Kris Abdelmessih, Co-Founder, Moontower AI

[00:00:01] Hello, this is Dean Curnutt and welcome to the Alpha Exchange.

[00:00:06] Where we explore topics in financial markets associated with managing risk,

[00:00:10] generating return, and the deployment of capital,

[00:00:13] and the alternative investment industry.

[00:00:20] Most of the discussions on the Alpha Exchange podcast consisted guests

[00:00:24] sharing views on market risk and portfolio construction.

[00:00:28] To be sure that leads the conversations down the path of monetary policy,

[00:00:32] positioning, inflation and growth.

[00:00:34] There's a great deal of consideration around the price of optionality

[00:00:37] and the correlation of assets.

[00:00:40] But what about insights on the nitty-gritty of getting into option trades

[00:00:43] being a liquidity provider to the street and then risk managing those positions?

[00:00:48] Enter Kris Abdelmessih, who spent more than a decade doing just that.

[00:00:53] Now the author of the Moontower Substack and the founder of Moontower AI,

[00:00:57] Kris looks back at his time on the market making front,

[00:01:01] starting with his formative experience in the renowned

[00:01:03] Susco-Hanna training program and ultimately,

[00:01:06] trading volatility at parallax.

[00:01:09] We talk about how we sought micro-edge by maintaining

[00:01:11] cell-side relationships, getting into positions as cleanly as possible,

[00:01:16] and then having a dispassionate process for unwinding trades

[00:01:19] for which the valve profile was no longer suitable to own.

[00:01:23] We also gain insights on the parallels of trading off the run ETFs

[00:01:27] like those on natural gas and crude oil with the April 2020 meltdown

[00:01:32] in the latter an important case study.

[00:01:34] I hope you enjoyed this episode of the Alpha Exchange,

[00:01:37] my conversation with Kris Abdelmessih.

[00:01:44] My guest today on the Alpha Exchange is Kris Abdelmessih.

[00:01:47] He is the founder of the Moontower Substack, also the founder of Moontower AI

[00:01:53] and Options Analytics platform.

[00:01:55] Kris, it's great to have you on the podcast today.

[00:01:57] Thank you very much. It's a total pleasure to be here and I'm a fan of the show.

[00:02:01] Yeah, and I am very happy to have reconnected with you.

[00:02:05] I've followed really your insightful contributions.

[00:02:08] I would say to the world of Twitter on this complicated subject matter called

[00:02:14] Options Valuations. So you do a lot on that front.

[00:02:17] So we'll have plenty of really fun stuff to talk about.

[00:02:21] Let's just learn a little bit about your background.

[00:02:23] You've got some experience on the buy side and the market making side with respect to

[00:02:29] Options. Give us a little bit of a flavor for your background.

[00:02:32] I graduated in 2000 and I started at SIG.

[00:02:35] I was hired into their assistant trainer program.

[00:02:39] So I started the business on the floor of the American Stock Exchange.

[00:02:43] The very first job I had was I was the clerk and spy share.

[00:02:47] Not the options. Back when ETS, they were fairly new at the time.

[00:02:51] There was a big crowd that made markets in spy shares on the floor.

[00:02:56] Which sounds crazy today, but that's how it was.

[00:02:58] That's where I started and I came out of college not knowing anything about trading.

[00:03:02] I mean, I learned how to use Excel on the job as a clerk in that position.

[00:03:07] And then I run through the rotation.

[00:03:10] The way at SIG, the way it works, you spend six or nine months or something.

[00:03:14] Rotating at different posts on the floor.

[00:03:17] So I spent some time in the ETFs. I spent some time in options in particular.

[00:03:22] And then you go to trading class for three months.

[00:03:26] Went through that and came out and was placed into a pit on the MX as an option market maker

[00:03:32] and equity options. And then I spent several years doing that.

[00:03:36] Then I went to the New York Stock Exchange also with SIG.

[00:03:39] I was a floor broker for a year. I spent about six months after that as a specialist

[00:03:44] and a NIC in the blue room. There was an area where they had one specialist post for ETFs.

[00:03:49] So it was a specialist in some ETFs like FES and LQD and a bunch of the Excel products.

[00:03:55] And then I was asked to go to the NIMX and help start the commodity options business there.

[00:04:03] So I went with another trader who was more senior than me and he traded natural gas options.

[00:04:07] And I started the oil options business for SIG on the NIMX 4.

[00:04:11] And then I spent about three years with SIG there. I was in the oil options pit for six months

[00:04:17] and then I spent the remainder of those three years in the product options pit.

[00:04:23] So heating oil and our bob options for HU options, which was the original gasoline contract

[00:04:29] that was the transition point. I left SIG and 08 and then I took six months off and then I came back

[00:04:36] a firm called prime back to me. I was free to start my own business for them.

[00:04:42] I went into natural gas options. I ended up expanding into lots of different commodity options

[00:04:46] there and ended up getting memberships on the NIMX, the Komex and the ICE or formerly the NIMX.

[00:04:53] And then in 2012 I went to the BICIDE, parallax which is a large equity ball shop,

[00:04:58] relative value, fund in San Francisco, asked me to start the commodity options business for them.

[00:05:05] So I moved from New York to California where I lived today and I spent nine years with parallax,

[00:05:12] basically expanding that commodity options vision. I mean, we towards the tail end of my years on

[00:05:17] the floor started to develop a prototype for a cross-sectional option relative value model.

