Benn Eifert | Are We Entering a New Volatility Era? | U Got Options - From the Cboe Floor

Summary

This conversation dives deep into market strategies, focusing on tail hedging, zero DTE options, and the structural imbalances in the options market. It explores how macroeconomic trends, especially rising tariffs and interest rates, are impacting sectors like real estate, refinancing, and equities. The discussion also highlights the challenges posed by the housing market's unaffordability and the growing demand driven by protectionism. Ultimately, it underscores the importance of non-correlated strategies in navigating the current volatile economic landscape.

Takeaways

• 😀 Zero DTE options now make up about 60% of the trading volume in the market, with uses ranging from intraday leverage to income generation through selling options.
• 😀 Zero DTE options are commonly used by macro hedge funds and retail investors to take short-term directional exposure by buying upside calls or call spreads.
• 😀 Income generation strategies around zero DTE options include call overwriting, where investors sell options against their equity holdings daily.
• 😀 Prop firms and market makers use zero DTE options for daily portfolio adjustments, managing positions that expire within a short timeframe.
• 😀 The skew in the options market, particularly in crash puts, reveals supply-demand imbalances, with some institutions aggressively selling long-tail options, creating risk for market makers.
• 😀 Skew curves show high volatility at the middle of the curve, reflecting demand for hedging, while crash put sellers drive the low skew at the front of the curve.
• 😀 Convexity in portfolios can be achieved by buying long-dated downside options (e.g., 10-20 delta puts) and selling against them for positive carry and hedging against major market drops.
• 😀 Structured products, such as knock-in puts, add mechanical long convexity in the market, where short squeezes and volatility spikes occur when these products' barriers are triggered.
• 😀 Tariff policies and global trade tensions, especially between the US, China, and Europe, will have major impacts on economic growth, corporate earnings, and market dynamics in the near future.
• 😀 Rising interest rates are starting to put pressure on refinancing, especially on debt issued in 2020-2021, and could lead to broader economic consequences, including a potential slowdown in corporate growth.

Q & A

What is the significance of tail hedging in the current financial environment?

Tail hedging is crucial in managing extreme risks in the market, such as sudden crashes. It allows investors to protect themselves against the unlikely but severe events that could lead to significant losses, particularly during market downturns. The discussion emphasizes that tail hedging is most relevant right after a market crash, when interest in it peaks.

How has the use of zero-DTE options evolved in recent years?

Zero-DTE options, which expire in one day, have become a prominent tool in the market. They account for about 60% of options volume, with three major categories of flows: directional bets by retail and hedge funds, income generation through selling options, and market makers using them to manage their books. These options are seen as a useful tool for short-term strategies and portfolio management.

What role do market makers play in the zero-DTE options market?

Market makers use zero-DTE options to clean up their portfolios daily. They frequently adjust their positions to neutralize or manage the risks associated with their book of options, which involves buying or selling options on the same day they expire.

Why is there a supply and demand imbalance in the crash put options market?

Crash puts, particularly those with long-dated expiry dates, are being sold by institutional investors and structured product sellers. This leads to a supply-demand imbalance as there is a limited number of buyers for such options. When markets experience significant downturns, this imbalance can result in rapid price adjustments, benefiting buyers of convexity.

What is the concept of convexity, and how does it relate to managing risk?

Convexity in this context refers to the asymmetrical payoff structure of certain options positions, particularly those that benefit from large market moves. By buying long-dated options, such as deep out-of-the-money puts, investors can position themselves to profit from extreme market events, providing protection against significant downturns while potentially profiting from volatility spikes.

How do structured products influence the options market?

Structured products, like knock-in puts, are sold by banks to investors seeking yield. These products trigger a short squeeze in volatility when the market moves sharply, forcing banks to buy back their short positions in options. This creates opportunities for investors who own long volatility positions, as the buying activity pushes up volatility and option prices.

What macroeconomic factors are expected to influence the financial markets in the near term?

The macroeconomic factors likely to impact the markets include tariff policies, inflation, and rising interest rates. The discussion highlights the uncertainty around tariff timelines, the long-term effects of inflation, and the delayed impact of interest rate hikes on refinancing and housing markets, all of which will shape economic performance and corporate earnings.

Why is the housing market particularly vulnerable to rising interest rates?

The housing market is highly sensitive to interest rates because higher rates increase the cost of mortgages, reducing affordability. While home prices have not adjusted significantly yet, higher rates could eventually make it more difficult for buyers to afford homes, particularly in expensive metropolitan areas, leading to a potential decline in home prices.

What is the potential long-term impact of high interest rates on corporate debt and refinancing?

High interest rates will likely create challenges for corporations with significant debt. Many companies refinanced at low rates in 2020 and 2021, and as those loans mature, they may face higher borrowing costs, impacting their profitability and potentially leading to a rise in defaults, especially in sectors like commercial real estate and non-investment grade credit.

How can investors protect themselves from the risks associated with rising interest rates and macroeconomic uncertainties?

Investors can protect themselves by diversifying their portfolios, focusing on non-correlated assets, and using strategies like tail hedging to manage extreme risks. Additionally, understanding market dynamics, including the effects of rising rates on various sectors, is crucial for adjusting investment strategies to minimize exposure to potential downturns.