, you hear about other firms that have. You know, 500 million notional vegas short. I don't know if that's true. I can really just ask around. I do have a better network than probably a lot of other people because I'm older, so doing it longer. Eventually you and you kind of can just pick up the phone and be like hey, bob, is this true that you know Millennium is short. 500 million notional Dega in this version. I'm making that number up. I'm not saying that is what Millennium has on. That is more. I have greater access to that information than a lot of people, but I absolutely guarantee you is that Illiter has better information than I do.
Speaker 1:Do I think that a lot of the edge has been wrung out? No, I don't, because even things that were working 10 years ago might be working 10 years from now. And again it cycles. Lumber was hot for a little while, gold was hot. Right now, gold was dead. For a long time, tech was hot and then it wasn't, and then reasonable stocks like the Dow or whatever else was hot in 2022.
Speaker 1:Relative to the ARK trade, I think being able to forecast markets or participate in the volatility market is fine. People say that, well, there was all this edge back in the day when you guys would trade 25 cent spreads on the options. That's true, but a 50 lot was a big size back then. A 100 lot. You're like the god and okay, fine, so you make 12.5 cents times 100. Now you can make a third of a cent times 10,000. There's just a lot more liquidity and sometimes that's good and sometimes that's bad.
Speaker 1:But I think that every year of my life my professional life the golden age was always five years ago Everyone's like oh man, it kind of stinks now. Nobody can make any money while the edge is gone, and that's always just been this shift in time in parallel with wherever now sucks and it was always awesome back then. I just don't think it's like that. I think there's more liquidity now, it's easier to do things now and you just have to kind of change with the times. A lot of the stuff that's available off the rack in terms of software or hardware that people used to have to build in-house cannot be purchased. So I mean you can do things as a retail trader that you know Susquehanna was doing 20 years ago, and you can do that with years worth of effort and not, you know, 10 years worth of effort times a thousand people, some parts of it are easier, like making a movie.
Speaker 2:I can make a movie now with my iPhone.
Speaker 1:The idea that I can make a stable image with my iPhone and color rate it on a phone it's lunacy from 15 years ago. You can do it now.
Speaker 2:But now that everybody can have a movie in their pocket, you have to come up with new ideas. I want to share something you seem to be excited about as far as this post you put out on X around variance futures coming soon to a screen near you. Let's go through that. What are variance futures? Why is it something you think is interesting?
Speaker 1:So volatility is a linear function and variance is a squared function. That's the simplest way to think about it. So if you're looking at just the math on it, you're going to see a line like this and then you're going to see a curved line like that. One is convex, one is linear. What variance features allow you to do is have more of a gamma agnostic opinion on the marketplace. So I can't say when people you know talk in math, because I think that they're doing it to obfuscate the fact that they're not smart enough. To simple things down Say the S&P 500 is at 5,600 and you are short that straddle. Now you are magically short, the 5,600 straddle in the SPX and that is what you want. And say now the market, the S&P 500 goes to 7,000.
Speaker 1:Well, your options are either 100 delta or zero delta and you're no longer making money or losing money at the same rate of change that you once were.
Speaker 1:So you are now in a linear function. Variance will allow you to participate in those same ideas in a nonlinear function. So I think it I think I haven't traded it yet because nobody has will allow you to express some of the ideas that you want to be convex, whether you want to be short, that convexity or long that convexity in an easier and more pure manner. So I think that for people that trade a lot of options and they care about where their strengths are relative to that money and through time and movement, so gamma risk I think that variance futures have a place there. And I also think that variance futures will have a home in the tail risk marketplace. If you look at what VIX options do, they operate as sort of a variance surrogate as opposed to VIX futures or something like that, and I think that variance might end up being a superior tail hedge if you get it for the right price.
Speaker 2:If that catches on in terms of interest and volume, do you think that has any impact on the VIX volatility in general itself? I mean the argument of the tail wagging the dog was some of these derivatives.
Speaker 1:Yeah, yeah, that can definitely happen. So we also have VIX options as they sit now, but there are. The CBO is also coming out with options on VIX futures, which sounds the same, because it is mostly the same. The crucial difference that right now, if you trade a VIX option, it's an SEC domain product. If you trade a VIX future, it is a CFTC domain product. So say, you have 10 million bucks in your account and you want to trade VIX options versus VIX futures and you say to the clearing firm something like hey, my options are hedging my futures.
Speaker 1:No, they're not because one is equity and the other one is the future. They're not but they are.
Speaker 1:So that's a problem from a cross-margining standpoint. So if you're having something that is fungible with something else, like a VIX future and a VIX option on a VIX future that is the same classification then you will get margin relief on that and I think that will end up being a superior product. I don't know why it wouldn't. In terms of will it cannibalize the VIX options marketplace, your guess is as good as mine. You know some things that are like really busy now, like VIX options. You know I started trading VIX options when it first came out. Nobody traded them, so it took years to click. And could it be the same thing in variance? Variance is not as intuitive as volatility, so it might be hard for people to pick up on that. I think we'll probably have decent institutional adoption out of the gate. But does that trickle down into the Twitter sphere? I don't know. Man, your guess is as good as mine. I hope so, because I think it's a cool product.