[00:05:23] And then basically implemented that with proper resources behind me at the hedge fund,

[00:05:28] ran out for nine years and then I left parallax in 2021. And since then I started writing a

[00:05:34] couple years before that and last few years have really dove into a number of educational

[00:05:40] projects and then more recently a software building the option analytics software and really

[00:05:47] leaning into the writing very hard in the last two years. Well, just in your recounting of your

[00:05:52] career you mentioned LQD, F-E-Z which is Eurostocks and NACAS and we're going to circle back to this

[00:06:00] but it got me thinking about exploring with you just this idea of the distribution of these asset

[00:06:06] prices. They're all pretty unique. There's some real ideas, synchroces there and when I think

[00:06:11] about products like that, gas especially, I want to circle back to Suscoe Hanna because as you

[00:06:18] write a lot and your sub stack is just a wealth of information and teaching and it's very clear

[00:06:24] that you're drawing on knowledge based that you've acquired over the years but I just think a

[00:06:30] root thought process that I feel like gets back to Suscoe Hanna. It's just been such an impactful

[00:06:35] organization obviously it's a dominant player in market making and liquidity provision but also

[00:06:41] in teaching and it was really early so you mentioned a couple of the segments of the training course

[00:06:48] and I just was hoping you could expand on it a little bit. The types of things you picked up on

[00:06:53] may be not really specifically but just the way to think about options and relative value. I'd love

[00:07:00] to learn more about that. Well, talk about how it was structured so first of all their headquarters

[00:07:04] are in Balakinwood, Pennsylvania so I spent the summer of 2001 living there for three months so

[00:07:11] ten weeks really. So before you go to the training class you're clicking for a senior trader on

[00:07:17] floor at a post and then after market you would go back to the office and you would basically

[00:07:25] go into mock trading classes so there would be senior traders or any trader that was walking around

[00:07:31] might hop in and just get involved and you would be doing mock trading meaning that there would

[00:07:37] be an options board up on it like board. The calls on the left that puts on the right very familiar

[00:07:42] just an option montage maybe you might have two months and the senior traders would act as brokers

[00:07:49] and they would create scenarios. The stock is 60 bucks and they say how's the 65 call and

[00:07:56] people would make a market and then the broker would make a bid and you might have to remember where

[00:08:02] the bid was because maybe comes in bid market and then maybe another broker comes in and offers

[00:08:06] some other option and you might say oh wow okay I'm going to sell these calls and

[00:08:12] it'll buy these puts and I'm going to buy the stock and I'll basically have led a risk reversal

[00:08:17] for this price which basically looks like a cost bread and I think that I'm getting 10 cents of edge

[00:08:23] to do that trade. So you're kind of putting together this matrix in real time you could imagine

[00:08:28] it's like getting poker training but with a coach over your shoulder or every step of the way they

[00:08:34] are asking well why did you do this? Why did you not hit that bid right then? What were you waiting

[00:08:39] on? What did you think the other market makers were going to do every single aspect of the decision

[00:08:46] making is deconstructed. You go through that and they can tell and later on I would teach these

[00:08:52] classes and you can tell very quickly who it's clicking for basically who's seeing the matrix here

[00:08:59] quickly and playing the game well. Basically how well you played that game determined how fast

[00:09:05] you would go to class and then when you would go to class in Bella the first four weeks

[00:09:10] were very heavy on theory so it was all classroom in the morning and I remember their head

[00:09:17] clock would come in and over the course of two days he would derive the blacksholes assumptions

[00:09:22] and then second day he would derive blacksholes and it was four hours a day so eight hours total

[00:09:28] of blacksholes and I'm not a proper math guy so it was like wisely as though over like 15 minutes

[00:09:33] into this experience but you would get all the theory and then you would have homeworks and you

[00:09:39] would be making spreadsheets and you would be building binomial trees and you would be pricing

[00:09:43] converts and all this stuff that I've largely forgotten by this point but you would spend four weeks

[00:09:49] doing that and then you would play poker in the evening some people will play back and then

[00:09:53] but you were expected to play a hundred hours of poker over the ten weeks and then the grand winner at

[00:09:59] the end would be the person with the best sharps ratio at the end of the ten weeks. After those four

[00:10:04] weeks of theory then you would have six weeks of mock trading when I say mock trading this was

[00:10:09] on a whole other level so they had a simulated trading floor in the building on the classroom

[00:10:14] and you would have your computers the handheld computers that you would carry around on the floor

[00:10:20] exchange you would have your micro hedge options model and whatever other tools and excel or whatever

[00:10:26] that you wanted on your computer and you would make markets in the screens that were overhead

[00:10:31] were just like they were on the floor full option montage is a full simulation behind the scenes but

[00:10:37] now you were really simulating the floor you were mock trading for half the day and the other half

[00:10:42] the day a different head of a business at sig would come and talk to the class and in fact

[00:10:48] Jeffias always comes one of those times and addresses the class so the one word to really

[00:10:55] tie it all together is immensely immersive it's so immersive you are living and breathing

[00:11:01] options I say that probably everybody was dreaming in option montages by the time they had gotten

[00:11:09] through all this so that was the training and they make you sign a non-compete I remember nobody really

[00:11:15] wants to sign a three or non-compete but in hindsight I think that education was well worth it

[00:11:20] and it was the best thing to happen to me it served me well for the next 20 years as you were

[00:11:24] describing the immersive experience of his thinking boy to make that investment in people and then

[00:11:29] have them run off sounds asymmetric against you in terms of what you're putting out and the risks

[00:11:36] they made you sign the contract before you went to class there you go in the spirit of

[00:11:42] optionality that's right you talked about market making backing into things like risk

[00:11:48] reversals and having to understand combos and where stock is and so forth and that's really

[00:11:55] just a arithmetic it's not really volatile it's you got to be fast and you got to be a translator

