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    Forward Guidance

    Dean Curnutt: Market Insurance Is Cheap, Stock-Bond Correlation Is Positive, And “Interesting” VIX Opportunities

    Mon Feb 05 2024
    stocksbondscorrelationforward guidancedebtvolatilityBitcoinoption pricingcredit volatilityVIX optionsmarket pricing

    Description

    This episode discusses the changing correlation between stocks and bonds, the influence of forward guidance and debt on the bond market, volatility and Bitcoin as macro assets, stock-bond correlation and market volatility, volatility trading and selling options, option pricing and credit volatility, VIX options and market pricing, long volatility and option strategies, market pricing and option skew, VIX options and future pricing, market events and option insights, and long volatility and market opportunities.

    Insights

    The stock-bond correlation has shifted since 2022.

    Both stocks and bonds have started moving down together instead of following their traditional patterns.

    Investors relying on the negative correlation between stocks and bonds for diversification may face challenges.

    The change in correlation poses challenges for investors who rely on the negative correlation between stocks and bonds for portfolio diversification.

    Low policy rates have led to malinvestment.

    Current low policy rates have led to malinvestment, and Dean Kurnut prefers higher yields on Treasury bonds.

    Volatility trading can be profitable when market risks are low.

    Selling volatility can be profitable when market risks are low, but sizing becomes crucial when dealing with volatility trades.

    The VIX reflects the cost of option insurance on the S&P 500.

    The VIX reflects the cost of option insurance on the S&P 500 and is currently low.

    Being long options can be worth it during market downturns.

    Being long options can be worth it because you can buy assets at low prices, especially during market downturns.

    Option structures can provide risk-controlled exposure to assets.

    Option structures can be used to buy exposure to assets like FXI in a risk-controlled manner.

    The upcoming US election is expected to be rough.

    The upcoming US election is expected to be rough, causing concern about geopolitical and political risks.

    Volatility was used as a basis trade in 2020.

    Volatility was used as a basis trade in 2020, with people buying the VIX not because they believed stocks would crash, but because they thought others would think so.

    Trades involving options require careful monitoring and adjustment.

    Trades involving options are dynamic and require careful monitoring and adjustment.

    Chapters

    1. The Changing Correlation Between Stocks and Bonds
    2. The Influence of Forward Guidance and Debt on the Bond Market
    3. Volatility and Bitcoin as Macro Assets
    4. Stock-Bond Correlation and Market Volatility
    5. Volatility Trading and Selling Options
    6. Option Pricing and Credit Volatility
    7. VIX Options and Market Pricing
    8. Long Volatility and Option Strategies
    9. Market Pricing and Option Skew
    10. VIX Options and Future Pricing
    11. Market Events and Option Insights
    12. Long Volatility and Market Opportunities
    Summary
    Transcript

    The Changing Correlation Between Stocks and Bonds

    00:00 - 07:26

    • Historically, stocks and bonds have had a negative correlation, serving as a diversification tool in portfolios.
    • Since 2022, there has been a shift in this correlation, with both stocks and bonds moving down together.
    • This change poses challenges for investors who rely on the negative correlation for portfolio diversification.
    • Long-term investors may overlook this change, but institutions and hedge funds heavily reliant on correlation trades could face margin calls.
    • Current low policy rates have led to malinvestment, and Dean Kurnut prefers higher yields on Treasury bonds.

    The Influence of Forward Guidance and Debt on the Bond Market

    07:02 - 14:04

    • Markets rely heavily on forward guidance and promises from the Fed.
    • The stock of debt in the US poses a threat to the bond market's fundamentals.
    • During COVID, there was fragility in the bond market with eroded dealer balance sheet capacity and increased volatility.
    • The Fed's promise of low rates influenced option prices, leading to low volatility.
    • An upshock in rates pushed the Fed off its tightening cycle and resulted in a rally in two-year notes.