Speaker 2:Yeah, I can't wait for people to show screenshots of their accounts using those features. They're definitely not Photoshopped at all, definitely not.
Speaker 1:That's always such a funny thing because I don't know anybody that's real, that's ever done that. Nobody that has any kind of size or integrity or reputation is going to show us screenshots of their First off. They can't from a compliance standpoint. Second off, it's just so lame. And third off everybody who knows them that they actually want to impress they already know.
Speaker 2:Yeah, I mean, real wealth is not. Doesn't shove it in your face, right, and fake rich certainly can be Photoshopped. Okay, so I want to go back to your trading on the 10-year futures side of things. I'm going to make the assumption that you are very attentive when there's inflation data, because obviously it impacts rates. Is there anything that's been surprising in the last I don't know six months as far as trade movement, inflation data, anything that's either thrown some of your models off or changed the way that you trade some of these instruments Hardest possible?
Speaker 1:yes, it has been longer than six months. It's been really since COVID. You know the after money volatility in the 10-year note, futures options used to be, you know, like two or three right. So that comports to some kind of a straddle in tick values, because options on futures traded ticks not dollars. So if the straddle was 15 ticks or whatever else, now it's like 50 ticks. It's just a lot different now than what it was. There's a lot more volatility, both to the upside and downside, and what that really does for me is it does change the math, Because if you're looking at a historical precedent to kind of guide your present or future projections, the models are all different. So that particular part of my trade has probably been one of the harder parts because the quantitative basis is out of sample.
Speaker 2:I love that, because it's exactly right, there's been a lot of interesting out-of-sample dynamics with this last several years where the cycle has been bizarre. That actually gets into a discussion around normalcy, right. I think we're maybe entering a cycle where some of these historical relationships start to kind of come back to the way they used to be. Are we going to reenter this kind of more normalized environment where things don't look so diverged from each other, things co-move a little bit better than they used to?
Speaker 1:I think I tell you.
Speaker 2:One of my answers is kind of a guess, because I never know.
Speaker 1:But yeah, like what are we? 3% off all-time highs in S&P? You know gold's at an all-time high. And you could go back to this Keynesian or you know Ludwig von Mises type of argument that you know the world is going to fall apart because you know the interest on the debt is higher than our defense budget. Fine, no problem, I understand all of that, but that hasn't really changed my entire lifetime. I can reference stuff before I was born that was saying similar type of stuff, and I think the argument was, from an intuitive, illogical standpoint, just as compelling back then as it is now.
Speaker 1:So, is the dollar going to go down because the Fed can't raise rates fast enough to stem inflation? Therefore it's got to come out of the balance sheet of the dollar. It makes sense from a logical standpoint. But if everything else is going the same direction, but in reverse, faster again in rate of change terms, maybe not If the euro is doing the same thing, but worse, and there's some kind of cabal of currencies in Asia, those things are so hard to figure out so as to figure out the weather 10 years from now on Mars. I just don't think anybody knows. So going back to first principles on this, I'm looking at the options market. Why Because that's what's happening right now Do I know where our interests are going to go if there is a hot war and nuclear on the table? I have no idea. That sounds crazy to me, but I also didn't think that we'd be in a soft war with Russia?
Speaker 1:right now, I don't have any idea how that stuff's going to work, and I don't think anybody does, and I think anybody who does know, or does tell you that they know, is either self-aggrandizing, lying or devotional.
Speaker 2:So in environments where it's easier to be an interest rate futures trader versus not rising rate environment, falling rate environment, flattened environment are there certain environments that you like better than others?
Speaker 1:Yeah, One-way trades are much easier. That is easier. I wrote a white paper in December of 2020 basically saying exactly that. So I kind of thought that rates would go up a lot in 2022. And again, I wouldn't say it now if I didn't write about it then, because then you can easily just call BS on it. So that was an easier trade than just like who knows right.
Speaker 1:That's difficult and, frankly, the who knows scenario is where things are most of the time, unless you know that inflation is skyrocketing because of COVID or whatever, and therefore the reaction function is going to be to raise rates at the path that is steeper than most people are accustomed to. That's an opinion. We ended up being right on that, but Powell called me and told me what was going to happen. So that was just kind of an educated guess. The other way around, if you look at actual COVID, did they chop rates? Yeah, they did. Did I think the market was going to rip as a result of that? No, that was way too fast. I didn't buy the bottom. So I think that whenever you have those large inflection, points.