[00:12:00] very quickly and so that's probably going to help you get into positions in a favorable way

[00:12:05] once the positions are on they obviously live in breath we know all about options in terms of

[00:12:11] how they're Greek characteristics evolved based on spot the passage of time changes in

[00:12:15] ball and so forth my question is just around reflecting on your days let's say at parallax

[00:12:21] in terms of getting into positions at the right price versus nursing them along and baby

[00:12:28] sitting them properly being thoughtful around what the market was telling you giving you chances

[00:12:33] to alter that position once it's on give us a sense of the combination of those both getting

[00:12:39] into the position the importance of that relative to once it's on the books and risk

[00:12:44] managing it successfully for getting into the positions I think the experience of being a market

[00:12:49] maker that was its main value was that you understood how screens were being framed why they

[00:12:57] be being framed in a certain way you learn to price options in a relative way let's say

[00:13:03] I'm looking at GLD ball and somebody is coming in and they're offering a one month option in GLD

[00:13:11] and I might like the ball level I may have a signal or an opinion that says I think these balls

[00:13:17] look relatively cheap versus the way I'm looking at the world but you still want to maximize

[00:13:22] on the execution at the end of the day this is a game that is pretty much a game of pennies you

[00:13:28] are trading tens of thousands a hundred thousand options a day you can imagine if you're making a

[00:13:35] penny on a hundred thousand options a day that's a hundred grand a day it's a 25 million dollar

[00:13:39] year business but you know if you make a half a penny you're cutting that in half it is a game of pennies

[00:13:45] at the end of the day so you can screw up any strategy with bad execution so the market making

[00:13:51] mentality was very very key to getting in and out of positions and it did evolve but

[00:13:57] take the example when I was at prime and then I'll contrast it the parallax when I was at prime

[00:14:02] I was much smaller I was trading a lot of my own money I had a backer but I have a bunch of my own

[00:14:08] capital in escrow you're trying to make much smaller sums of money per day than you are at the fun

[00:14:13] you are trading smaller lots and your value to the broker is that you are almost in the customer

[00:14:21] service business I'm going to be fast I will respond to your phone call quickly I will be easy

[00:14:25] to deal with I'll be very upfront I will basically try my best to make you look good while I

[00:14:33] make enough edge that you keep calling me and that this business relationship works

[00:14:38] when I'm at a fund where I'm trading much larger and I'm trading more names I have a much

[00:14:44] more bird's eye view than being just an actual gas market maker where it's all I look at all day long

[00:14:50] if you're a natural gas market maker you're a broker you're one of a hundred that I have on my

[00:14:55] I am or is it ice chatter whatever it was I have a hundred brokers blinking on my I am's all day long

[00:15:02] plus the screens there's so much coming at me and I need to be able to respond be able to parse

[00:15:09] and prioritize very very quickly so that I can find the best orders and put together a picture of

[00:15:16] I can pick up two cents at the fund I'm not going to be able to be that fast I can't compete with

[00:15:22] the person who's entirely lively would depends on being the best phone call for that broker for

[00:15:27] the 25 lot so I have to have a different proposition I would tell the brokers I understand I'm

[00:15:33] not going to be the most responsive person all the time but here's what I can do the markets five

[00:15:39] five and five ten and you've got a guide that wants to buy 500 straddles there's 200 straddles

[00:15:45] offered at five ten that 200 straddles is four little market makers that are offering 50 lots each

[00:15:51] I can show you 300 more at five 15 and you can fill your whole order at five 15 I'll do 60% of

[00:15:59] the order and that's a value to the broker because here the the broker is concerned with size not speed

[00:16:06] for him to look good he doesn't want to move the market that much that's the service I'm offering

[00:16:11] for that broker and because I'm willing to offer that service to the broker I'm willing to take down

[00:16:16] more size that's how I get the phone calls there so you have to understand all the time

[00:16:22] what your niches in a marketplace are you going to be fast and trying to get like that broker

[00:16:27] is not calling me with the 25 lot unfortunately but that's okay the 25 lot I'm going to need

[00:16:34] a whole lot of them to move the needle one at the fund so it's okay I understand my role in this

[00:16:39] ecosystem and that is the execution part is understanding your service to the marketplace

[00:16:46] the position management part that's the risk management piece so I buy this ball I think this

[00:16:52] ball is cheap like an relative value basis but maybe that assets just stops moving and what I thought

[00:17:00] was cheap ball ended up being self-fulfilling and the entire cloud of asset prices on this cross-sectional

[00:17:07] view has all moved around and in fact this ball is now high well now I'm just working out of it

[00:17:13] I'm just selling out of that because my signal says this is now expensive all the fact that I lost

[00:17:17] money it's irrelevant I don't even know where my entries were I don't care this is now expensive

[00:17:23] I'm now selling it it's irrelevant the fact that at one point I thought it was cheap some part of

[00:17:28] that is based on the history of the specific asset specifically in derivatives we have a view

[00:17:35] that the past matters we certainly should incorporate the past sort of behavior of let's just use

[00:17:42] the S&P we have some version of the boundaries of the VIX at least up until now that doesn't mean

[00:17:48] it's not going to change I always say that boy at the end of 2019 no one knew that an 81 VIX

[00:17:53] was coming three months later no one knew that 2017 was going to see the S&P realized six and a half

[00:17:59] for the year you just didn't know the environment changes over time but there is some

[00:18:05] element of the NASA having certain properties I'd love to just talk a little bit about some

[00:18:10] of these quirky ETFs anytime you get into a commodity especially something like not gas

[00:18:15] where you have the weather a big part of it you weren't trading like as options when the

