As my main man Logan Roy would say, “let’s get into it”.

As I write this, we face one of the most daunting backdrops for appreciating the set of uncertainties in front of us. The pace of change – in technology and in geopolitics – is unimaginably rapid. In the meantime, the architecture of the financial system is being redesigned. And also in the meantime, the US fiscal condition only deteriorates.

Let’s start with technological advancements which are coming at breakneck speed. The promises and the potentially positive outcomes are incredible. The threats, however, are daunting. AI is forcing a wholesale re-underwriting of assumptions about the value of knowledge work. And in the process, about future cashflows and annual recurring revenue. About industries like insurance, wealth management, logistics, cybersecurity and, of course, software.

A Substack memo, written about a future that looks back on the past, catalyzes a giant sell-off in sectors deemed exposed. There’s no earnings announcement or unwelcome economic statistic the market is confronted with. It is the thought experiment alone that is the risk-off. It leads to downside vol in the very way that a thought experiment a year earlier led to upside vol. Then, it was endless possibilities. Now, sky’s the limit became the sky is falling.

What should we take away from the impact of the Citrini memo? First, I believe its framing was highly effective. The piece zooms forward but looks back. We are in 2028 and I am showing you news stories that occurred a year earlier. There’s something about reading a headline from a press story you are told has already happened. That feels definitive. It’s a statement of fact – a review of the past - about something that hasn’t happened yet.

Second, Substack and Twitter. The memo has 16mln views and counting on Twitter. On its best day, the Goldman tech research team couldn’t dream of such exposure. The speed with which information gets shared is new and powerful. We live in an era of attention capitalism. Remember the Nick Shirley video on “Learing Center” fraud in MN? That got, wait for it, 135mln view on Twitter. It went live on December 26^th. Tim Walz withdrew his bid for re-election 10 days later. Action, reaction. And here we thought it was gonna be Sean Hannity that took down Walz.

Our second takeaway from Citrini is that market prices are always built on assumptions and sometimes those assumptions become fragile. What makes them so? Price does. When we pull forward a future based on especially optimistic assumptions, we embed them in price. I’ve often said that market vol events are the result of a confrontation between the existing and a new set of assumptions. Markets are incredible mechanisms for allocating capital. But, of course, they are wrong on a regular basis.

Sometimes these errors are small – a mistaken assumption on NFP or inflation. Occasionally, the market gets it very, very wrong. As a view is underpinned by a stronger consensus, it becomes baked into market prices. It means that when the consensus is shattered, the repricing can be violent. Two decades ago, as the real estate market sizzled and all kinds of derivatives were built around the notion that housing prices could not decline on a national basis, the price of credit risk for mortgages melted away.

There’s a scene in the Big Short book in which, in late 2006, a trader at Deutsche Bank working for Greg Lippmann is buying protection on a super senior tranche of subprime CDS from a counterpart at Morgan Stanley. As he forks over 28 basis points to get 2bln of short exposure, he says, “we both know there is no risk in these things”. Of course, nothing could have been further from the truth. The point is that the more convinced we are of something, the lower the probability we assign to that not being the case. The Citrini memo succeeded in having the market reprice a tail outcome.

Of course, as “death of knowledge work” deflationary outcomes are contemplated, the existing set of exposures, underwritten on assumptions now tested, becomes stressed. Blue Owl is largely the poster child for publicly traded vehicles engaged in private lending. The stock’s 2m realized volatility has doubled from 30 to 60 since last September. There is furious trading in the shares. Option volume, almost non-existent last year, is up, averaging almost 100k contracts daily. As we watch the AI displacement theme play out, we must recognize that a financial risk-off, one that is sponsored by wrong-way exposures, is a possibility. Illiquidity breeds illiquidity and we are seeing various episodes of gating.

Cliffwater, Morgan Stanley, BlackRock and Blackstone have announced that they are limiting redemptions because they cannot satisfy them. I can’t help but think of the scene in Casino when Nicky Santoro tells his hapless banker, “Frank, I think I want my money back.”. Not being able to turn your exposure into cash in a moment’s – or in this case even a quarter’s notice – is a problem.

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If there’s one lesson, I believe investors consistently fail to learn it’s the value of liquidity. We underprice liquidity risk. It’s fine to bear liquidity risk, but in hindsight, amidst a shortage of it, we almost never believe we were properly compensated for doing so.

I’m old enough to remember 1998 and the LTCM debacle. It was a superb example of when the risk of a portfolio really found its way into the market’s crosshairs. It was a preview of the big one that would occur a decade later. Of course, nothing was more protracted than the GFC, when the entire system was upside down. There’s a lot of discussion of whether today’s circumstance is similar. The answer is yes in the sense that more people want their money back than can be satisfied. Let’s hope those redemption lines don’t resemble those at the Houston or Atlanta airports.

Yes, there’s a liquidity mismatch which is similar to the GFC. Bloomberg reports that “A wave of redemption requests across the private credit industry has left more than $4.6 billion of investor capital trapped behind withdrawal limits, with more asset managers expected to impose curbs in the coming weeks. Investors have looked to pull roughly $13 billion from over a dozen funds so far this quarter.”

The important caveat when looking at today’s dynamic and comparing it to seismic events like the GFC is around the degree of leverage in the system. There’s far less of it today. In 2008, the XLF was realizing 100 vol for stretches of time. It’s realizing below 20 now. When it comes to systemic financial risk, we ought not to ever shut the door to the possibilities. But the core of the system is not currently showing any real stress relative to that suffered in prior events.

So, let’s take stock of where we are. We have a groundbreaking technology called AI. It’s singlehandedly created a massive capex cycle and been responsible for trillions of dollars of additional market cap assigned to mega cap tech stocks. Google alone added 1.5 trillion in market cap in 2025. The SPX rose by 86%, an annualized return of 23% from 2023 to 2025.

And because there’s two sides to AI, the promise of productivity, but also the displacement of it, the market recently went from “the sky’s the limit” to “the sky is falling” in it’s what-if exercises. From industry to industry – software, logistics, insurance, recruiting, real estate brokerage – we’ve seen significant selloffs. And as investors reprice securities, it could be the case that certain vehicles – like private credit – are viewed as increasingly vulnerable and find themselves unable to meet redemptions.

Now, let’s introduce the second main catalyst for risk, the war (or should I say, engagement) in Iran.

Around the world and across the asset classes, it’s hard to find a risk premium that isn’t considerably higher now than it was on February 26^th. VIX, MOVE, credit spreads, credit vol, break-evens, FX vol. Look further and more nuanced measures like volatility skew and implied correlation are steeper and higher. In Europe, there’s been a spike in realized correlation among stocks (in the SX5E, it’s 52% over the last month) as the repricing of the ECB’s path has been dramatic.

These risks are priced into US and other major developed markets, but EM volatility has also surged. The EEM VIX started the year at 17 and was recently north of 35. EM credit spreads are similarly wider.

These are all financially centric risk measures. In market risk, a rising tide lifts all vols. But it’s not all that applicable to soft commodities. Until now. Claude tells me that roughly 1/3 of globally traded fertilizer transits the Straight. An index of 1m implied vol on corn, wheat, sugar and soybeans, currently maps well against the VIX. The correlation of these two over the past month is 72%.

If there’s one thing we’ve learned about vol events over the years it’s that a supply shortage and resulting imbalance of supply/demand is at the heart of nasty price moves. LTCM in 1998, VW in 2008, the 2010 blowup in long dated equity variance, the 2011 surge in the Yen after the nuclear disaster, the 2018 VIX implosion, the GME event in 2021, and the surge in nickel prices in 2022. Nothing leads to vol more than a material imbalance of supply and demand.

Supply shortages resolve through the demand destruction that results from much higher prices. Easy to write, but it’s a process that imposes incredible risk on the global system of asset prices. “Move fast and things break” I say. In the same way that higher prices are the cure for higher prices, higher rates can be the cure for higher rates. At some point, if the market sees a material economic slowdown as likely, the US bond market sell-off will reverse as the “stag” part of stagflation is prioritized by policymakers over the inflation side.

This could clearly be wrong. And the reason is that the US, long viewed as a stabilizing force in the world, is now becoming a chief source of risk. In the process, the treasury bond market may be losing one of its most important characteristics: the insurance feature. That is, its capacity to be durable to and even benefit from market shocks. We’ve all got to be asking how can US government bonds be a shock absorber when the US government is the source of the shock?

Now strange things to do happen. For example, who could forget the epic bond market rally in August of 2011 as a stand-off between Obama and the Republicans took us to the brink of a debt-ceiling induced default? About to default, let’s make the market rally. The 10-year effectively rallied from 3% to 2% in August’11. These things are sometimes difficult to understand. It was the case then that US debt was 15t, its now 39T. Interest costs per year have increased by 770bln. Debt to GDP has risen from 97% to 122%.

Those numbers are daunting to be sure. But it is the reason we got there that matters and this is where I want to go next. Our politics are poisoned. We’ve lost the capacity to compromise.

There was a time when investors thought of the United States as the place where political risk went to die. Political rancor in Washington is certainly not new. Elections have been ugly in the past and the two parties could fight, but beneath all of it sat a deeper assumption: the institutions were strong, the rules would hold, and this would lead, the country’s political machinery, however messy, would ultimately produce continuity.

It’s impossible not to see that this is breaking down.

One of the most important shifts in the global macro landscape is that the United States is no longer simply the absorber of political risk from abroad. Increasingly, it is a producer of it. Avoid Trump Derangement Syndrome and Trump Apologist Disorder equally. Just notice things and then ask yourself, “what are the market implications?”.

As I have been thinking a great deal about this question, I began engaging with experts on geopolitical risk and hosting them for conversations on the Alpha Exchange. Traditionally, that term always conjures up conflict with other countries, like Russia, China and Iran. But it needs to include not just our strategic rivalries around the world, but internalized strife at home and its global implications.

Here’s what Alex Kazan, Head of the Geopolitical Practice at the Brunswick Group had to say:

“The US is now the world’s major source of geopolitical risk and uncertainty. That’s a big, big deal. It may sound sort of obvious thinking about that right now, given all the policy volatility that we’ve seen around Washington, but it’s actually pretty spectacular in terms of a macro development. I’ve been doing geopolitical risk analysis for most of my career, 25 years or so, and what I work on has evolved a lot.”

And that matters because of the vulnerabilities this imposes on one of our most prized assets: the government bond market which has long been priced as the global risk-free benchmark. This market has historically been a destination for capital seeking safety. It has exhibited an insurance quality, rallying in times of uncertainty. I’ve walked through this a great deal over the years, tracking the negative correlation between stock and bond prices quite closely.

Here’s what Ken Rogoff, former Chief Economist at the IMF, had to say about this:

“You flock to the United States because the dollar’s stable, because the economy’s stable, because policy is stable. And to the extent we become more unpredictable, to the extent our court system is replaced by the whims of an executive, not necessarily Donald Trump, it could be some later president. It’s less reliable, it’s less safe.”

With respect to the consistency with which the bond market rallies on a risk-off, it simply doesn’t work that way anymore, at least not on a reliable basis. Remember the tariff tantrum last year? The SPX experienced a large drawdown, the VIX spiked to the 50’s and the Treasury market actually sold off in the process. And, in 2026, the TLT is down almost 5% since February 26^th, 2 days before the US and Israel attacked Iran.

About the 2025 tariff event, Libby Cantrill, Head of Public Policy at PIMCO, had this to share on a recent Alpha Exchange podcast:

“You also saw dollar weakness, currency weakness, rates backing up, plus risk assets selling off. That’s a characteristic of an emerging market country, not the US historically. And so, I do think that was a bit eye opening. The behavior, during that period in time. You saw a little bit of that during this Greenland bout as well. Obviously very short-lived. But it is a good reminder that Sterling was a reserve currency until it wasn’t. These relationships exist until they don’t. You can’t take them for granted.”

I’ll just repeat what Libby said: these relationships exist until they don’t.

Ken Rogoff added this:

“People all too often think if you look at 10 years, 20 years, 30 years, you just know everything and forget these tail events... China would grow to the moon forever. Real interest rates would be zero forever. And also that the dollar’s dominance, which had been rising steadily, is something you could just count on.”

The US and by extension US markets have served as the anchor of the postwar alliance system, and the jurisdiction where institutional credibility was deepest. That’s been earned over many years of durable global leadership. It can be un-earned as well.