    Volatility and Bitcoin as Macro Assets

    13:47 - 20:47

    • Hedge funds faced losses as rates unexpectedly went down, causing tension and volatility in the treasury market.
    • Bitcoin is establishing itself as a macro asset that can hedge against government devaluation of currency.
    • Extreme movement in bond prices occurred in March 2023, with expectations shifting from rate hikes to rate cuts by the Federal Reserve.
    • Market predictions reflect capital availability and can be influenced by buyer-seller dynamics.
    • Currently, six rate cuts are priced in by Jan 2025, but it is uncertain if they will be fulfilled or have a significant impact on the stock market.

    Stock-Bond Correlation and Market Volatility

    20:31 - 27:20

    • The stock-bond correlation has varied over time, with positive and negative correlations observed.
    • In 2022, stocks and interest rates showed a positive correlation.
    • Concerns arose in the stock market about potential negative consequences if there was no significant bond market rally.
    • Despite rate increases, the real economy impact has been limited so far.
    • Implied volatility tends to be low when stock markets rise, leading to lower options premiums.

    Volatility Trading and Selling Options

    26:52 - 33:46

    • Selling volatility can be profitable when market risks are low.
    • The VIX reflects the cost of option insurance on the S&P 500 and is currently low.
    • Shorting volatility can become a crowded trade, leading to market implosions.
    • Being tactical and thoughtful about buying volatility can be beneficial.
    • Sizing becomes crucial when dealing with volatility trades.
    • Trade construction and finding better deals in the options market can provide value to investors.

    Option Pricing and Credit Volatility

    33:16 - 40:38

    • Option prices depend on the underlying asset and its volatility.
    • Buying VIX calls and VIX call spreads can be considered a Widowmaker trade.
    • The credit default swap complex has changed due to regulations.
    • Corporate balance sheet fundamentals indicate companies have taken on debt at low rates.
    • The HYG index of high yield bond prices has both an interest rate and a credit spread component.

    VIX Options and Market Pricing

    40:08 - 47:20

    • The VIX cannot go to zero because options don't cost any money at that level.
    • Market prices and trades are influenced by reflexivity and self-fulfilling prophecies.
    • Short covering dynamics can create a spiral effect with winners making more bets while losers run out of money.
    • Option prices during certain episodes, like GameStop, became extremely expensive and difficult to break even on.
    • Being able to execute on a shopping list of cheap stocks during a crisis can be beneficial.

    Long Volatility and Option Strategies

    46:53 - 54:01

    • Being long options can be worth it because you can buy assets at low prices.
    • It is currently a reasonably attractive time to be long volatility due to concerns about the Treasury market, debt, and interest rates.
    • Correlation across stocks in the S&P 500 is currently very low.
    • The wealth concentrated in top stocks may be underpriced due to their lack of correlation with each other.

    Market Pricing and Option Skew

    53:47 - 1:00:38

    • Option structures can be used to buy exposure to assets in a risk-controlled manner.
    • The skew of option prices reflects relative implied volatility across different strikes.
    • In 2022, realized volatility on up days was higher than on down days, leading to a flattening of the skew in option pricing.
    • Currently, there is lower volatility and a flat skew in the market.

    VIX Options and Future Pricing

    1:00:08 - 1:06:41

    • The VIX curve is currently in Contango, with upward sloping futures prices.
    • Contango steals value from trades and can be punishing for investors.
    • The upcoming US election is expected to be rough, causing concern about geopolitical and political risks.
    • Market pricing already reflects potential volatility around the election day in November 2024.

    Market Events and Option Insights

    1:06:32 - 1:13:34

    • Volatility was used as a basis trade in 2020, with people buying the VIX not because they believed stocks would crash, but because they thought others would think so.
    • There are certain market events where it's advised to avoid shorting risk at all costs.
    • Option prices provide insight into potential paths and volatility levels.
    • In 2022, the upside call options had a lot of value due to the market jumping up, flattening the skew.

    Long Volatility and Market Opportunities

    1:13:08 - 1:20:13

    • Being long options can be worth it because you can buy assets at low prices.
    • It is currently a reasonably attractive time to be long volatility due to concerns about the Treasury market, debt, and interest rates.
    • The market doesn't necessarily price a correlated move of stocks like Amazon, Apple, and Google.
    • Trades involving options are dynamic and require careful monitoring and adjustment.
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