[00:18:21] Russia Ukraine war started and it was all this risk around the cold winter in Europe and

[00:18:27] it just created it obviously an explosive uptail in not gas the vologist went bananas

[00:18:33] I know you traded the USO in April of 2020 pick out a couple from your perspective that

[00:18:40] were just really really good learning experiences that taught you that the history of data is important

[00:18:48] but you gotta be careful not to lean into too much because the world is new and changing every day

[00:18:54] we can go into the USO one I know you've heard that one before but there's a predecessor trade

[00:18:59] to that one that primed my mind for being able to think about the USO one sort of recognized what's

[00:19:06] going on very quickly it comes from a scar back in I think it was 2010 at the time I'm at

[00:19:13] prime I did have this background in ETFs not so much in ETF options but I had it in ETFs and

[00:19:20] prime they mostly backed futures and futures options traders you could think of them as basically

[00:19:25] regulated by the CFTC they didn't really do any SEC kind of products but I'm trading natural gas

[00:19:32] and UNG is an active product and I went to them and said I would like to trade options on UNG also

[00:19:39] I have a little model here in general I think with these commodity ETFs those are more of tourist

[00:19:47] markets like if you are a serious commodity trader you are using the futures options and so the

[00:19:54] much deeper bigger markets and they are the fair valls come from those markets the ETFs

[00:20:02] should be priced off of what is fair in those markets if you put a trade on ETF you could go

[00:20:07] hedge it in the futures options the futures options are fair the ETF has an opportunity to be

[00:20:13] misprice so I said I want to trade some natural gas I want to trade UNG options as a compliment

[00:20:18] to my natural gas book so they're credit they'd never done anything like that before and they

[00:20:22] came to the green light so I started doing this there's an opportunity I'm like okay look at the

[00:20:26] UNG this was summer 2010 and remember UNG looked like three valls cheap compared to the future

[00:20:32] options so buying some UNG wall and offsetting it in the future options and I think I'm running

[00:20:39] getting like this three-volve arb if you remember this was at a period of time where they was all

[00:20:44] this talk about is like the paper barrel thing oh all the investors the speculators are pushing

[00:20:51] up the price of real things that real people need people they're pushing up the price of energy

[00:20:56] we're pushing up the price of corn all of these things that are causing distortions at the

[00:21:01] pomper in people's lives there was a bit of a backlash to the financialization of commodities

[00:21:08] so UNG announces that they are going to stop they put a limit a cap on how many shares they

[00:21:15] are going to allow to be created in response to this backlash a very very smart trading firm that

[00:21:22] I did not work for anymore and why don't know for sure exactly who it was but one out there

[00:21:26] and created all the shares up to the cap knowing of course they're taking the very informed

[00:21:31] bet that you see if we'd go to our premium to its nav so here I am long UNG options and short

[00:21:40] net gas futures options is a big premium in the nav and what happens is UNG stops moving

[00:21:47] on long options on UNG and it stops moving the futures options continue to whip around

[00:21:53] and I'm short straddles on those so what was happening as natural gas futures would drop

[00:21:59] the premium to nav would just simply expand because UNG is scarce the shares are scarce

[00:22:05] so the price really wouldn't go down so the premium would just expand and then on the days

[00:22:11] when natural gas futures would rally again I'm short options on those UNG just doesn't move

[00:22:16] and the premium would just narrow some so what happened is the premium to nav was abhorving

[00:22:23] all the volatility of the futures so the futures are moving at 60V I bought new in GVol at 57

[00:22:30] and now UNG first of all is not moving because my real life's piano I'll just be roting on the

[00:22:35] theta and then the implied vol on UNG just collapses because everyone can see it's just not moving anymore

[00:22:41] so on long 57 vol on vol is to 35 so I lose several months of expectancy

[00:22:49] on this one trade luckily I only had put the trade on you know as like a one month trade not a

[00:22:56] great experience from my back or to their credit they let me do this kind of stuff more and more

[00:23:01] this is a great example you're just not sure how strict these relationships can be there are

[00:23:07] gotchas in here so that was one example that example was the thing that prepared me for the USO

[00:23:14] example I'll give the short version of the USO example you're really remembers the oil futures

[00:23:19] in spring of 2020 they had went negative we woke up one day and USO was trading at a large

[00:23:26] premium to its nav the naive view is that oh there's a lot of retail people buying USO because

[00:23:34] they see that oil futures went negative and they just want to buy the snap back and they're not

[00:23:38] enabled for futures so they're going to go in and try to buy the ETF but we looked at it and said

[00:23:45] I actually think that well there should be a premium to the nav because if you think about USO had

[00:23:50] fundamentally changed it was no longer an oil future but it was an oil future with a zero strike

[00:23:56] put or you could think about it as it was the zero strike call on oil and you can understand that

[00:24:03] because imagine you are long USO and you are short oil futures when oil goes up trading 10

[00:24:11] box or 15 bucks they're going to add to the same oil goes up you lose on your oil future and

[00:24:17] you make on your USO and you break even but what happens when oil drops below zero is your stop

[00:24:24] out on your USO you're long USO and it cannot go below zero and then you are just short

[00:24:29] the futures so your P&L diagram looks exactly like a put option and just the bearer of that risk

[00:24:36] because effectively an option has been given away think it was called the United States oil fund

[00:24:42] the ETF provider there's a free option there that's been provided who is short that free option

[00:24:48] they're bearing the risk because they have the futures backing the ETF that's the problem

[00:24:52] which is an important key to where we're going here by the way their futures are now trading negative

[00:24:57] so there really is a zero strike call that is out of the money so you can look at the option