Mark Rosenberg, founder of GeoQuant, a firm that models geopolitical risk, said this:

“The United States has a particularly vulnerable set of political institutions. There isn’t really another developed market that has something like the electoral college...a Senate that is constructed to kind of overrepresent rural areas. And so what we have is a particular set of institutions that, as social risk starts ramping up, the institutional risk is vulnerable to ramping up as well.”

When confidence in those foundations begins to erode, even gradually, the consequences do not stay confined to politics. They can spill into market prices like rates and FX. They can impact global capital flows, and into the premium investors demand to hold long-duration US financial assets.

The first issue imposing risk on our institutional framework is polarization. Political disagreement in America is as old as Bernie Sanders, but what has changed is its intensity and its character. It’s longer simply a contest over tax rates, spending priorities, or who champions big business versus the little guy. Politics has become fused with identity, culture, geography, and media consumption. The opposing party is not just viewed as wrong, but increasingly as dangerous, illegitimate, or even un-American. That kind of negative partisanship changes the way a system functions. It makes compromise more costly, trust more fragile, and procedural conflict more likely.

And when polarization deepens, the risks are not limited to rhetoric. Investors need to think about process risk. And this is what has me most concerned. Markets are generally comfortable pricing outcomes. That’s the business. They can price a tax hike, a tariff, a change in regulation, even a war if they can map the channels.

What markets struggle with is uncertainty around the process itself: disputed election mechanics, contested certifications, legal escalation, executive-legislative confrontation, or battles over who has the authority to decide and enforce political outcomes. The underappreciated risk in the US today is that process instability is becoming more central.

I think a logical question to ask is, “how did we get here?” Many blame Trump. He’s an easy target. Alex Kazan suggests otherwise:

“I want to be very emphatic about this point. It’s not primarily about Donald Trump. It really isn’t. These things are structural, and we’ve seen signs of them emerge in the US for the past 10 years or so. Part of that is the deep, deep partisanship in the U.S. which makes it much, much harder for the U.S. political system to align around and have consensus around major foreign and economic policies.”

It’s certainly not difficult to link the increasing loss of faith in the US political system with the global financial crisis. Alex adds this:

“The response from political, economic, business elites to these massive, massive crises were self-serving, did not represent the interests of the average American. And at the end of the day, as we came through those crises, the people who many Americans view as responsible or partially responsible paid no price...And ultimately the narrative matters more than the specifics of the fact.”

The numbers are not subtle. Pew found that only 4% of Americans say the US political system is working very or extremely well, while 72% say it is working not too well or not at all well. A full 63% say they have little or no confidence in the future of the political system. More than eight-in-ten Americans say elected officials don’t care what people like them think. And trust in Washington remains near historic lows: Pew reported 17% of Americans in late 2025 say they trust the federal government to do what is right always or most of the time. These are alarming statistics.

Let’s build on this with some of the analysis done by Mark Rosenberg, His work, which did an excellent job of assessing the 2016 election where the mainstream media missed the bid for Trump, focuses on the polarization that has been brewing for years. Mark said this on a recent podcast:

“There’s even a term for that called a threatened majority, that they tend to start becoming more radical in politics and start seeking out more ethnopolitical entrepreneurs or kind of candidates that speak to ethnic grievance more. And that was what we saw in the United States.”

There is also a deeper fragmentation underway in how Americans consume reality itself. Pew’s 2025 work on media trust showed Republicans and Democrats not merely preferring different outlets, but often mirroring one another in trust and distrust. For example, 58% of Democrats trust CNN while 58% of Republicans distrust it. On the other side, 56% of Republicans trust Fox News while 64% of Democrats distrust it. That kind of split does not just produce polarization. It produces separate informational universes, which makes shared political outcomes harder to accept. Half the country thinks the 2020 election was stolen. The other half thinks that is an absolutely outrageous claim.

Abortion, guns, immigration, taxes, climate, healthcare, gender identity, affirmative action. On each of these, one side is convinced that the other is simply on the wrong side of history. There’s no scope for compromise when this is the case.

Then there is the international dimension. Domestic political fracture in the United States does not stay domestic. Allies watch American elections not as spectators but as stakeholders, because the continuity of US policy has clearly become less certain.

The erosion of America’s standing internationally is no longer a matter of conjecture — it is now quantifiable, and the numbers among our closest allies are striking. According to Gallup’s 2025 survey of all 31 NATO member states, median approval of U.S. leadership fell 14 percentage points to just 21% — a level comparable to the low-water marks of Trump’s first term and the George W. Bush years.

Germany saw approval crater by 39 points in a single year, Portugal by 38, and across the Nordic countries — Sweden, Iceland, and Norway — approval sits around one in 10. Perhaps most sobering: Washington and Beijing now receive nearly identical approval ratings across NATO, with China at 22% and the U.S. at 21%. The deterioration in European public opinion has been equally swift and measurable. The Spring 2025 Eurobarometer showed that positive views of the U.S. among EU citizens collapsed from 47% in October 2024 to just 29% by March/April 2025 — an 18-point drop in a matter of months — with Denmark experiencing the most dramatic fall, from 47% to 13%. Across the EU, unfavorable views of the United States have now jumped to 67%, meaning the U.S. scores no better than China in European public opinion.

The security dimension is equally troubling: in every European country surveyed by the Institute for Global Affairs, fewer than 10% of respondents were fully confident that a NATO Article 5 would trigger an American military response. A March 2025 European poll placed Trump’s trust score at just 2.6 out of 10 — second worst among 14 world leaders, behind only Vladimir Putin at 1.5 — a data point that would have been unimaginable just a few years ago. Rogoff’s warning that dollar privilege rests on the perception of American stability and trustworthiness is not abstract — it is being stress-tested in real time, and the early returns from our allies are not reassuring.

Trade relationships have been redrawn more abruptly, and arguably in haphazard fashion. Security commitments are being offered with greater conditionality. Longstanding alliances increasingly look less like treaty-bound arrangements and more like relationships subject to political improvisation. The result is not just geopolitical anxiety abroad. It is a subtle repricing of US reliability.

Alex Kazan framed it this way:

“The administration views access to the US market as its primary point of leverage. And so, negotiations on any set of issues, even if they aren’t purely economic issues, that is a point of leverage. So, the active use of trade policy, of investment policy, of tax policy in order to further other policy gains. That’s been, I would argue, the defining feature of the Trump administration from a global perspective.”

One of Trump’s gifts as a politician is his flexibility. Because he’s untethered to any real ideology, he’s often able to pursue highly unconventional policies. But on tariffs, he’s had a strong view for years. Libby Cantrill said this

“If you just sort of look at President Trump, where did he spend his time as a public figure, as a private citizen? In the 1980s he was really focused on trade deficits. At that point it was mostly with Japan. But he was very consistent in terms of his view that trade deficits are bad, that they’re effectively a scorecard between the US and the rest of the world, that tariffs are good not only as a means to an end in terms of leverage over negotiating partners, but also ends in themselves. He really believes that tariffs work in terms of making manufacturing and US industry more broadly more competitive. He was against NAFTA in the 1990s. He was against China’s accession to the WTO in the early aughts.”

On Tariffs and now war, Trump’s playbook is becoming better understood. Here’s how Alex Kazan described the strategy on international trade:

“You escalate to de-escalate. You start by throwing out a bunch of obstacles...And it’s really to build leverage to gain what you want in more of a steady state going forward. The problem is you risk not ever being in a steady state after...

And this is certainly true. We saw the giant climb-down on April 9^th of 2025. After driving the VIX to the mid 50’s, generally an unwelcome development, and swap spreads to substantial inversions, also unwelcome, Trump responded to Bessent’s claims for no mas. A big fat never-mind over a mid-afternoon tweet lifted the QQQ by 12% on the day, the 3^rd largest one-day move since 2000.

But Trump, strangely does have a strong view that tariffs create wealth for your country. Libby Cantrill said this:

“We think the President believes that tariffs work. He believes that trade deficits are bad. And as a result, I think we should expect trade policy to be volatile, to be a source of volatility over the next three years and the tariffs remain high.”

Of course, for now, given the focus on Iran and the court’s judgement that tariffs in their current form were not legal, trade negotiations are off the front page of the Wall Street Journal. In the movie starring Bud Foxx and Gordon Gekko, it was called the Wall Street Chronicle, by the way.

But let’s put tariffs – and the Iran war – as examples of the United States acting in increasingly unilateral fashion. In 2003, the Bush administration devoted enormous diplomatic capital — roughly 18 months — to building international legitimacy before the invasion of Iraq. The framework was explicitly multilateral: Colin Powell’s February 2003 UN Security Council presentation was designed to persuade skeptical allies with intelligence evidence (however flawed it later proved). The U.S. sought to assemble not just military partners but political cover — the “Coalition of the Willing” ultimately included 49 nations.

The contrast today is stark on almost every dimension. Military action came first; coalition-building was not a precondition. Only Israel is fully on board with the U.S.-Israeli strikes on Iran that began in June 2025.

The European response has been fragmented and reluctant rather than enthusiastic. France’s Macron warned that military action outside international law risks undermining global stability and called for emergency UN discussions, while the UK under Keir Starmer initially restricted U.S. use of the Diego Garcia base.

When Trump did seek allied help — specifically around securing the Strait of Hormuz — the string of refusals indicated his stock of European goodwill was low, having put allies through the wringer over tariffs, Greenland, and other issues. None of this is to suggest that a confrontation with Iran was not building and necessary. It is to highlight the “go it alone” instinct of Trump.

I recently watched The Apprentice. No, not the show that made “you’re fired” famous two decades ago. The movie about the Donald under the tutelage of Roy Cohn that was released in 2024. It’s worth a watch and Jeremy Strong is exceptional as always. We learn a lot about how Trump was taught to think in the movie the Apprentice. Roy Cohn’s 3 rules:

“Rule one: Attack, attack, attack.

“Rule two: Admit nothing. Deny everything.

“Rule three: This is the most important rule of all. No matter what happens, no matter what they say about you, no matter how beaten you are, you claim victory and never admit defeat. Never admit defeat.

So, with Tariffs as with war, Trump follows a similar playbook. Agress substantially, see what happens and then react to what happens. “We’re gonna hit them as hard as ever” quickly becomes “talks are going well.” A day later, and re-escalation has occurred. Hopefully Susie Weiles isn’t speculating on polymarket.

It should be clear; this is not the ideal setup for prudently allocating capital.

I’d like to finish this less than optimistic discussion on two topics. The 2026 midterm elections and US fiscal dynamics. Back to my four risks: economic, monetary, financial and geopolitical. Here, a weakening of our capacity for effective governance threatens our financial condition, possibly leading to a self-imposed risk premium.

Again, what we are doing is simply noticing things and asking whether what we see is sufficiently priced.

Now is a good time to repeat one of my sayings on vol and risk: “Politics, like asset returns, are not normal”. We know that indices like the SPX are famously leptokurtotic, or fat tailed. Any conversation that includes leptokurtosis is a good one, by the way. For the SPX, there’s no model using the normal distribution and a reasonable volatility assumption that allows for a 20% one day plunge as we saw on October 19^th, 1987. Stock returns are not normal. And, neither are politics, especially US politics, especially today’s version of them.

This brings us to the election cycle and the 2026 midterms. Midterms are often treated as a referendum on the incumbent administration, but in the current environment they may be something more consequential. They may become another stress test of the country’s election infrastructure, legal norms, and administrative legitimacy. We are in an era where every close contest has the potential to become a procedural contest. Vote-counting rules, certification disputes, court challenges, district maps, ballot access, and federal versus state power are no longer arcane matters for election lawyers. They are becoming market variables.

And tied to that is the redistricting fight. Redistricting used to be something most investors ignored completely. Now it sits inside a broader struggle over the rules of representation and control. The issue is not simply who gains a few seats in the House. It is that repeated rule fights reinforce the perception that politics is no longer a contest within stable guardrails, but an argument over the guardrails themselves. Once investors begin to sense that the legitimacy of the system is regularly up for debate, they should at least ask whether US assets deserve to trade with the same institutional discount rate they once did.

Our politics are a civil war in which the objective is to win at any conceivable cost. Right now, the Trump presidency is on the wrong side of polls and thus the midterms.

