For those of you who haven’t checked out our Big List of Alts folks on Twitter (and VolTwit list), you may have missed the great thread/reply storm (we’re not sure what you call a bunch of replies nested in replies nested in retweets?) around what the next crash will look like.
Q2 2021 hedge fund letters, conferences and more
It started with @squeezemetrics saying “You’re not gonna get another crash”. Strong words indeed, and a little off the cheek, perhaps – but then Resolve’s Adam Butler @gestalu weighed in with a little more historical/behavioral/structural perspective:
Everyone always focuses on the character of the most recent crises, but obviously the most recent crises are the most likely to retard the very behaviour that led to those crises.
Next bear mkt likely to resemble 2000 – 2002 slow grind lower.
Tail hedging dead money for years? https://t.co/H5J0wikpXd
— Adam Butler (@GestaltU) August 10, 2021
Now the wheels were greased for a full on tweetstorm across some of the best follows out there. @choffstein replied to our own @attaincap2 question on how this lines up with his liquidity cascade thesis, saying:
I still think a lot of the same dynamics permeate the system (namely, excessive risk taken driven by low interest rates; adoption of systematic strategies; influence of options on underlying) – but the build up of risk that ???? alludes to may be gone for some time.
— Corey Hoffstein ????☠️ (@choffstein) August 10, 2021
This was a great point by Corey – if not unscientific. It does feel like the market loves inflicting max pain on the most people, meaning if tons of us are protected from a sharp decline – maybe that’s not what will happen. But what if the market is less liquid now? Maybe the fact that there’s more protection (in and of itself not proven anywhere), is belittled by the thought that there’s much less liquidity – especially in a crisis. Enter @ksidiii, sharing his thoughts on how there’s not enough market makers to act as a buffer – and calling out the thought that OTC exposure is down by showing there’s a TON of autocallable risk out there – pushing @gestaltu to come back full circle re-thinking if there’s triggers down below which could accelerate a move lower…
On top of that, the market participants and their role have also changed drastically as we have cut down the overall liquidity providers as the space has become monopolized.When things go risk off, these main 5 providers (in reality) pull liquidity much faster than they once did
— Kris Sidial (@Ksidiii) August 10, 2021
Sure direct variance tails is dead but risk is absolutely being hoarded in a lot of the autocallable market…. the US is on pace to now be the largest autocallable mkt. Dealers hedge that risk on the listed side (I was part of that desk a year ago)
— Kris Sidial (@Ksidiii) August 10, 2021
How do the payoff functions of the most popular exotics map to dealer gamma? Are the reaction functions not substantially different than what we’ve seen from systematic vol selling prior to March 2020? What sort of market environment is most toxic to these products?
— Adam Butler (@GestaltU) August 10, 2021
Which brought out the auto-callable folks, one of which we had on a recent pod talking structured products and buffered notes (Joe Halpern). The view in our pod is there isn’t really any added risk here. But FinTwit had different ideas, led by @nihilisttrader pointedly pointing out that the search for yield drives all of this, and those providing the yield are the ones taking on the “gap risk”:
Notes, volcontrol, you name it. mkt hungry for yield enhancement or illiquid optionality these days. and that leaves the risk warehouses short gap risk.
Coupled with tighter risk limits/regs and no layoffs.. and it’s fairly obvious why shit-gap-cliquets print at 50bps
— nihilist trader (@NihilistTrader) August 10, 2021
Leading into, after a night of sleep, the conversation about how the government is likely to react in teh next crash to prop up the market with concentrated market maker activity, per @TradeVolatility
Consolidation of MMs will just make it easier for the Fed to create an Emergency Lending Facility to directly prop then up.
(Started as definite sarcasm and finished unsure)
— Trading Volatility (@TradeVolatility) August 11, 2021
And lastly – to Inflation… by @breakingthemark, after some well placed rhetorical questions on what happens if we don’t backstop the market, if we don’t prop up market makers, if we actually let the market fall to where participants start to come in and buy…
inflation or interest rate concerns in a long time, and I wonder what’s going to happen when policy makers are forced to make a choice between propping up the market or keeping inflation down.
— Matt Hollerbach (@breakingthemark) August 11, 2021
Go check it all out for yourself by surfing between these different replies, and let us know what you think. Will the next down move be even faster and more nasty than the last – or rather tame and measured because the last was so nasty.
Article by RCM Alternatives