[00:25:04] prices of the various strikes the zero strike option and the future's options and you can say

[00:25:09] I have an idea I'm looking at that implied ball and I can actually model

[00:25:13] that premium to nav as extrinsic option premium it was an option USO turned into an option when oil

[00:25:20] is below zero so what we did was we computed what we thought the fair premium to nav was dynamically

[00:25:28] based on the implied ball in the underlying futures we were able to form an opinion about what

[00:25:34] that premium to nav should be and of course as oil futures move away from zero like if they went

[00:25:39] back up to 50 bucks the premium to nav would go to zero it makes perfect sense it's exactly

[00:25:45] like an option it would be very deep in the money at that point there would be no extrinsic

[00:25:49] the thing that we had noticed was that we thought that USO evolved to the options on USO were a sale

[00:25:57] relative to the future's options there was really three components to that opinion the first was

[00:26:02] ahead of small leet and it was just the idea that as you said USO the fun backing it is bearing

[00:26:08] the risk there is a non zero chance that this product goes to zero that USO gets wiped out obliterated

[00:26:14] off the face of the earth which would zero out all the extrinsic time premium and there were nine

[00:26:20] months one year longer than one year options listed on this thing and they were fat because

[00:26:24] the balls were elevated all this extrinsic time premium what I want to zero if USO goes to zero

[00:26:29] I'm an observing barrier so that's one small reason why we thought there was should be some

[00:26:35] discount to these options because of that possibility the bigger reason the second reason

[00:26:40] which is a bigger reason is that USO was no longer an oil future but it's an oil future plus

[00:26:45] a put in other words it's not just a portfolio of oil futures it's a portfolio that includes a hedge

[00:26:50] a hedge portfolio is mechanically less volatile than just the portfolio without the hedge we knew

[00:26:57] that when you're near zero in the oil futures as oil rallies USO is going to go up but not one

[00:27:04] for one because what's going to happen is that premium to nav is going to decay and act as a head

[00:27:09] wind on the rally and vice versa the same thing's going to happen when oil is going farther below

[00:27:14] that portfolio that's called USO which is actually a put plus the futures is less volatile

[00:27:21] than oil futures so that's another reason why it deserves a discount the final reason again goes back

[00:27:29] to thinking about the position of the United States oil fund is in and that is they tip their hand

[00:27:34] they're worried about their business they don't want their ECF to go to zero so they rolled out

[00:27:39] the futures off cycle they just decided hey we're going to roll the futures out here and said

[00:27:44] deferred contracts deferred contracts in commodity futures are mechanically less volatile than

[00:27:51] the front month future the nerds called as the Samuel Senate effect a easier way to maybe think

[00:27:56] about that is that an oil future a year out in time has some mean reversion baked into it the demand

[00:28:03] and supply are more elastic a year out people can decide they were going to drill more or we're

[00:28:08] ration our use of oil so the price in the long term is just less volatile than the price in

[00:28:14] the near term which really when this case we just ran into storage constraints so you'll see the

[00:28:19] same in rates you'll see the beta of the front month of the future is going to be higher than the

[00:28:24] beta of the four or five month of future so yeah that was definitely

[00:28:29] vol dampening in combination with I think this idea that the longer dated ones I remember looking at

[00:28:35] is that you could sell this and this is always to me an interesting aspect of

[00:28:41] especially complicated unique ETFs that especially when they had things like commodity

[00:28:47] the user they're targeting they're on vol when it's not on an equity asset you just cancel it

[00:28:53] they just decide and then there's always a real risk I think for the long dated auction holder

[00:28:58] in that context of just losing time value the intricacies only become important in these edge

[00:29:04] cases where stuff gets weird and then these relationships really blow up I want to talk a little

[00:29:08] bit more about this just notion of vol surfaces and distributions but maybe a little bit more from

[00:29:14] a technology standpoint I think this will lead us into some of your work at moon tower one of the

[00:29:20] things I was just talking about on this podcast was the extent to which we are flooded with not just

[00:29:27] thousands of ETFs with options on them but even for ETF you've got so many strikes and so many

[00:29:34] explorations now in the S&P you have an expiration every day and you've got hundreds of strikes

[00:29:42] and it's much more than a mere man can look after you're going to need the help of a pretty fast

[00:29:49] machine to do so and I was kind of riffing on this idea of price discovery especially with your

[00:29:55] experience in trading these non-standard ETFs price discovery in something like spy no big deal

[00:30:01] you kind of know where it is because everybody knows where it is but with something that's non-standard

[00:30:07] and off the run the price discovery process is a little trickier and that's for at the money in

[00:30:12] kind of the expiration sweet spot but then you've got all these other expertise all these other strikes

[00:30:19] and the construction of the vowel surfaces is very much a mathematical undertaking with heavy

[00:30:27] help from computers and technology I just hope you could talk a little bit about that the idea

[00:30:33] that we start with at the money valve but then we get this big giant vowel surface across strike

[00:30:38] in time and the thought process behind that and I guess I'll just finish with I saw one of your

[00:30:46] pieces talked about GMA you wanted to do something in GMA I for one was just absolutely blown away

[00:30:53] by the pricing of GMA on January 27th of 2021 not because the vowel was 880 but because it was

[00:31:03] four vowels wide at 880 I know it's a triumph of machines and being able to price something with

[00:31:09] that specificity at such a high and inflated vowel level so tell us just a little bit about how

[00:31:15] a vowel surface is created starting with close to the money options and sort of the way in which

[00:31:21] someone like yourself thinks about the surface and the distribution if you trade things that are opaque

[00:31:27] this is a major issue for things that are basically liquid it's sort of a non-issue I mean these