The SAVE Act — formally the Safeguard American Voter Eligibility Act, now reintroduced as the SAVE America Act — is ostensibly about preventing noncitizen voting. Democrats will say that the evidence available shows that this problem barely exists. Reasonable people, myself included, and a giant share of voters favor voter ID. Pew Research found that 83% of U.S. adults favor requiring government-issued photo ID to vote — including 95% of Republicans and 71% of Democrats.

The legislation has become, in Trump’s own words, his “No. 1 priority” one he has declared so urgent that he vowed not to sign any other bills until it passes. The bill passed the House in February 2026 by a vote of 218 to 213, with only one Democrat in support, and now sits in the Senate, where it faces a 60-vote filibuster threshold that Republicans — holding just 53 seats — cannot clear.

Democrats warn that Trump appears to be constructing a pretext: if the bill fails and Republicans lose seats in November, he will have already laid the groundwork to claim the elections were rigged. The cynical view is that the bill may have been introduced to make the point that elections aren’t secure, so that a loss can be contested before a single vote is cast. Trump himself told Republican lawmakers that passing the SAVE Act “will guarantee the midterms,” adding “if you don’t get it, big trouble.” For anyone watching the arc from 2020 forward, that framing should sound familiar.

Kalshi has a healthy dollop of political bets waiting for you to entertain. The Blue Tsunami is the parlay where the Dems take both the House and Senate. It’s the one line going up these days. It’s now nearly a coin flip at 47%, having started the year as a 1 in 4 chance. Trump, in case you haven’t noticed, does not like to lose.

Disentangling the components of the risk premia embedded in a security is always difficult. 10y yields are currently up substantially since the start of the US / Iran engagement, mostly on the back of higher inflation expectations. Is this contested mid-term election scenario priced? I can’t say for sure, but I don’t think so.

It’s not just Trump that calls foul on election integrity. The data on election confidence is striking not just for how low it has fallen, but for the way it has become a mirror image of itself, flipping entirely based on who wins. Heading into 2024, Gallup recorded a 56-point partisan gap in confidence that votes would be accurately cast and counted — 84% of Democrats expressing faith in the process versus just 28% of Republicans, the latter having fallen 16 points from even their 2020 level and down from a majority of 55% as recently as 2016.

An AP-NORC poll from the same period found only 22% of Republicans held high confidence that votes would be counted accurately, compared to 71% of Democrats — a near-perfect inversion of where each party stood in 2018. Then Trump won, and the numbers flipped: post-election, PRRI found that 66% of Republican voters expressed confidence in the fairness of the 2024 results, while Democratic confidence fell to just 44% — and 63% of Republicans simultaneously maintained the 2020 election had been stolen.

What this tells us is that election confidence in America has become almost entirely outcome-dependent — less a measure of institutional trust than a running score of how your team did. If the losing side in any future election begins from a baseline of deep skepticism the question isn’t whether there will be controversy — it’s how severe.

I think the odds are non-trivial that this conflict spills out into the open, consuming our news cycle and possibly impacting market prices. Everything is an action and then a reaction. In this context, we need to watch the ratings agencies. Two recent downgrades of the US Sovereign, one by Fitch and one by Moody’s have cited not just the unsustainable debt trajectory – more on that in a second – but also the erosion of governance, the main topic of this podcast. Here’s what Fitch said in the press release accompanying its Aug 2023 downgrade:

“In Fitch’s view, there has been a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters, notwithstanding the June bipartisan agreement to suspend the debt limit until January 2025.”

The press release goes on to say:

“The rating downgrade of the United States reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to ‘AA’ and ‘AAA’ rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions.”

If I am correct, and there’s escalation of the US political war around the 2026 midterms, we should expect the ratings agencies to weigh in.

Mark Rosenberg did not mince words:

“I’m trying to choose my words carefully because I still am an employee of Fitch, but from my perspective and from the perspective of the Geoquant data, the US should be downgraded again based on its level of governance and political risk and institutional risk, just given where it sits relative to other developed markets.”

Now layer onto all of this the fiscal backdrop, because this is where political risk and market risk truly converge.

The United States is running deficits at a scale that would historically have been associated with recession, war, or national emergency, yet it is doing so in a period of low unemployment and reasonably good nominal growth. That tells you something important: the fiscal imbalance is no longer cyclical. It is structural.

The wedge between what the government spends and what it takes in has become embedded in the system, and neither party has shown much political capacity to close it. The agency costs are immense and if anything, polarization makes it harder. One side resists tax increase, the other resists entitlement reform, and both have incentives to promise more than they are willing to finance.

That matters because debt dynamics are not just an accounting issue. They are a confidence issue. As debt rises and deficits persist, Treasury issuance must be absorbed by an investor base that may become more price-sensitive over time. At the same time, interest expense rises, which worsens the deficit, which requires more issuance, which can lift term premium further. It becomes a reflexive loop.

For years, the US benefited from deep foreign demand, reserve-manager sponsorship, and the belief that Treasuries occupied a category of their own. But if foreign official demand becomes less dependable at the margin, or if geopolitical realignment weakens the appetite of traditional buyers, then the Treasury market becomes more exposed to ordinary market discipline.

And then we arrive at the place where political risk and market risk truly meet: the fiscal position.

Here the numbers are stark. CBO’s February 2026 outlook projects a $1.9 trillion federal deficit in fiscal 2026. Debt held by the public is projected at 101% of GDP in 2026, rising to 120% of GDP by 2036 — above the previous record set just after World War II. CBO also projects net interest outlays rising to $2.1 trillion in 2036, or 4.6% of GDP. Meanwhile, CBO said the actual 2025 federal deficit was 5.9% of GDP, in an economy that was not in recession.

That last point is crucial. These are not classic cyclical deficits associated with recession or emergency. This is a structurally large gap between what the government spends and what it takes in during a period of ongoing expansion. In other words, the fiscal deterioration is not an accident of the cycle. It is becoming a feature of the system.

And politics makes it harder to fix. One party has little appetite for higher taxes. The other has little appetite for entitlement reform. Both parties remain comfortable making promises that expand the fiscal burden. Polarization doesn’t just make politics louder; it lowers the probability of credible fiscal consolidation.

That matters because debt dynamics eventually stop being a bookkeeping story and start becoming a confidence story. The Treasury market has long benefited from a kind of exceptionalism: deep liquidity, reserve-currency status, foreign official sponsorship, and the belief that US paper occupies a class of its own.

For years, the Fed accumulated bonds, even during periods where there was no emergency. Bernanke and Yellen’s bid was completely price insensitive. From 2011 until the end of 2016, 10-year real interest rates averaged 19bps. The current level is 2.1%.

A market financed more by price-sensitive private buyers and less by the country’s central bank and official reserve managers is a market that may require a higher term premium. And when the borrower is the United States, even a modest change in required compensation becomes a global event.

And that is really the point. Political risk in the United States does not need to culminate in some dramatic constitutional rupture to matter for markets. It only needs to alter the probability distribution. It only needs to make investors ask for a little more yield, a little more optionality, a little more compensation for uncertainty around policy, fiscal direction, and international credibility. A modest repricing in the issuer of the world’s benchmark collateral is not a modest event. It is a global event.

Here’s what Mark Rosenberg shared:

“It’s now we’re in a space where the US sovereign could be the source of that crisis. And that is a fundamental change in the way that I think investors should think about global financial markets. That doesn’t mean that the S&P 500 is going to crash. That doesn’t mean that the dollar is no longer the reserve currency or that treasury yields aren’t still the cleanest, dirtiest shirt in the global economy. But what it means is that the expectation that the US sovereign will act and has the tools to act to allay or seriously mitigate the next financial crisis is seriously in question.”

The question is whether political dysfunction is becoming durable enough to impact market clearing prices by weakening the dollar and increasing the cost of credit. Ultimately, this is a market risk premium that is a proxy for a weakening view of the credibility of American institutions.

And that may be the biggest change of all. For decades, the United States exported stability and imported capital. Today, it risks exporting uncertainty while asking the world to keep financing it at privileged prices. That is not an equilibrium that should be taken for granted.

The challenges to righting the ship are certainly about our fractured politics. But they are also about math. Here’s what Libby Cantrill had to say:

“There’s this joke that the government is basically an insurance company with an army attached to it. That’s what the budget looks like. 60% entitlements, 13% defense, and then the balance is what’s called non-defense discretionary spending and then interest expense. So especially if you’re not getting into the real source of the expense, you’re not going to actually change the trajectory.”

Alex Kazan had a more sanguine take.

“I don’t want to overstate it where we’re talking about the US as having a crisis of governance that will undermine faith in the robustness of our financial system. I think we’re incredibly far from that. I don’t think the dollar-based financial system is going away anytime soon because all of this is a relative game. And for all of the challenges that the US is going through, much of the western world, many developed economies are going through similar challenges.”

He’s of course very likely correct. This is certainly a low probability event. Playing for a “US government debt event” might be like waiting for Godot. But, while unlikely, it sure would be high of high impact. I’m only here to make the point that while the probability remains low, there’s good reason to believe that it is under appreciated by way of market prices.

So, we should be contemplating the implications for additional risk premium in the US government bond market and what that means for the sister asset classes. It strikes me that corporate credit protection could be cheap in such a scenario. Interest rate vol, the shape of the yield curve, the pricing of FX vol…these are all really interesting prices to do some thought exercises on should unhappy scenarios actually unfold.

Well, that’s it for me for now. Remember, “risk management suffers from a failure of imagination”. We’ve got to keep thinking through this stuff. As we do, let’s hope that Kalshi and Poly don’t have bets on there around the timing of a US default. That wouldn’t be a great sign.

I wish you an excellent week. I’ll catch you next time.

On the markets front, we are, as widely expected, ending the year on a quiet note. I asked ChatGPT to calculate the % moves of the SPX over the last seven trading days of the year. I did have to tell it not to write Python code, but it got the job done anyway. We all recall the down 2.7% Christmas eve, up 5% day after Xmas caper in 2018. But almost always there is nothing going on. Since 2010 the average of the absolute value of the daily moves is just 56bps. Eliminate 2018 and you are at just 47bps. That is skinny. Zoom out and it’s not just a holiday inspired decline in vol. One month realized on the SPX is 8.8. Even 3 months, which captures the 3 week, 5% SPX drawdown that began as October ended, is only 12.4.

And it’s not only equity vol that suffers from George Constanza like shrinkage. The “risk free” asset class, the US government bond market is actually living up to its name. The daily moves have narrowed dramatically in the TLT where 1 and 2m realized are 6.7 and 7.8%, respectively.

What I hope to present to you over the next thirty-five odd minutes is some version of “closing thoughts.” As I do so, I want to look back on 2025 with an eye towards pointing out its unique characteristics from a market risk perspective. I probably say this too frequently, but these are fascinating times with a lot at stake.

Embracing the notion that absolutely anything can happen in markets is a good starting point for risk management. But for right now, the aforementioned absence of meaningful daily moves on the important macro assets is imposing downward pressure on option prices. The SPX and TLT are, recently at least, accident free and that’s all the market cares about in pricing options. Count me as pretty excited that we will start 2026 with market insurance that feels reasonably priced. It’s a nice offset to the car, health and homeowners insurance affordability mess most folks are experiencing.

Let’s start this exercise in closing thoughts by highlighting what I consider to be 2026’s three most interesting days from a vol and risk perspective. And that must begin with the chaos that ensued post April 2^nd liberation day. Previously, there were only two other instances when the VIX surpassed 50, the GFC and the Covid Crash (we exclude 1987). The Tariff Tantrum is the third. On April 7^th, the Monday after the SPX experienced a 2-day 10.5% melt, we were all forced to ride the VIX roller coaster, hands free, I might add.

April 7th was truly wild as the market was caught in the cross-hairs of unreliable information that hit the tape on the severity of tariffs. Around 9:45am, we saw the VIX fall from 54 to 38 in just 30 minutes and then rise back to 53 over the following 14 minutes only to fall to 44 over the next 30 minutes. There’s only one word that comes to mind: Absurd.

Markets simply cannot absorb that level of risk for too long. Things break. And it became clear to me that the “VIXgilantes” would require a full blown “never mind” from Trump on April 9th to restore order. He obeyed orders from the market. This was a good lesson in thinking about trading the policy response. That is, anticipating how market prices would force the Administration’s hand and how those prices would react once the retreat occurred. I wrote a fair amount about this, using the Bill Gross GFC strategy to “shake hands with the government and buy what they’re buying” only this was to sell what they’re selling, in this case the VIX. You knew the VIX could not be allowed to remain in the 50’s because the GFC and Covid precedents told us that it would be 50 on the way to 80. Hopefully, Don Jr. got his VXX short off at the April 8^th peak. Just kidding. Maybe.