Speaker 2:there is more activity and there is more to do. As you know, this business is part managing portfolios and part raising assets. Now, maybe less so on the hedge fund side, but certainly in the mutual fund ETF world, you got to constantly try to focus on trying to raise assets. If you're an SMA manager, you have to also try to get new clients. If you're not growing, you're dying to some extent, and hopefully the cycle allows you to do that, which is a whole nother discussion. I'm curious for you, right? So you've got the hedge fund. I don't know how large it is, but are you actively out there trying to get additional assets or are you just kind of happy with the way it is, the size it is?
Speaker 1:No, we're a small fund. I can raise 100x and be fine. So really I have two jobs, one of which is making money for people I have a relationship with now currently, and my other job is walking around town hat in hand, begging strangers for money and anybody. You know, there's only a handful of funds that are closed for economic reasons, and those are very few. So definitely part of my job is to talk to people that are interested in what I'm trying to achieve and, you know, get them to do business with me. That's definitely part of my business.
Speaker 2:Is it already good people convinced? I mean, that's definitely part of my business. Is it already good people convinced? I mean, it seems like an environment where it's purely about the S&P. Everyone's like, oh, if it even broke, don't fix it. Why should I consider all things like this?
Speaker 1:You know, making money is a lot harder, a lot easier than raising money.
Speaker 2:Yes.
Speaker 1:Raising money is a funny business because you know it's the interpersonal thing that you know that you never really know Like and I can have this awesome rapport, but we talk to somebody else that is different than us and the guy's like no, I don't need you guys, you guys are weirdos, or the other way around.
Speaker 1:So convincing somebody that is doing something to stick their neck out or make a financial decision is difficult to do. Ironically, a lot of allocators they're all looking for something new. They can't give any more money to Citadel, so they got to whittle their way down and come up with something that is investable but yeah, different enough. So everybody says they want to see a new movie, but they all go see Avengers, right? So if you come out with your little art house movie, and yeah, it's different, but nobody cares. So what we're trying to do is spread that needle right, which is like different enough, but not quite so different. It's like unintelligible and it's blazing such a trail that it's just nobody understands what we're doing. So raising money and trying to convince strangers that what we're doing has merit is part of my job, for sure.
Speaker 2:Yeah, I don't know if people really appreciate how hard that is unless they're actually in the seats. It is, to your point, not easy. As we start to wrap up here, noah, for those who want to track more thoughts, more your work, where would you point them to and then maybe give us a little bit of an experience lesson? As far as for those that want to actually have their own hedge fund and be in this business, some things that you've learned that you think are worth imparting some knowledge with.
Speaker 1:Sure I can take that as far as you like, so get a hold of me. Twitter is a good place. I'm at Noel Convex. Our website is ConvexAM, like ConvexAssetManagementcom, so ConvexAMcom. We're reachable unreachable both places.
Speaker 1:And in terms of the hedge fund game, I mean, that's a long chat, but you got to start with some money. The worst news is the most accurate news, which is you got to start with money, which is even harder than starting with alpha. So if you don't spin out of Millennium or something like that with $500 million there and starting with alpha, so if you don't spin out of millennium or something like that with $500 million, there's just almost zero chance you're going to get a meeting with an endowment. So you have to have a private network of people that are willing to invest in you.
Speaker 1:I have seen amazing returns with no AUM and I've seen terrible returns with amazing AUM. Go figure, because if you think about most people that are allocating the hedge funds, they're not really the private party that is wealthy. It is usually somebody that's acting as their surrogate, and their main job isn't making you wealthy, it's making them wealthy, and part of the way they get wealthy is don't get fired. They have to make decisions that are just different enough to make some money, but not so different to get fired, and that is a needle that they have to thread.
Speaker 1:So you have to present yourself as somebody that is fully intelligent, can be a master of the domain of expertise that you claim to be, and the numbers help a ton. But the thing that I'm probably most shocked by being in the hedge fund space, as opposed to the prop trading space, is your P&L is not as important as you think. In other words, being up 8% is nowhere near as important as being up 12% if you don't have the connections. So you have to have some kind of connections and access to money. That there isn't one path, right? You know your rich uncle Great.
Speaker 2:Nobody has that Fine. Now you got to go talk to, like go talk to the firefighters union in Topeka, kansas.
Speaker 1:Good luck, because those people are tough to get meetings with and they have a lot of boxes that they have to check, and a lot of those boxes look something like you have to have a billion dollars, you have to be in business for five years and you have to have a sharper place one, and in order to get to those levels, you have to have a different firefighters union that's willing to give you money or something. So that's the chicken and egg scenario that almost all startup hedge fund managers have and, believe me, if that was an easy path, everybody would do it. It's a very difficult path.
Speaker 2:Everybody. Please make sure you're following Noel Smith. Appreciate those that watch this live. Again, this will be an edited podcast under Lead Lag. Live on all of your favorite platforms. Hope you found the conversation interesting and worthwhile and, I guess, get some more screens. Be like Noel, right, when you grow up, get more screens to trade with. I appreciate you, noel, thank you. Thank you. Cheers everybody. Bye-bye.