[00:31:34] market makers they're setting curves at incredibly fast speeds they have very sophisticated models

[00:31:41] it feels like a salt problem from if you're looking at the grand scheme of things where it's

[00:31:46] the most interesting is where markets are opaque and I have a lot of experience with this the big

[00:31:52] example was going into the product options pit so I was trading oil auctions and even when I

[00:31:59] started in oil auctions it was a bit of a problem because when I got in there we were just transitioning

[00:32:06] into a world that actually had screens what you had was you had some very primitive software

[00:32:12] that had a bunch of strikes and you could basically set a spline and you would have some fixed grid

[00:32:17] points you could set them say oh one standard deviation up two standard deviations up and

[00:32:22] let's say the at the money is $100 I know what the straddle is straddle is very liquid so

[00:32:27] I can use the straddle to get the at the money ball and then let's say the 110 calls the 25 delta call

[00:32:33] okay the 25 delta call just traded for this price and straddles five bucks and let's say that

[00:32:42] the 25 delta call if you set it to a dollar you end up with like an a pretty smooth ball curve

[00:32:48] between at the money in 25 delta but right now all of a sudden that call trades a dollar can

[00:32:54] and now you have a problem because the question is is did the call skew blowout or is the straddle

[00:33:02] and if you don't have any screens and you go to quote the straddle you don't know if the straddles

[00:33:08] actually higher because the market will be made higher because everybody else saw that the call

[00:33:13] straight 110 so they suspect are coming in here to buy straddles so that you could like this call

[00:33:19] spread for a cheap price 110 calls for it but their bid may not be real what happens is in

[00:33:26] opaque markets you always have this problem that the vault changer that the skew change because

[00:33:31] the things are not trading simultaneously and there's no screen for you to look at and compare or

[00:33:38] the screens are wide they're wide enough that there's enough variation in his relationship

[00:33:42] if you could be wrong on a $5 wide possible you could be off by a dime on what that thing is really

[00:33:48] worth so what happens is you really have to be heavily involved in that market watching every

[00:33:56] paying attention to where the stock was when that thing printed and seeing where adjacent prints

[00:34:01] are and then you're pouring a picture by analogy is you are catching fireflies it's a summer

[00:34:08] night in New Jersey your 12 years old and you're out there and the firefly flashes and then

[00:34:13] you're like where do I think it is now because I want to catch it and I'm not sure if it went to

[00:34:17] the left to the right or went down and to try and emulate where the fireflies are I need to see

[00:34:22] like a couple prints in a row to see what direction it's going in this problem was very acute when

[00:34:28] I went to the product options because there nobody wants to give up any information the quotes

[00:34:33] it's all fog the quote could be um five dollars at five ten fair values for 80 and the

[00:34:40] markets five five ten because people think that the order is a buyer there's no way to really figure

[00:34:47] these things out until you just get super immersed in that market and over time you figure

[00:34:52] out the patterns you figure out the patterns of flow and you start to understand why are these

[00:34:57] markets lean this way I think that people think this sounds like old tradecraft from the floor

[00:35:03] this is happening today it's happening electronically I was talking to a friend that was talking

[00:35:09] about how there's these derivative income ETFs these large ones they have these large rolls and

[00:35:14] they're predictable and he was kind of remarking how amusing it is that these rolls will go up

[00:35:22] or these trades will go up at mid-market you might look at that and be like wow look how efficient

[00:35:26] this market is it's just willing to take down I don't know if the numbers are it's willing to take

[00:35:30] down 10 million vagumid I think that table has been set 20 years ago you come in in the morning

[00:35:36] and you have an opinion about I'm going to set my curves this way because I know that this guy bought

[00:35:43] some puts three weeks ago the market has went down just puts a double-band value you see they're

[00:35:50] going to come close or he's going to roll down because he's still bearish so if he's going to

[00:35:54] come roll down he's going to come sell that foot and he's going to buy a put below so he's going

[00:35:59] to sell the puts bread so if he's going to sell the puts bread what do I want to do I want to lower

[00:36:04] my at the money straddles and I want to raise my puts you and make that put spread really cheap

[00:36:09] so he comes in he offers it mid-market I buy it mid-market I buy that put spread for four bucks when

[00:36:16] I think it's worth 420 and then over the next couple days you walk that market back up to 410

[00:36:20] 430 you are anticipating that flow ahead of time you know that that guy's not going to come

[00:36:27] in and want to hit the bit so you know he's going to be looking for a mid execution so

[00:36:32] all of this stuff I still think is happening it's pretty hard to do these things in spy

[00:36:36] like maybe if that telegraph flow is enormous you could do it but this has always been part of

[00:36:43] the options trading game and I think that that trade craft is just hit in by technology now

[00:36:49] and when you say wow how was GME 4V all's wide at 800V I would have to wonder

[00:36:56] how good is those market makers information their market width is a reflection of their confidence

[00:37:02] so if they are making the market tight maybe they think this thing is a sale they think the

[00:37:07] fall should be 800 and they're making it tight and high because they know that the flow is a buyer

[00:37:14] the flow is a fall insensitive and if they make it really wide maybe nobody would trade so they

[00:37:21] make it tight and high knowing that there's very small likelihood they're going to get hit on their

[00:37:25] bit and if they do get hit on their bit they'll just buy a little bit and move but this way they

[00:37:29] hold it up so they can smack the bids that are coming in this is just me speculating because I

[00:37:35] thought on those desks this is sort of what happened in the VIX on August 5th clearly this stuff

[00:37:41] originated outside of the United States there's a Yan Carrey trade online but it filters through

[00:37:48] we know there's a linkage between these classes of risk assets could be anything could be a yield