The next most interesting day, for me at least, was the September 10th surge in the share price of ORCL. Recall, this was earnings date for the company and it came with a forecast of a tremendous revenue increase along with a tie-up with OpenAI. The stock price jacked higher by 36%. Larry Ellison briefly overtook Elon Musk as the world’s richest man. But the stock is down 40% since. And most interestingly, the 5Y CDS spread has risen 100bps from 45 to 145 since 9/10. Does the market’s judgement of ORCL’s credit have information content and is it some shorthand for whether AI financing aspirations are too ambitious? Zooming out, ORCL is up 19% on the year and its CDS is more than 100bps wider. Its 2m implied vol has nearly doubled from 25 to 45. The equity is being treated more like an option than a stock. ORCL may be unique in just how aggressive its borrowing and capex plans are relative to its market cap. But, if we look at 5y CDS for a basket of GOOG, AMZN, AAPL, MSFT and AVGO, that’s up from 24 to 36bps this year. The 5y IG, by contrast is flat on the year at 50bps. Too early to derive any strong conclusions, but put this on your dashboard of metrics to watch for market warning signs.

The last most interesting day is the October 21st Gold Meltdown. As its cousin silver delivers epic vol on moves both higher and lower, let’s recall the dramatic spiral up and one day unwind that the GLD experienced in late Oct. One of my little sayings is that “risk on and risk off are curious cousins” It’s a nod to the way in which profits from a trade invariably draw attention and lure in fresh capital, eroding the margin of safety in the process. When the success of a risk-on episode is significant enough, it paves the way for a sharp unwind. In the limit, like a GME, it’s a certainty that it will occur.

While timing is never easy, It wasn’t difficult to see the giant one day unwind of very extended positioning in the GLD coming. The GLD had rallied 10.3% over just seven trading days (10/9-10/20). That’s just way too much for a 15 vol asset and the FOMO nature of gold led to a chase.

All of the classic signs were there – a spike in implied vol (the GVZ reached 32.8), an inverted vol termstructure, an inverted call skew and massive call volume.

I shared the following on Twitter on October 8^th,

“The strength of the recent gains in Gold, paradoxically does two things at once: first, the rising price is the advertisement compelling folks to buy. There’s no Graham and Dodd valuation work to do. As Soros said, “when I see a bubble forming, I rush in to buy, further adding fuel to the fire.” The rising price is a source of new demand. The rate of change of upside moves is accelerating. Since 2023, there are 14 days when the GLD has move up 2% or more. Eight of them have occurred since April.

Second, as the “sky is the limit” narrative builds, implied volatility rises reflecting the market’s understanding that the risks are becoming more two-way. That is, for folks wanting to play the upside, using call options may be preferable as the recent strong gains could quickly reverse. The call option permits you the right to walk away if wrong. 2m implied vol on the $GLD has gone from 15 to 18 over the last 2 months even as realized vol has fallen from 15 to 13. This is not about how the option is carrying (i.e., implied vs realized). It is simply about one-way demand for options.

You wind up in a situation where the strength of the risk-on creates the vulnerability for the risk-off as those investors in early take profits and those in late try to limit losses. It’s a sharp unwind that clears out positioning. It may be good for 3-5% decline over a few days. The option dynamics may accelerate it. If the buyers of all the calls that have traded in GLD are outright and the sellers are hedging, you might get some feedback as these hedgers need to rebalance their deltas by selling into a falling market.

When an asset experiences a “stock up, vol up” event that is substantial enough, there’s really no way for it to unwind expect a “stock down, vol down” reversal. GME in 2021, MSTR in 2024-2025 are examples. This also occurred in silver in 2021 as it is now.

And that naturally leads to the next part of this review which is to highlight two main themes in risk, the first of which is that stocks are behaving like options. As the prices of many companies rise, the market assigns their option a higher implied volatility. This is completely antithetical to the relationship between the SPX and VIX, which have a consistent correlation of around -80%. Take GOOG for example, up an astounding 65% this year. At one point in late November, two-year 20% out of the money call implied vol reached 39, up 12 on the year. This is a MASSIVE increase. To give you a sense, a 2y 120% call at 39 vol costs 64% more than it does at 27 vol (the level we saw at the start of this year).

This is the market’s way of assigning a considerably wider degree of potential outcomes to the stock. The relationship between GOOG vol and spot isn’t atypical, it’s just a good example of the vol characteristics common to today’s highfliers. Stock returns and implied vol are very often positively correlated these days. It’s a reflection of a winner take all market in which speculation and taking convex upside bets has been rewarded.

The other side of this stock up, vol up dynamic is the seller of vol. Hedging upside calls used to be easier. The stock would rise, typically gently, and implied vol would fall in the process. Now, upside price shocks underpin volatility by a far greater degree than in the past. Over the second half of 2025, GOOG is realizing 32.6 vol on up days and just 20.7 on down days. The seller of upside calls is having to contend with this new kind of return distribution and account for it in his or her hedging protocol.

Consider 2 year implied volatility on both GOOG and NVDA at 36 and 46, respectively …8.3T of combined market cap and both have Aa2 ratings from Moody’s with tons of cash and FCF. Credit risk, often a driver of volatility in an equity, is not a thing that comes to mind for these money printing enterprises.

NVDA’s market cap is 40x that of GM and F. yet Their 2 year implied vols are around 32. The carmakers are rated BBB, the bottom rung of IG. For these companies, unlike the tech mega caps, debt can be an issue.

Why the lofty long dated option prices on GOOG and NVDA, even as their stock prices are doing so well and their credit ratings gold plated? My take is that the market cap of the tech behemoths is so large and has increased so quickly that the options market is struggling to provide insurance against loss on them. The option price may clear at a high level because there’s not enough natural capital ready to bear risk of loss. All else equal, a higher premium is needed to bring sellers to the table.

There’s almost an options market equivalent of what’s happening in the broader insurance industry ... Premiums are simply higher and it’s not necessarily only a result of risks that are materializing today. It’s more about compensation for future uncertainties and, related, a shortage of capital.

But tech stocks aside, if there were an annual “Stock Up Vol Up Award” (perhaps there ought to be, btw), it must go to silver in 2026. Let’s take a look-->

1. the SLV is up 150% on the year

2. 2m implied vol started the year at 25. It is ending it in the 60’s.

3. The Correlation between price and 2m implied vol is running consistently >90%

4. Realized vol on up days 32.4 versus down days of 29.4

5. Since November, up day vol 53.6 vs. 26.9 on down days

6. 8 moves of >4% up versus just 2 of 4% down

7. massive call volume, far outstripping put volume

8. a highly inverted vol termstructure …the market prices short dated vol higher than further out vol

9. a highly inverted call skew …the market is paying a 17 vol premium for a 1m 10d call versus a 1m 10 put.

As silver spiked, there are lots of takes on whether to be in the mean reversion or momentum camp positioning long or short. With respect to the latter, I often quote Soros who said, “when I see a bubble forming I rush in to buy, further adding fuel to the fire.”

My framework suggests that when a stock up vol up event is this protracted, it’s more likely than not that lower prices and lower vol are coming. But here’s the thing about a market dislocation…as you think about capitalizing on it, you’ve gotta respect the forces that created it in the first place.

Market prices don’t stray far from fundamental value without very good reason. And those same forces could very likely push it even further away. Think the 29.5 vs 30 year UST basis in 1998 due LTCM’s leveraged position gone wrong. Think the 2008 Volkswagen squeeze. The 2009 implosion of the div swap market. The 2010 blow-up in long-dated SPX variance. The 2020 crude melt-down. The previously mentioned 2021 spiral in GME. The 2022 short squeeze in Nickel. The UK Gilt crisis in 2022.

In each of these, the vol and correlation assumptions that investors, credit risk officers, and exchanges had assumed proved remarkably wrong. Suddenly, the existing trades, underwritten at much lower vols and correlations, became much larger in terms of value at risk. The process of finding the right sizing can amplify an already unstable situation.

All of this is to say, be careful. If you see a trade that looks compelling and is a result of a large dislocation, commit only a small amount of capital to it. Whatever your bias, the massively expanded vol makes a given dollar at risk more uncertain. Be smaller. Or find an option structure that limits your losses in the scenario in which the trade moves against you.

And speaking of dislocations, I’m a Big fan of the “The Big Short” book and movie and I’m firmly in that camp versus “Margin Call” (which I also enjoyed). In the Big Short, Mark Baum (Steve Carell) asks the exact two-part question which gets to the heart of how to think about systemic risk: “Is there a housing bubble? And if there is, how exposed are the banks?”

You need two ingredients for a real spillover event: 1) a large mispricing and 2) leverage

When you get these in combination to a substantial degree, disaster awaits. Ultimately, the market is forced to confront the mispricing (in this case of mortgage credit risk and correlation). When that process imposes losses on mark to market sensitive investors, a reflexive risk unwind can materialize.

There are plenty of instances when a repricing does not lead to wide-scale spillover. The Internet bubble comes to mind (though 2002 was quite a credit widening event). The unwind of the Euro-Swiss peg in 2015 is another. There were some smaller hedge funds that went under but it didn’t become systemic.

What you need is a significant combo of Mark Baum’s 2-part question. A big mispricing and widescale exposure to it through leveraged entities that are mark to market sensitive. And then, to hit the home run that John Paulson did, you have to perfect the structuring and timing of a convex trade. What was so entirely unique about the pre-GFC era was that a centerpiece of the bubble inflating was massively downward pressure on risk premiums like the VIX and credit spreads. While these measures will start 2026 at pretty low levels, they ended 2006 much lower in a system in which a tidal wave of leverage was set to come undone. 2y implied vol on the SPX hit 13 back then. It’s 19 now. The straddle costs 50% more using 19 vol versus 13.

With that little detour, let’s return to our two main themes on risk. As discussed, stocks are behaving like options and the market is reacting to the consistency of “stock up, vol up.” These aren’t just Meme or Degen stocks. These are market behemoths like Google. Over time, as the tech trade has gotten larger and larger, so too has its weight in the S&P 500.

It’s no secret that the SPX is epically concentrated with high vol tech names. “this ain’t your father’s index...you’ve gotta know what you own”. Passive investing can lead to some strange outcomes... in 2000, depending on how one measures it, the P/E of the SPX reached 30-40x. Today, it’s quite elevated but not at that extreme. That peak of the tech bubble will forever be a very tough valuation comp.

What is extreme today is the concentration with very volatile stocks. “The Index” that attracts so much passive capital and is a benchmark that no one can ignore is top heavy like never before with stocks all pursuing the same AI riches. Here are some stats.

1. the top 4 stocks are 27% of the index.

2. the top 8 have combined market cap of 22.4T and are 40% of the SPX

3. these top 8 have a 2 year weighted average implied volatility of 37%

4. the next 8 have a combined market cap of 6T (10% of the SPX) and get you to half the index market cap. 16 stocks are half the SPX.

5. these next 8 have much lower vol than the first 8. the weighted 2y vol for them is just 27.

In words, we can describe the SPX as

“An index that is highly tracked, highly concentrated with highly volatile, highly valued tech stocks that have proven remarkably uncorrelated to each other.”

And that’s the second theme I want to highlight, as I have all year. The low level of correlation among stocks and the risk implications of this new phenomenon.

First, let’s establish that Markets generally price what they see and experience. A scatter plot of 30 stocks will show a very consistent cross-sectional relationship between realized and implied vol. The same goes for correlation. As 2025 ends, one-year implied correl on the SPX is basically a match for 1y realized correl. Just as the marginal price setters for vol are beholden to the feedback between RV and IV, so too is the mathy dispersion crowd reliant on how correlation carries. Low RC justifies Low IC.

But to be clear, one-year implied correl at 21% is really, really, really low. There’s no equivalent, except last month, last quarter and last year. This isn’t entirely new and that is part of what I think makes it risky. When a clearing price endures, no matter how high or low it appears to be, it makes its way into how we consume risk. Because the dispersion trade - buying single stock vol and financing most of the premium by selling index vol - is working, even at low levels of IC, more of it will be done. The profits it generates get recycled back into the same trade that spit them out in the first place.

