Authored by Peter Tchir via Brean Capital,
Momentum Trader: It’s going to zero!
Sales: Protection is worthless. Why pay up for protection, it always turns out worthless?
Quant Trader: The skew and relative steepness makes timing critical on any purchase. The theta decay is virtually impossible to overcome.
Desk Head: Why aren’t we selling more?
Bear Trader: Because we are at all-time tights and there is no #*#*!@$ value! This is just #@*($& stupid.
Risk Management: I can’t let you sell more than you already have. I’ve already increased limits and I’m extremely uncomfortable increasing them again.
All: Oh shut up!
Desk Head: You and your stupid risk limits are why we are all here in the first place! Had you let us sell more 2 months ago we wouldn’t all be here stuck trying to figure out what to do – we’d be sitting on great P&L and could relax, but no, now we are behind and have to sell as much as we can at the lows.
Bear Trader: This can’t possibly continue. It’s already overdone and when it reverses, it is going to be UGLY!
Sales: All I’ve got is sellers. No one wants or needs protection.
Quant Trader: It doesn’t even have to go lower, so long as it just sits here, the theta decay coupled with the funding arbitrage performs well.
Technical Trader: All support is broken, we are in uncharted territory. This could continue.
Risk Management: I will concede that several new products seem to have changed the landscape and may have reset the boundary conditions. I will review again.
Desk Head: Good!
Bear Trader: This is going to end badly.
All: It might, but not any time soon!
While this is a fictitious conversation, it is largely based on conversations I was part of in the spring of 2007 around CDS Indices.
Any similarity to conversations surrounding VIX yesterday are purely coincidental.
The sense that risk assets can only grind higher and that the value of any protection is useless, really seemed to reverberate throughout Wall Street yesterday as the S&P 500 hit all-time lows on 10 days realized volatility.
The types of conversations reminded me a lot of what was discussed in the Spring of 2007 – though who was right and who was wrong depended heavily on whether those conversations were had in late April or early June.
* * *
With stock turbulence evaporating further, betting on market swings has become cheap -- for real.
As Bloomberg details, for the first time since November, the S&P 500 Index’s one-month implied volatility has dipped below the gauge’s actual price moves from the previous 20 trading days, as VIX sank to its lowest close in more than two decades.
S&P 500 implied volatility was higher than realized for 108 straight days, the longest run since the 132 days ended Feb. 27, 2007... and most know what happened next.