[00:37:54] curve trade certainly VIX has a vulnerability it got much more dislocated I think than most

[00:38:00] people thought it could and so my take is the pricing was okay we can't really sell any more of this

[00:38:07] so we're going to price it really really high such that no one really want to buy it but we don't

[00:38:13] really want to buy it either at these prices it's kind of a market that's just reflecting the

[00:38:19] prices desired but I also want you to reflect on this as we were talking about GME I was just thinking

[00:38:26] about the triumph of technology on such a high vial asset and you've got all these strikes people

[00:38:32] are trading furiously with enormous option premiums obviously because the vial realized vial is so high

[00:38:40] but it really is a triumph of technology to be able to make all these prices available and actionable

[00:38:48] had a given point in time and what I would want to really differentiate that against is what you

[00:38:55] said earlier which is let's say in your old days in a seat getting a call from a sell-side

[00:39:01] firm who's got a client who wants to do something and you realize you are there obviously to make

[00:39:07] money for your firm but there is some version of hey I want to keep this call coming in it's a good

[00:39:13] call there's a relationship here and so you may put something up its marginal because you want to

[00:39:19] keep that call coming in that's the way the sell-side voice game has been played for decades

[00:39:25] in the world of electronic liquidity it's faceless it's nameless you can be at a price and then just

[00:39:33] suddenly not be there your machine just kind of shuts down at the sides it sees something in the

[00:39:39] hall regime or the behavior of the asset underlying asset that doesn't set up and so suddenly your

[00:39:47] price change is quite a bit it's not really a person making that decision it's already been made

[00:39:52] by the parameters that are embedded within the model and that's very different that's I think

[00:39:57] quite an interesting change the advent of technology in the way in which executions are done especially

[00:40:04] think about the zero DTE space that's not someone calling someone up who makes his way to a sell-side

[00:40:11] trader Goldman Sachs and makes a price there is no voice intermediation on 95 plus percent of this stuff

[00:40:19] and I think that just creates a different dynamic I'd be curious what you think about it

[00:40:25] there's a 100% true and it's been increasingly true I mean there's no value add for you to be a phone call

[00:40:30] to trade something in the front month in a future's auction there's just plenty of screen liquidity at this point

[00:40:35] you're there because it's still crickets 12 months out your role there is to trade these longer

[00:40:41] duration things and stuff that's just generally harder to price something that I do think is kind

[00:40:46] of interesting this kind of gets into like the fragility or not of liquidity in the microstructure today

[00:40:53] I'm no expert on this but I think that there is a story out there that is very valid about

[00:41:00] liquidity is far less than what it used to be and these quotes they can just vanish

[00:41:07] I don't know to what extent that has to do with consolidation because

[00:41:12] the story of the options market of the last one years if you're just zoom out when I went to the

[00:41:17] floor I don't know how many different colored jackets there were on the floor there were a lot of

[00:41:23] firms down there lots of mom and pop little trading shops sig was a big player team for hills a big

[00:41:29] player yet spear leads and there was plenty of larger players but there was so many wildcats

[00:41:35] now the market making world is vastly consolidated you would know far better than me today just

[00:41:41] exactly how many firms make up 80% of the market share or something like that but it's a

[00:41:46] much much smaller number than it used to be and the story of options over the last 20 years has

[00:41:51] been returns to scale I say the market making the prop firms Jane Street sit at these companies are

[00:41:58] converging on tech companies as a matter of fact they're hiring the same people so they all want

[00:42:03] to hire the same people that Google wants to hire they don't want to hire me they want to

[00:42:06] hire math Olympiad kids the returns to scale have been enormous I don't know if this is

[00:42:15] by consolidating if you've made it more fragile I'm like all these firms they're running pretty

[00:42:20] similar models I mean Jane Street came out of sig sit at all securities their options desk

[00:42:26] there's a lot of sig influence in at least the most recent iteration of it there is a lot

[00:42:32] of similar thinking that is behind all the firms that run these trades I mean parallaxes a sig

[00:42:37] lady is as well when somebody's asking me for a quote in some bond option ETF it's a customer on

[00:42:44] one side trying to buy 50,000 puts it's like me Jane and Nanger cast the characters on the other side

[00:42:51] we're not trading with each other because we think the same that consolidation probably has made

[00:42:58] the market more fragile the other argument to that would be with payment for order flow and

[00:43:05] the competition to be in the exchanges good graces at the end of the day the exchanges are

[00:43:11] the point of power and centralization to be in the exchanges good graces you probably do have to

[00:43:18] be a good citizen market maker and stand there and take some trades that keep an orderly market

[00:43:25] they have much more visibility into the executions in your behavior and so they can kind of hold

[00:43:30] your feet to the fire on that and I'm not sure what the competing effects are my guess is that it's

[00:43:35] more fragile but there's no way for me to really know going back to the August 5th thing I went

[00:43:40] into the community chat on moon tower and the first thing I've chatted that morning was I looked up

[00:43:46] in the USO and I saw that D's USO of all was 3238 which is obnoxiously wide for USO and

[00:43:58] he wj was 20 balls wide it was 2040 on the ball I had never seen anything like that in my life

[00:44:04] for wj to be 20 balls wide is unheard of and I know I listened to your episode with veneer

[00:44:09] on solie and he talked about this too about it never seen the liquidity vacuum that happened in the

[00:44:15] end in his career and he's been around a lot longer than I have. I think that there's a lot of

[00:44:20] credence to the market becoming more fragile because there's less players but let's finish off with

[00:44:28] a couple of your current pursuits so talk to us a little bit about moon tower the sub stack