There are a couple of things to think about here. First, consider the relationship between realized correl and realized vol for the SPX. A chart I posted on Twitter shows that for a given level of realized vol, realized corr used to be considerably higher than it is today. There are two ways to interpret this. First, single stock vol is doing more of the heavy lifting today to generate the overall index vol.

The second way to look at this is that given these very high single name vols that come from a top heavy, tech concentrated SPX, a tremendous amount of diversification is occurring to keep the index vol where it is. The incredibly low realized corr is a significant vol suppressant. Will it continue? I’m not so sure.

A second chart I posted on Twitter illustrates a similar point but does it through implied vol. I created an index of the simple avg 1y implied vol for NVDA, GOOG, MSFT, AAPL, AMZN, META, AVGO and TSLA. One of the time series shown is the ratio of that to 1y SPX implied. The second series is 1y implied correlation, inverted. Not surprisingly, these move closely in tandem.

So, the question might logically be, “is single stock vol too high or is index vol too low?”... That’s actually not the question. It doesn’t matter. It’s the relative price that matters and I strongly believe it’s too low. That is to say that single stock vol is too high relative to index vol or as I prefer to say it, index vol is too low relative to single stock vol. Framing it this way is consistent with the view that the repricing higher of implied correlation is more likely to occur in tandem with a higher overall implied vol environment. If the global economy slows for example, commitment to the Capex cycle could get tested, causing a broad and correlated retreat in share prices.

Let’s explore how the relationship between single stock and index vol reprices. First. A shorthand for implied correlation is (index vol / weighted ss vol)^2... Using 37.4 for the average of the Big 8 in the CIX I created and 17.4 for 1y SPX implied, that squared ratio is 21.5%...right where Bloomberg has 1y IC on the SPX.  Let’s flip the formula around and ask what happens to index vol as we keep SS vol the same but move IC to 35. The 13.3-point bump in correl adds 4.7 vols to SPX vol. That is a very large move in 1y implied vol. And to be clear, 35 is still very low for implied correlation historically.

There are two primary channels of repricing. First, a macro shock like the April Tariff Tantrum. As I shared in a chart on Twitter, implied correlation spiked during that episode. It was, of course, self-imposed by Trump and thus relatively easy to undo via a “just kidding” (on 4/9). But there are many channels for macro shocks - monetary policy, geopolitics, a slowing economy, a glitch in the Shadow banking system - to name a few.

The second channel is less about global macro and more about the AI ecosystem and how intertwined these companies are. They are all chasing the same riches, spending fabulous sums, making lofty assumptions, and increasingly raising lots of debt to do so. The capex spending itself is keeping this going. As long as the capex cycle is robust, the market caps are supported, which, in turn, supports the capex. It does remind me of how both the mortgage credit and LBO funding machinery kept the the leverage cycle going 20 years ago. 

And there is a more technical vantage point from which to contemplate the repricing of SS vol to index vol. This concerns the prominence of “stock up, vol up” in today’s US market, even in mega-caps. It’s the feature of this market that is most like the Internet bubble. As mentioned, GOOG is up 65% YTD and its 2y implied vol was recently up as much as 12 from the start of the year. As suggested earlier, the stocks themselves are options. As they rise, the market pays more and more for the lottery ticket.

Here’s the analogy back to the dotcom era: from the peak in March 2000 to the end of 2004, the QQQ fell by 65%. The Nasdaq VIX  fell from 50 to 19 in the process. In the current market, if the AI trade loses some of its shine, you could see the stocks driving it not just fall in price but fall in implied vol as well. What goes up, must come down kind of thing as the “optionality” of the trade falls. This process would also lead to implied correlation rising, perhaps by a fair amount.

All of this is to say that we are at the lowest level of SPX 1y implied correlation we’ve seen and there are multiple pathways to it rising from here. It’s a real vulnerability for the market as it would make the SPX considerably more volatile than it currently is. And we know that the same conditions that make stocks more volatile make them more correlated as well. It’s a double whammy.

We can look back on 2026 as a year of highs and lows. The SPX is up 17% on the year even as it experienced a 19% drawdown along the way. Don’t call it a comeback, as LL Cool J told us. 1m realized vol on the index was as high as 51 and as low as 6. For correlation, the peak was 67 and the low was, wait for it Dean Wormer… Zero.point.zero. Correlation has no grade point average. Note that we are ending the year with 1m realized correlation of 8. You can’t blame the market for pricing 1m implied correlation at 11. I argue that that number is eventually going higher because stocks are eventually going to start moving more closely together.

The market, the investing public and the economy at large are over-exposed to the AI trade. So too are the AI stocks over-exposed. I certainly can’t predict when or if something will go wrong, but these ultra low correlations are the equivalent of driving without a spare.

As I close this discussion, I want to say thank you for being a listener. I was able to host 26 podcasts this year with extremely high quality guests. These are hedge fund and asset management CIOs, fintech founders, heads of strategy efforts and leaders of independent research firms. The conversations are not about predicting the next move, but in seeking to add value to the process of portfolio construction and risk management. I’ve also, including this one, dropped 15 podcasts in which I’ve shared my own thoughts on risk. I’m looking forward to a year of expansion for the Alpha Exchange in 2026. I’ve got some creative new ideas for delivering content and look forward to bringing them your way.

Until next time, have a relaxing holiday and rest up for what promises to be a critical year in markets. Be well.

Let’s start by framing it out. Yes, the daily motion in the equity market has increased. We are almost exactly unchanged since October 9^th, the day prior to the 2.7%, China-related dump in the SPX that kind of kicked off this higher vol profile. Yet, 1 in 3 days since then sports a daily move in excess of 1% either up or down. That’s 10 days in 32 with a move that large. In the 32 days preceding October 10^th, there were exactly zero 1% moves. I’m not sure my main man Heraclitus ever risk-managed a vol book, but I am reminded of his timeless quote that there is nothing permanent except change. I’m betting he was more a premium payer than generator of carry, but we can take that up another time.

6 week realized vol on the S&P 500 was running at 6.6 and has materially increased to 15.8. That’s clearly not nothing. But still, 16 vol isn’t the stuff that dreams are made of for the long convexity crowd. In fact, post the big payoff to being long optionality on 10/10, there isn’t much to write home about. Listeners to this pod will know that I really like the CBOE gamma index. It measures the results of a trading strategy that buys and delta hedges weekly straddles on the SPX. From 10/10 till now, it’s actually down. Mind you, its recent performance looks in no way like the “falling off a cliff” losses experienced from May to Oct. But it’s not like being long vol recently in the strict sense has yielded great results.

The explanation, as with almost everything in markets, lies in the entry price. I’ve spoken a good deal about the healthy vol risk premium at the SPX level that has been persistent over the past several months. When your insurance policy is pricey, the payout to you, should you make a claim, nets out to be less. Over the last 6 months, the average of the VIX has been 6 vols and nearly 60% north of realized volatility. That’s quite a spread and competes with what we saw in 2021 when the market was still working through the equity derivative losses incurred in 2020. As I’ve said, it’s not entirely clear why the VRP has widened. And it goes against much of the common narrative that vol sellers aren’t being duly compensated for bearing risk. The miserable performance of the GAMMA index would say otherwise.

To summarize, we have the following opening observations. First, both realized and implied vol have picked up, but not to any truly notable degree. This is hardly a vol shock like April. Second, we can assert that the hefty vol risk premium has been a complicating factor in playing defense. This is to say that the market is charging you a lot to buy insurance. It’s not property insurance in Florida or California, but option-based insurance in the market is no steal.

To make this point, let me run through an exercise I’ve done before. If the VRP – that is the spread of implied to realized - is typically 3 and it’s more recently averaging closer to 6, what does that translate into hedging cost? Well, we might observe that 15 realized should produce a VIX of 18 but instead it’s 21. I’ll use a dirty approximation that the VIX is pretty close to 5% SPX 1m OTM put vol. Using 21 vol, the cost of that put is 1.5 the cost at 18 vol. If you wanted to spend 1mln of premium, you are protection 250mln at 18 vol, but only 167mln at 21 vol. These are consequential differences.

If there’s been a large spread of implied to realized, there’s been an even wider gap between narrative and realized. That is, the breathlessness of bearishness over the last few weeks has been highly out of step relative to the actual perturbations typically concomitant with such commentary. I worked hard on that sentence, btw. Perhaps the writer’s block is over. I know at least one loyal listener who may owe me dinner for using the word concomitant so well.

They say there’s always a bull market somewhere and a chart on doom commentary has surely been up and to the right. Perhaps it’s been the joint decline in the equity and crypto markets. NVDA is down 10% in November and Bitcoin is down almost twice that. Perhaps it’s been that there wasn’t a hard and fast enough of a catalyst to point to…no trade war, Powell presser, CPI surprise or earnings shortfall. These would have at least left us with plausible drivers, satisfying our need for markets to make sense.

Absent these traditional places to look, but having to stare anyway at flagging prices, we were forced to ask hard questions. “If there’s no obvious fundamental driver, is this the market’s way of telling us that things went way too far?” If we have ridden assets much, much higher based on a narrative in which price was the only fundamental, what happens when price falters? We are forced to embrace less appealing narratives that fill in the blanks that fundamentals typically occupy.

If there’s one idea that best captures my own curiosity about markets it lies in studying our presence in them. As Alec Baldwin said, “it’s complicated.” And here’s where the Soros theory of reflexivity is so relevant, especially to modern day risk-taking. By the way, I’ve always found it quite ironic that Soros - the most effective thinker on the concept of market reflexivity - has a last name that is a palindrome, backwards as it is forwards.

Reflexivity is a brilliant concept, and price is central to it. The financial news media, a publish or perish outfit, woke up every day for the last few weeks and it chose bearishness. Price forced it to do so. Price is surely an outcome that results from changes in economic data, corporate profits and adjustments in the stance of monetary policy. But that’s kind of old school stuff.

Today, price is more properly thought of as a driver of wealth, which in turn, allows it to drive investment behavior and also narratives. In the process, it can actually shape fundamentals. Price, as Soros (or maybe Mark Twain) said, is the only fundamental. Confidence has eroded in crypto only because price did as well. It’s the same with AI. We question the story because, absent anything else we can point to, price forces us to.

And there are many prices to watch that help us construct narratives. I’ve said before, we over consume prices and overindulge in trying to figure out what they mean. There are all kinds of business models built around the study of price and in crafting narratives around what they tell us. You are listening to one right now. Not every last wiggle in a market derived price is meaningful, and some prices can be outrageously difficult to read. Prices lie as John Burbank told us. He ought to have told policymakers, sipping fine champagne and staring at a VIX of 11 in 2006 at Davos, as much. They tragically saw ultra compressed risk premia levels as a sign of success, not danger.

But we should carefully watch asset prices anyway. And there are a few prices I see that I don’t really like. First, we should ask the question of whether the market is speaking through higher CDS levels on MAG7 type names. I created a custom index on the ‘ol Bloomie to track the average 5y CDS level of GOOG, AMZN, AAPL, MSFT, ORCL and AVGO. This has widened a substantial amount – and is now only a few bps tighter than the broad CDX IG. It’s not as if the economy hit a wall or these stock prices plummeted, either. It’s a repricing based on supply/demand for credit protection. Worth putting on your risk dashboard and if you request, I will happily send you the CIX over the terminal. Just ask.

A second market price I have paid attention to is the pickup in correlation across the Mag7. From June to October 9^th, the average correlation of the non NVDA Mag 6 to NVDA was just 22%. Since then, it’s 52%. That’s informative, especially as the CDS index I mention has widened from 28 to 50 over the time frame. We stare at these market implied prices and our minds entertain the factors that drive them. Realized correlations are rising AND CDS levels are as well? That makes for a pretty good story about risk. It might even be true. We are swimming, check that, drowning in prices and commentary as to why they moved.

Amidst a bearish tone in markets that has far outstripped the actual price damage, the bubble word came up over and over. The question around a market (in this case AI) bubble is important but mostly not properly framed. Ask 5 intelligent folks and you won’t even find agreement on the word’s definition. What can be agreed on, however, is that implicit in the question is the notion of vulnerability in prices. This matters because unless you are truly insensitive to mark to market risk (Bernanke, Buffet and Bessent?) drawdowns matter.

If you bought AMZN in early 2000, you experienced an 80% drawdown. It’s more than reasonable - in fact advisable - to have cut your losses along the way. It would have taken you until 2007 to break-even. The rest, as they say, is (very profitable) history. So, the bubble conversation is really more effectively framed as whether prices for AI related equities, which certainly have pulled forward quite a bit of the expected productivity and profit gains, are vulnerable to a correction that is large enough to force a risk management decision. While today’s economy bears little resemblance to that of 20 years ago, there’s too much riding on MAG7 market cap today in a way similar to the pre-GFC period when the lynchpin was rising home prices. In both cases, the economy is at the mercy of the market, rather than vice versa.

The economy-market feedback loop today is similar to that of the pre-GFC period. It’s the market that will take the economy down, not vice versa as is traditionally the case. Today’s SPX can be summarized as “highly concentrated with highly volatile, highly valued but remarkably uncorrelated tech stocks”. A good argument can be made that the market is not properly identifying the linkages, crossholdings, investments, and extent to which customer/supplier relationships underpin the correlation in outcomes for AI focused stocks.

We are still in the leveraging period and stock price changes have been vastly idiosyncratic. A similar argument could be made for home prices in pre-GFC era. Housing price appreciation was clearly driven by a common factor: the bottomless extension of mortgage credit. But that did not show up in city-to-city correlations until there was a break in the circularity. Once defaults picked up, the credit machinery failed, and the correlation of housing prices surged. In the aftermath of large drawdowns, investors consistently realize they’d underestimated the degree of “sameness” in assets. It took us until 2008 to recognize that the huge run up in housing prices was linked to a common driver: the vast supply of mortgage credit.

Today, we have to forcefully ask ourselves whether we are missing the vulnerability to a Mag7 sell-off. The negative wealth effect would be substantial. If market cap is the “currency” to fund Capex and that same Capex is driving economic growth, a sell-off in Mag7 has multiple pathways for spill-over. Starting with Gita Gopinath’s piece in the Economist in October, there have been a number of pieces that sought to model the economic impact of a protracted sell-off in the Mag7. I think there’s a lot of value in this type of thinking right now.

Next, I want to shift to bitcoin which has had a tremendous drawdown, not just in percentage terms but in dollars lost. The 33% drawdown was the 10^th larger than 25% since 2017. But the wealth hit – more than 800bln – is most substantial this time around. You know which asset had an even larger drawdown and more significant loss of market cap this year? NVDA went from 3.5 trillion in late Feb to 2.5 trillion at the post Liberation Day lows. But NVDA, while certainly rewarded with a healthy P/E and expected growth rate, reports profits, lots of them.

The speed with which the narrative recently turned on bitcoin was unsettling if not unexpected. If price is the only fundamental and price plunges, now what? I captured the violence of the drawdown in a table posted on the Tweeter showing those ten 25% DDs since 2017. This most recent one has occurred in 47 short days...it rivals those that took place in 2017, but as mentioned, the market cap was a pittance relative to what it is now.

Let’s talk about crowding. The LTCM episode feels relevant. It goes back a ways, but, as Mark Hannah said to junior broker Jordan Belfort in Wolf of Wallstreet, “stay with me”. 1998 was a great year for the Yankees, but a bad one for carry trades. Risk exposures that LTCM engorged on, like swap spread and short equity index vol became especially risky - even at prices that provided what looked like a good deal of margin of safety - because the market knew the fund was long, wrong and huge. LTCM is the poster child for the risk that having exposure that overlaps with a vulnerable, large investor can create headaches. You need to know the mark to market reaction functions of those alongside you.

Some might say that today’s John Meriwether is named Michael Saylor. Both seemed to have diamond hands. But the latter doesn’t have bilateral OTC derivatives on – or at least not that we know of. It does not appear that he has any mark to market call for variation margin heading his way as the banks famously demanded of Long Term. But Saylor’s presence in the bitcoin market probably matters, just as LTCM’s giant positions in options and swaps mattered.

These things are impossible to truly disentangle, but one could easily argue that swap spreads would have been wider and vol higher had LTCM not taken on its famous carry trades. Where would bitcoin be without Saylor’s buying is an interesting question. He’s the single best marketer of our time and his capacity to create the fear of missing out is unparalleled. With both capital and tremendous communication skills on his side, his PR campaigns have influenced price which influenced what people believe. That, in turn, has further impacted price.

But what happens when price fails to be the advertisement it once was? With bitcoin, the question may be best framed not as whether a forced seller will emerge, but how the drawdown and significant mark down in MNav impact the buying campaign – not just for MSTR but for all the digital asset treasury companies that injected copy-cat capital into the bitcoin market. This, by the way, bears similarity to the manner in which the banks covering LTCM and enamored with its success sought to replicate its favorite carry trades leading into 1998.

If price is the only fundamental and fresh capital is needed to repair it, we ought to ask where that’s going to come from. And I do have one place to look and here’s where I’d like to close. And that’s on how to think through a couple of dimensions of risk.

One shorthand I’ve developed is to categorize sources of uncertainty as monetary (Central banks), economic, meaning growth and profits, financial which captures leverage, carry and correlation, and lastly, geopolitical. We’ve seen them all...

Geopolitical is non-market, market risk. This dynamic conjures referendums like Brexit, countries like Russia, China and Iran, conflicts like trade wars and actual wars...but the war to pay attention to continues to be waged inside the US and the escalation is hard to miss... as recent podcast guest Alex Kazan (link below) said, “this is not primarily about Donald Trump, it’s structural.” For the headline of the day, see below. Left, right or center, that this can be an actual headline is not good for that “shining beacon on the hill”, USA Inc. these things are mostly unobservable in market prices and don’t matter until they do...they may never matter. A US political crisis is very low probability, but very high impact...sadly, there’s no obvious pathway to de-escalation.

And looking ahead to 2026, which sets up to be a win at any cost mid-term contest for the House and Senate, we might see some unbelievable stuff. One of my old sayings is that “US politics, like stock price returns, are not normal”. And it might be the case that you ain’t seen nothing yet. Fiscal discipline – whatever that might mean in today’s lexicon of enormous debt and deficits – is unlikely to be a thing next year if it means losing control of Congress. If there’s a chance to fatten people’s wallets – even if temporarily so – to goose the economy and increase enhance your standing with votes, it’s going to be attempted. The stakes are viewed as way too high not to. Lower rates, higher deficits and more dollars floating around the world…ultimately both gold and bitcoin are outperformance options versus the greenback. Michael Saylor may not be a disciplined buyer, but there is something to be said about assets with disciplined supply.

The US government is hardly disciplined in how it releases dollars into the world. When a slowing economy and an incredibly polarized US political climate run into a critical election year, strange things can happen. We shall see.

Well folks, I am coming up on 3000 words, two of which were perturbation and concomitant. I’d like to wish you a very happy Thanksgiving and also express my own appreciation for you all being a part of letting me do what I love – thinking about markets and risk. On Thursday, please eat and drink as much as you are able, but do take the time to reflect on the good things, especially health and family. Until next time.

With the first 25 saying completed in 2024, I recently added 5 new ones, getting us to 30. Over the next 20 minutes or so, I will share 5 more. What ties these 35 adages together is more than 3 decades of cumulative observation of both the behavior and misbehavior of markets and the humans that populate them. What do we learn from prominent risk events? From the vulnerabilities that inevitably result from our inherent biases? How do institutional considerations like benchmarking and the risk of being wrong impact how investors choose risk exposures? When and how do trading strategies morph from a good idea, to overconsumed and likely to sew the seeds of their own demise? These are all wide-open questions without truly definitive answers, but our sayings are meant to help think through these complexities.

You’ve heard me rattle on about Succession often. The writing and the acting keep drawing me back in. There’s a great scene between Logan Roy and his daughter Shioban as she seeks to get more involved in the family business. Complaining that without his backing, she will lose internal support, she says, “Dad, there’s a line”… he interrupts and says “Nothing is a line. Everything everywhere is always moving forever. Get used to it." I think that’s one way to think about markets. Clearly prices are forever moving. But markets are too, not just because prices are, but because change is constant – in regulations, in technology, in the economy, in trading strategies and so on. So, as Logan Roy suggested, let’s get used to it.

We’ve got 5 new sayings for you, starting with the statement that “risk management suffers from a failure of our imagination”. What do I mean? Well, who had the Meme stock episode of January 2021 and the way in which individual investors sought to move stock prices by trading – or in the case of diamond hands, not trading, in unison? Who had year over year CPI peaking at 9% in June 2022? After all, two-year break-even inflation was 68bps in June of 2020.

Who had the speed with which capital ran from SVB in 2023 as a possibility? The Fed certainly did not. Nor did the hedge funds that got carried out on rates falling, not rising in the aftermath of SVB’s downfall in March 2023. Let’s review this for a second because it speaks to the notion of the butterfly effect in markets. From early Feb’23 to early March, the 10 year yield rose by 70bps. The 2 year moved up by 100bps. There was significant concern around not just SVB but whether there would be a broader depositor run on the banking system. The Fed got involved, guaranteeing deposits. The market saw a big change in monetary policy coming and the two-year note yield fell by 130bps in just 2 weeks. Hedge funds, believing that “higher for longer” would prevail, had sold call options on two-year note futures. The massive rally in this security and explosion of vol that came with it, caused huge losses.

You had to have quite an imagination to piece this one together in evaluating whether being short calls on two-year note futures was going to prove especially risky. First, you had to envision that Silicon Valley bank would be exposed for its lax risk management protocols and for getting long duration at the wrong price. Next, you needed to anticipate that an electronic bank run would quickly ensue, perhaps following Peter Thiel on Twitter. Next, you saw that the Fed would be forced to act. Then you’d have to link the Fed’s playing the systemic risk card with a giant rally in the front end of the curve with the expectation of meaningful Fed policy easing. And the Twitter grifters say that investing is easy! Note, the Fed wound up not easing at all in 2023. A big fat never mind in market prices as the two-year note which got to as low as 3.7% in yield in late March 2023 was again yielding 5% by August.

Risk Management does indeed suffer from a failure of imagination. I’ve been re-rereading books on the financial crisis. I read House of Cards on Bear Stearns. Now I’m onto the Big Short, featuring folks like Michael Burry and Steve Eisman who profited handsomely betting against mortgage derivatives. Also featured in the book is LibreMax founder and CIO Greg Lippmann, then a trader at Deutsche Bank. There’s a great chapter in the book in which Lippmann pays 28bps to buy credit protection on the senior tranches from Morgan Stanley’s Howie Hubler. In coughing up the premium, the DB trader says “we both know there is no risk in these things”. Even Lippmann, on the right side of the epic unwind and with a keen understanding of just how misplaced the credit and correlation risk was, could not imagine that what he was buying was actually really worth something.

And that leads us to Saying number 32 and that is that “markets are a never say never business.” The text books teach us that markets are efficient and that price discovery takes place at every instant. Markets can accommodate what you want to do at all times and in any size you like. But what we see is that prices are simply where two counterparties happened to transact at a given time. For the most part, buyer and seller exchange money for an asset in the context of market conditions where the price is within the realm of fair value. Clearly, the two parties wouldn’t trade without a difference of opinion, but it’s generally the case that prices are linked to some economic value. There are exceptions. Many more than you’d expect.

Market prices can do really strange, almost inconceivable things. They can stray so far away from equilibrium levels. For example, crude oil in 2020. How about GameStop in 2021. How about Nickel in 2022. Three years, 3 distinct assets and each of them showcasing prices that any model of underlying price distribution would struggle to accommodate. These prices are the result of a protracted imbalance of supply and demand. There’s nothing more dangerous, because when there is no capital left to buy or sell, arriving at the clearing level will require a massive change in price.

How about two recent, related examples, the VIX and NKY in early August of 2024? The VIX closed at 23 on Friday, August 2^nd. It would reach 66 in the morning session of Monday August 5^th, as the SPX options market, the calculation engine for the VIX, lost its way, breaking down from a liquidity standpoint. How about Japan’s Nikkei 225 index? It fell by 12.4% on August 5^th and rose by 10.2% the next day. Up until these enormous swings, the Nikkei was roughly a 16 vol index, moving around 1% per day, up or down. While we know that the normal distribution fails to capture the “fat tails” of equity returns, consecutive 10 standard deviation moves? That’s serious stuff. Never say never.