[00:44:35] and what you're up to there I've certainly spent some time reading through it and you've got a lot

[00:44:41] on your mind and obviously it's very option centric but you tend to relate some of your

[00:44:47] options expertise or your philosophy to life matters as well so I think you have some fun with it

[00:44:53] and obviously have a very strong subscriber base and then just tell us a little bit about moon tower

[00:44:57] AI as well. For the sub stack I started at five years ago but today I publish

[00:45:02] times a week I publish the OG letters on Sunday and then I publish on Wednesday and then I

[00:45:09] tend to publish a much more options centric the third day one is paywall I mean that's the one where

[00:45:16] I'm really diving into stuff more and oftentimes looking at data and showing stuff but

[00:45:22] the letter it started is curation here's things that I read that I thought was interesting and then

[00:45:27] maybe my like take or blurb and that's kind of how it started it was just an experiment

[00:45:31] as I would comment on things especially things that were financial I would

[00:45:36] analogize to options trading and that seemed to resonate it was weird I kind of realized at that point

[00:45:43] I might know some stuff that is not common knowledge and I started writing about that and that's

[00:45:48] really how I got the following I do write a lot of stuff that's not options related I write a lot

[00:45:53] about family matters and raising kids and playing games and teaching kids and some culture stuff

[00:46:00] in a lot of readers give me the feedback of I came for the finance and stayed for the life

[00:46:04] that's been a very consensus thing the letters very personal as well as being technical sometimes

[00:46:11] when I left parallax I did not even look at markets and any consistent basis for probably at

[00:46:18] least a year and a half but then I started getting a hankering to be able to see the world through

[00:46:23] the lens that I had become accustomed to the way I looked at things for 15 years through

[00:46:28] some of it's certain deputy I met a guy named Enigal who he's the founder of his company called

[00:46:33] Ezra and he's a software developer by background by was coaching him on options stuff

[00:46:38] he was trading crypto options for his PA and as I was coaching him I realized that

[00:46:45] the way I was teaching him was this progression that was the very progression

[00:46:50] of how I thought through trade ideas because he was a software developer it was already buying

[00:46:56] all this data and everything I would teach him something in two days later you would turn around

[00:47:00] like a prototype in the UI to be like okay here's this idea here's how it looks this is

[00:47:05] populated with data and I'd just be blown away like he just turned us around so quick

[00:47:09] it's not even as job we started doing this and then I was like let's build this out because

[00:47:14] I want to be able to have dashboards like I used to have one day he went and bought the

[00:47:19] Nuntower AI URL and said we should make this available to subscribers since we're doing it for ourselves

[00:47:26] I want this thing anyway so we can't really fail we want it for ourselves we finally launched it

[00:47:31] in March and the way I would describe this analytics platform is if we back up we understand that

[00:47:40] most of the world does not think about options as their own source of opportunity they have

[00:47:47] opinions about assets stocks and bonds and currencies and what have you well I could say is they wake

[00:47:53] up with an opinion or an ax on whatever stock in other words they think the securities are mispriced

[00:47:59] and they just assume the options are fair and they go to the options market and they sometimes

[00:48:03] they express their bets through options. Voltrators are the exact opposite. Voltrators

[00:48:09] luckily us brain damaged people we make up a very very small percent of the overall investing

[00:48:16] landscape and we look at options as a source of mispricing and then we assume the underlying

[00:48:23] is fair so our position is exactly the opposite of the typical investor's position.

[00:48:30] What the software does it's a step-by-step progression for how we think about options where we're

[00:48:36] really trying to do is say you had this idea that you wanted to trade options to express your bet let's

[00:48:40] give you the Voltrator lens and I've always had that mantra take with the VALS surface gives you

[00:48:45] and you don't even have to think that something is theoretically rich or cheap and we can argue

[00:48:52] all the long if that's really something you can calculate I think experts can professionally disagree

[00:48:58] on whether something is rich or cheap but the surface does move around and there are times when it

[00:49:06] really does facilitate something that you'd like to do. I always go back to certain energy names

[00:49:12] for example when crude has had a big rally let's say it's post rush a Ukraine and you get a big

[00:49:19] ramp in crude in March of 2022 and obviously the call skew gets really high so that translates

[00:49:27] into the equities and you can do things like one by two call spreads and get paid to handsome

[00:49:32] amount for selling off that upper strike risk. So sometimes the surface does come your way it's

[00:49:40] well Chris this has been a fantastic conversation give us a lot to think about it's also really good just

[00:49:46] to say that you found a professional passion and being able to take that and combine it with your

[00:49:52] own voice on life and getting a lot of subscribers and folks that are interested in hearing

[00:49:58] which I have to say so congrats on that and that's the luck on the very specific business pursuit on

[00:50:04] Moon Tower AI as well. I appreciate it Dean I appreciate you having me on as well like

[00:50:08] said I'm a fan and I'm a fan of your firm you get bombarded when you're on the biceye of

[00:50:13] different research pieces but the ones that your team sense were always a must read for me because

[00:50:19] they tended to be very actionable insightful and brief they were just super punchy and great and

[00:50:26] when you're getting swamped with stuff I think you guys cut right to the heart of things often

[00:50:31] you guys are doing great work and I appreciate it. You've been listening to the Alpha Exchange

[00:50:36] if you've enjoyed the show please do tell a friend and before we leave I wanted to invite you

[00:50:41] to drop us some feedback as we aim to utilize these conversations to contribute to the investment

[00:50:46] communities understanding of risk your input is valuable and provides direction on where we should

[00:50:52] focus please email us at feedback at alpha exchangepodcast.com thanks again and catch you next time