Because risk management suffers from a failure of imagination and because markets are a never say never business, it turns out that markets break, on occasion. And, in the words of Mike O’Rourke from Jones Trading, “broken markets break down.” That’s our saying number 33 and I appreciate this one not just for its wonderful brevity but because it captures a vulnerability unique to asset markets. There are some exceptions, but crashes do not come out of the clear blue sky. They are an outcome of a process in which risk takers have already sustained losses, losing both wealth and confidence along the way. Think of market wealth as one’s chip stack. With a string of successes and a big stack in front of you, taking the inevitable loss on a hand won’t hurt that much. But should the stack erode over time, your effective leverage rises along the way. In markets, losses typically coincide with conditions that have become more volatile, further amplifying your effective leverage. You wind up with less chips, and being forced to play in a looser game.

Thus, while there are risk events that can materialize quite suddenly – an awful event like the 9/11 terrorist attacks or the 2020 pandemic – it’s more often the case that asset markets that have already experienced a meaningful drawdown become more vulnerable still. Losing confidence and capital, investors may be on the wrong side of trades that sought carry but are exposed to a pop in volatility. Margin calls may be made and mark to market collateral may be demanded. If liquidity and volatility are some kind of inverse cousins of each other, faltering markets can become more difficult to trade, with less visibility on whether trades can be implemented or unwound.

“Nothing bad happens above the 200 day moving average”, is a statement generally attributed to Paul Tudor Jones. My vol nerd equivalent is that “nothing bad in markets happens when realized vol is below 15”. In some ways, these are the safety zone corollaries of Mike O’Rourke’s “broken markets, break down.” All 3 reflect the idea that assets become more or less vulnerable based on their price history and the wealth created or destroyed in the process. Recently, the SPX crossed its 200 day moving average on March 6^th. Over the course of the next month, it would lose 13%. This may be a cherry-picked example, but the point is that from the Feb 19^th all-time-high in the SPX to March 6^th, the SPX was down 6.6%. From March 6^th to the April 8^th low, it would fall another 13%.

Next on our Sayings on Vol and Risk is the statement that “this is not your father’s ETF market.” No-siree-bob. There are, apparently, a lot of things that are not your father’s. This is not your father’s Oldsmobile, or root beer. There was a “not your father’s podcast”, but it’s no longer. I guess it’s no one’s now, including your father’s. Joe Biden – remember him – told us in 2022 that this is not your father’s Republican party. I guess I see his point, though I’m not sure he could make it today.

This is not your father’s ETF market is a nod to all the new flavors of exchange traded vehicles that continue to be created. Today’s ETF world increasingly consists, as Alpha Exchange guest Eric Balchunas calls these products, “hot sauce”. First there was SPY. TLT and GLD came along. VIX products – both long and short – were launched and then imploded. Today’s world of ETFs are on discretionary baskets with various new themes like AI, water, genomics and cyber security. They sit atop totally new assets like bitcoin, Ethereum and Ripple. They provide access to private credit.

They embed optionality, both vanilla and complex forms. They have daily resetting leverage features, both on the long and short side. I’ve done a series of podcasts on the leveraged ETF universe that I’ll point you to. Check out episodes with Rocky Fishman of Asym 500, Mike Green of Simplify and Victor Haghani of Elm Wealth. Each does a fine job discussing the mechanics of these products, with specific attention to those with MSTR as the underlying.

Big picture, and back to Logan Roy, “everything is moving, always.” These new products introduce new dynamics into the market. There’s no one at the helm of MSTU, the 2x levered long ETF on MSTR, that has much to say about Michael Saylor. The Portfolio Manager of MSTU is there to deliver twice the daily return of MSTR, for better or worse, each day. That’s it. But, as we’ve covered extensively on the Alpha Exchange, the hedge for this product requires said PM to buy on days when MSTR has risen and sell when it’s fallen. And, while it’s counterintuitive, the leveraged short ETF does the same thing, also reinforcing a price that is rising or falling. Taken together, the leveraged long and short daily reset products act like the delta hedging of a short straddle.

Mechanical trading strategies that require a rebalance each day that go the same way as the underlying asset are worth paying attention to. There are instances when the leveraged ETFs are large enough relative to the liquidity profile of the underlying asset that they exacerbate the volatility.

Some of these new ETFs also come with embedded optionality. There are risk managed products that utilize collars, seeking to create a “defined outcome”. There are overwriting strategies that generate some option premium by sacrificing upside in both indices and single stocks. NVDL, for example, sells calls against NVDA. It’s got nearly $1.6 bln in assets. We are seeing ETFs with OTC swaption and barrier options tucked inside them as well. For potential users of these products, it’s really important you understand what you are getting. I’ve seen one product nominally called an inflation hedge that did poorly in the post pandemic inflation surge.

If you have a Bloomberg terminal, hit up the ETF and run the MHD command to see what the portfolio is composed of. You can often see real specificity, even on complex OTC options. You want to be convinced that this additional kind of exposure is serving the right objective and at the right price. Please, please please, don’t be like Congress passing a 1,000 page piece of legislation without reading a single line of it. On the investment side, do have a look at the prospectus. On the leveraged ETF front, it’s remarkable how clear the prospectus makes it that holding these resetting products over time is not wise and yet, many do anyway.

Alright, we are set to close out these new addition to our sayings on vol and risk. We started with “risk management suffers from a failure of imagination.” We added “markets are a never say never business” and then added “broken markets break down.” Now that we know that this is “not your father’s ETF market”, we conclude with an old standby from Voltaire himself. “Doubt is not a pleasant condition, but certainty is an absurd one.”

Lots of wisdom here as applied to markets. First and foremost, investing fits in the category of various disciplines that requires decision-making under uncertainty. Try as we might, there will always be more that we don’t know than we do. The work is about reducing that ratio, but always respecting there’s only so far it can be reduced. The list of unknowns in markets - emanating from all corners of the world, from geopolitical risk, monetary policy, technological innovation and so on – is a long and formidable list. Doubt is unpleasant. In markets, we might call it humility and it’s an essential part of the first rule of risk management: don’t die.

And while we haven’t met, I gotta concur with Voltaire on the second part of his statement as well: “certainty is an absurd condition.” Taken literally, Buy 0 and Sell 100% odds all day long in whatever size you can. Certainty in markets can be a bad thing. Joe Cassano of AIG Financial Products was clearly certain. In August of 2007, about his desk’s enormous exposure to sub-prime, he said, “It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of those transactions.”

Michael Saylor is today’s version of certain. There are few better salespeople, probably because he is so entirely convicted. He once said, “only buy bitcoin with money you can’t afford to lose”. What a fabulous turn of phrase. There appears no price at which he would decide to take profits or cease his buying campaign. Like Joe Cassano in the 2005 and 2006 era, Saylor has been dead right so far. And, that becomes the problem. The “up and to the right” path of bitcoin’s price, is an intoxicating “I told you so.” It clearly reinforces his own thinking and enables him to rev up his sound machine, seeking to bring in fresh buyers.

It’s working remarkably well. He just has no business being so certain it will continue to. There’s nothing about bitcoin that should leave Saylor so entirely convinced it’s going so much higher. Recently, he suggested it would hit 13mln by 2045.

To be clear, I’ve advocated pretty strongly for exposure to bitcoin as some part of the portfolio. It’s got a very unique distribution of returns and, given the total budgetary irresponsibility of our elected officials, both gold and bitcoin serve a purpose. At the same time, we should take note of those peddling the “sure thing.” Remember when Bud Fox said to his boss Lou Manheim in Wall Street, “I’ve got a sure thing” to which his boss responds “no such thing only death and taxes”. I might add never ending and large auctions of US Treasury securities to that list. But that’s about it.

We’ve now completed 35 sayings on vol and risk. To be sure, there are plenty of overlapping elements among them, but I am hopeful they provide you with some insight in thinking through this high-contact sport called financial markets. Until next time, have a wonderful week. Be well.

Our relationship with prices is a complicated one, to be sure. They make us wealthier, or less so. They motivate us to move and always force us to think. Above all, markets provide us with feedback. And feedback, according to Ken Blanchard, is the breakfast of champions. I’m just finishing reading “The Fund”, the book from 2023 on Bridgewater. And with this in mind, I can state unequivocally that Ray Dalio consumed his share of Wheaties. A unique culture they’ve got at The Fund, to put it mildly.

What follows are 5 new sayings on vol and risk. And I will follow up with 5 after that, getting us to 35 in total. I speak my own book, of course, but there’s a lot of risk philosophy shared here. What ties everything together is an appreciation for the reflexive nature of markets, where feedback matters. And, so, too, do the undeniable biases that we humans experience. We put too much emphasis on events of the recent past, extrapolating a future that will look much the same. Conversely, we forget that which happened longer ago. Time passes and our appreciation for history is dulled.

Ray Dalio may have the Principles, but we’ve got 25 (and counting) sayings on vol and risk. So, let’s explore the newest 5, shall we?

Let’s start by riffing on none other than Sir Isaac Newton himself and his second law of gravity. When applied to markets, it reads “financial objects at rest tend to stay at rest”. Perhaps this is Dean CurNEWtons law. Where am I going here?

When markets become especially stable and volatility especially low, the set of factors that played a role ought to be respected. Many, me included, have illustrated the correlation between low market and low economic volatility. Take the “2-2-2” economy that often was used to characterize the post GFC, pre-Covid era. Inflation, the 10 year and GDP all were consistently in the neighborhood of 2%. There were, of course, periodic risk-offs like the China FX repricing in Aug 2015 or the VIX event of Feb 2018 but in general, very low realized vol of these macro variables coincided with a sanguine backdrop for market risk. When the economy is stable, so are corporate profits. Again, we can easily illustrate that when earnings for the S&P 500 experience smaller fluctuations, the volatility of the index is low.

And this is where the feedback from markets comes in. We all read the same TOP page on Bloomberg or the Investing Section of the Wall Street Journal. The same talking heads pontificate regularly on CNBC. I may be one of them. Just curious, Does Wall Street Bets have a macro sleeve? Anyway…

We consume an impressive amount of content, most of which leans into a “consensus” view. A consensus view becomes one because the data – both economic and market – forces it upon us. It’s difficult to bet against something that has been happening with such consistency. The trend is your friend, they say. We become convinced that the consensus state of the world and of market prices will hold. And here’s the feedback loop part: we build trades around this idea. We short vol. “Sell the straddle and go to lunch”, as the saying goes, is a nod to getting fat and happy by betting on stability.

What matters, in this process, is that as vol is sold, it can reinforce the stability already in place. I’ve covered this quite a bit, but in simple terms, a short straddle on the SPX, purchased by a Goldman or Morgan type who hedges, will create index delta supply as the market rises and index delta demand as it falls. Voila. A “gamma well”, as it is sometimes called, in which the index just gets stuck in a narrow range due the just described manner in which the hedger buys and sells to rebalance.

It's always difficult to disentangle the why of market moves – or in the gamma well case – lack of them. I can say that around August of 2017, with the 30-year anniversary of the 1987 stock market crash soon approaching and with the SPX realizing 5 or so vol, I asked 25 clients what their forecast was of realized volatility over the next 1 and 3 months. Suffice it to say, these were very low expectations. But most telling was the expectation of SPX realized vol over the next week. The average response was 5.8%. And guess what, the realized vol over those ensuing 5 trading days wasn’t much different from that. Financial markets at rest did indeed stay at rest.

Ok, let’s keep this list moving. Related to this observation is saying number 27, which is that “realized vol rules the world”. Everything in markets - and many things in life - are a response to realized vol. Our thinking, our behavior, and the choices we make are always informed by the actual or perceived uncertainty of outcome. And past uncertainty of outcome maps directly to what we expect about the future. Drive into NYC and experience nightmarish traffic? You’ll think twice next time. Find your car ticketed after just a quick run into Starbucks? You are set back not just the 25 dollars for the violation but 8 for your salted caramel frap. You’ll think twice next time.

For option markets, realized vol truly rules the world. The machines that set the prices of the millions of put and call contracts flickering in real time couldn’t possibly establish and refresh levels without a heavy helping of math. And, at the heart of the price setting algo is realized volatility. Run a scatter plot of the 500 stocks in the SPX connecting realized and implied volatility for each. You will see a pretty tight – certainly not perfect – but impressively consistent relationship. The higher the realized vol, the higher the implied vol. Of all the factors that impact option prices - carry as we call it – the relationship between realized and implied vol – matters the most.

The marginal price setter of an option is the investor seeking to replicate it through a dynamic trading strategy in the underlying asset. When realized vol gets especially low, the prospects for monetizing the trading strategy are poor. It means the option isn’t worthless, but it is indeed worth less.

A good example of this is in the behavior of credit spreads and options on credit in 2024 and into early 2025. The CDX IG averaged 52 from the start of 2024 into Feb 19^th of 2025, when the SPX hit an all-time high. Incredibly, the IG price was contained entirely in a range between 61 and 47. Is it any wonder that the CBOE’s VIX IG index averaged just 26 over this time frame?

Saying 28 moves away from realized vol, but stays with the theme that we humans are prone to miscalculations, often resulting from our overconsumption of pricing data. In this little number on vol and risk we learn that “my portfolio is more liquid and more diversified than I thought,” but then in ironic twist, add said no one, ever.

It’s literally never the case that we find our portfolios more durable to a shock than we expected them to be. Even hedges themselves – built on that one asset in the world that is truly anti-fragile – vol – can be difficult to unwind when the opportunity to do so strikes. Just ask VIX call owners about the morning of Monday August 5^th. Turns out buying something from someone for a dollar and looking to sell it back to them at 8 just weeks later sometimes causes a problem.

Liquidity in markets can be, in the words of Mohammed El-Erian, a mirage. I decided to re-read one of the books on the GFC, “House of Cards” by William Cohan. It’s a story about the downfall of Bear Stearns. And in it, we learn of one of the earliest cracks in the system, the downfall of BSAM in July 2007. The fund’s chief, Ralph Cioffi, has most of the capital in subprime CDO’s, which for financing purposes, he has repo’d to the likes of Goldman Sachs. The prime brokers have been dutifully marking this very complex and highly illiquid paper pretty close to par over many months. Suddenly, Goldman has the paper marked at 50-60. Whoops. And that, basically, was the onset of a very fast lights out for BSAM.

Marking to model is one thing, if you have luxury of doing so. But true marks that reflect where an asset can be disposed of, or in the case of a short, covered, are altogether different. I often say that diversification is an elusive pursuit. Assets become more correlated and volatile at the same time. Take the Quant Quake that occurred just a month after the Bear hedge fund imploded. A big part of the crowded, factor-based exposure underpinning the August 2007 unwind was the expected diversification resulting from joint exposure to value and momentum. The speed with which that de-risking would take place flipped the correlation entirely, leaving quant portfolios with much more risk than contemplated. One of the quotes coming out of the Quant Quake that I always loved was from Goldman’s David Viniar who said, “We were seeing things that were 25-standard deviation moves, several days in a row.” Boy, I suppose that is surprising when you think about it.

Now, I can’t help but finish this bit on market liquidity with some reference to all of the growth in private credit. There’s nothing about the expansion of this asset class that is bad, it just needs to be thought of in the context of how quickly one can convert the exposure back to cash. My view is that investors consistently overestimate their time horizons and, as a result, over-allocate to the “hold to maturity” bucket. I’m reminded of the scene in Casino when Joe Pesci’s Nicki Santoro tells the banker, “I think I want my money back”.

The next item on our list is a function of a new risk dynamic in markets and it leaves me believing that “the 10-year Treasury note, not the SPX is the risk asset”. Let me explain.

In remarks delivered on May 5^th, Scott Bessent invoked the anti-fragile term in reference to US markets. The equity market can hardly be bullet-proof when the US government bond market - one of our most important assets - is anything but antifragile. There's no business plan for right sizing this complex or stabilizing the debt. Only an extension of the debt ceiling, for now. When one thinks of antifragile assets, the notion that an "X Date" beyond which the borrower is in some version of default, doesn't readily come to mind.

Unfortunately, the back end of the US bond market, long an “insurance asset” that rallied on a flight to safety, has become a threat. Higher yields are the market’s way of saying “no mas” to debt and deficits. Even Elon Musk has gone scorched earth on the “Big Beautiful Bill”. The Trump / Musk bromance was bound to end badly.

I talk a good deal about stock/bond correlation on the Alpha Exchange. We've certainly seen instances when stock and bond prices go the same way. 2022 is a prime example, and it caused a sizeable drawdown in the 60/40 portfolio. But that did materialize during a tightening cycle when the Fed was clearly behind the curve and the short rate was rising fast. The back-end followed the front end higher in rates as this occurred.

The recent dynamics are altogether different, as the long end is under pressure even as a Fed easing cycle is being discussed. The recent dynamics are about a risk premium emerging in the back end of the US bond market. It’s an irresponsibility tax. Sadly, this is well-earned.

In stating that the Ten-Year Note, not the SPX, is the risk asset, I am reversing the causality that investors have long been accustomed to. In the era of risk on/risk off, the bond market would rally as a RESULT of a stock market sell-off. Now, it is the bond market – and higher yields for the wrong reasons – that serves to threaten the stock market. Hopefully Scott Bessent is channeling some of his old boss, Soros, on the notion of reflexivity. Market prices don’t just react to fundamentals, they shape them. The ultimate systemic risk is one in which the US bond market badly malfunctions.

We are set to close out this addition to our Sayings on Vol and Risk, getting us to 30 in total. We’ll finish with the recommendation to “shake hands with the government and sell what they’re selling.” This is a play on a statement Bill Gross made repeatedly in 2008 as the GFC was set to intensify and there were questions about the soundness of Fannie and Freddie. Broadcasting his positions on CNBC, Gross said, about his ownership of GSE debentures, “shake hands with the government and buy what they’re buying.” It was a compelling PR campaign, and it worked. My twist, to shake hands again, but sell what the government is selling, is a nod to the reality that the Fed and Treasury simply cannot allow the VIX to go too high.

As it surpassed 50 in the days after Liberation Day, the VIX was quickly becoming a problem for Bessent. As I’ve said before, the precedent for a north of 50 VIX ain’t promising – it’s 50 on the way to 80 as happened both during the GFC and Covid crash. The higher the VIX went, the more destabilized markets would become. Anticipating the policy response amounted to recognizing that Bessent would need to sell the VIX, doing something that amounted to forcing it lower. And that, of course, is just what happened on April 9^th, when Trump reversed course on tariffs.

There are certainly other times when a surge in risk premium is extreme enough such that we can reasonably expect policymaker intervention. The all-weekend summits in the Fall of 2011 featuring finance ministers across Europe certainly had a “how do we lower sovereign spreads to Germany” theme to them. These folks didn’t like markets very much, but even they understood the risk of doing nothing.

In general, whether buying or selling what the government is, the general idea is to try to understand the policy response, its degree of urgency and its ultimate impact on asset prices.

If we go all the way back to 1994 and consider the Mexican peso crisis, we can remember that the U.S. initially extended a limited dollar swap line of $7 billion. The crisis worsened, and lines of credit from the U.S. and other countries were established. Another month passed, and the crisis deepened still. A loan package of $50 billion from the U.S., the IMF, and a consortium of banks was arranged. It was not until Mexico adopted stringent austerity measures in March of 1995, two months after the loan package, that the peso stabilized.

The big picture observation is that while tail risk events rarely play out as anticipated, an important cross-current to these occurrences is the specter of policy response. In seeking to stabilize markets and forestall crisis, authorities implement various programs that directly impact the market price of risk.

Well folks, that is all I’ve got for now. As I speak these words, we are 2 months past the short-lived but intense risk-off that hit the market after April 2^nd’s Liberation Day. There’s a good deal to be learned from this event – about the speed with which market prices sometimes need to incorporate a new state of the world, about how correlations can surge in a crisis, and about how policymakers need to be watched closely, because try as they might, they simply cannot ignore the misbehavior of market prices.

I look forward to coming back in short order as we build out our Sayings on Vol and Risk Series. I hope you’ve found this interesting and useful. I wish you a wonderful week. Until next time.

in 6 short trading days from 4/2 to 4/9, the SPX has realized as much vol as it did during the ENTIRE year of 2024. Put differently, if the market were to close for 246 consecutive days (i.e., 252 trading days in a year), realized vol, with just those 6 days of returns, would be the same 12.7% as it was for all of 2024. This underscores two of the most critical properties of volatility and the first one is that it clusters. Bursts of volatility are a cornerstone of the behavior of the SPX. Something happens – in this case “Liberation Day” (giant air quotes included here) – the market processes the new state of the world – and reacts accordingly.

And the second property – is that with respect to vol – big moves matter most. The long vol trader is an interesting character. He or she needs to be patient as most trading days likely produce losses. Manageable losses, but losing days nonetheless as the option theta exceeds the gains to be extracted from rebalancing a delta hedge. Losing most days isn’t fun. But…but…but…when disruption hits, a trader can make up for those small losses, quickly, sometimes realizing substantial profits by trading the explosive volatility.

Chris Cole of Artemis once said that volatility was an instrument of truth. The disruption that saw 10-day realized on the SPX reach an outrageous 65%, is the market’s chaotic search for a new equilibrium set of prices. It’s the squaring of positioning set against a new handicapping of uncertainty. To be sure, it wasn’t pretty. But, there are lessons to be had in contemplating the recent price action over the last few weeks with – hopefully – some insights that you find valuable.

What follows is my take on the recent chaos in markets and where we go from here. To set the table, and running with the previous observation on the burst of volatility just experienced, if we look at 10 day periods and sum the squared daily returns, the Liberation Day fallout ranks only behind Covid and the GFC in terms of severity using data going back to 1990. I exclude the 1987 crash because, well ya know, squaring a 20% daily return is going to make for an impossible comp. But the 10 trading days ending with 4/16/25 ranks ahead of the 2011 debt ceiling crisis, ahead of the 1998 LTCM episode, and ahead of the 2002 accounting fraud crisis in terms of severity. Each of those 3 episodes saw a VIX in the mid 40’s. Our recent peak in the VIX is 52 with intraday peaks closer to 60.

Late in Season 4 of Succession, in the struggle to buy the Roy Family’s prized assets, tech entrepreneur Lucas Madsen said, “things are gonna get nasty”. He could have said so about markets as well. As the dollar fell, as the basis trade wobbled, as correlations and gold surged, it was clear to most – but perhaps not to Trump – that the financial economy can’t run on a 50 VIX. American runs on Dunkin’, but the market don’t run on a 50 VIX.

Sure, Scott Bessent put on a brave face in the days after April 2^nd, telling us it was a Mag 7 not a Maga problem. Remember that? Was I the only one curious as to whether he’d come up with that himself? And here I thought Bill Mahar had good writers. Bessent’s seen a financial crisis or two over his career and he had to have had some lingering doubts about the sustainability of policy. That was on Friday April 4^th. It would only get worse a few days later after the market had the weekend to noodle on things.

By April 8^th, the VIXgilantes (see what I did there?) had taken matters into their own hands and we must recognize their role in motivating the giant climb down by Trump and Co. on April 9th. Throw in a vulnerable setup in swap spreads which reached maximum inversion at the same time the VIX peaked, and you are cooking with gas when it comes to fast perpetuating a market risk event. Perhaps Bessent was at the Sphere with me in Vegas, and the Eagles hit “Take it to the Limit” was on his mind.

The precedent for 50 VIX (subset of two: GFC and Covid) is unappealing: it's 50 on the way to 80. Bessent didn't take my call – or even read my tweet - but hopefully he understood the vulnerability. He should have known better well before April 9th and his comments were tone deaf at a minimum. We know from history that SPX vol is an interesting sale at 20, a really interesting one at 30, a compelling one at 40 and at 50 it's an exposure to cover as quickly as you can. We also know that a leveraged trade like swap spreads reaches its maximum level of attractiveness at the very time when a counterparty is about to need fresh capital, just ask John Meriwheter.

Such is the nature of assets or spreads that have high negative skewness. With respect to implied volatility on the S&P 500 Index, the forces that lifted the VIX to 50 are exactly those that can propel it much higher, especially when the sellers turn buyers for risk management purposes (first rule: don't die).

Each risk episode is the same, but also different. I always loved what podcast guest and former FOMC governor Kevin Warsh said about material disruption events: “if you’ve seen one financial crisis, you’ve seen one financial crisis”. Love that. My policymaking takeaway is that if you are in the business of financial firefighting, you’ve got to both identify the source of the flames and have the proper tools to douse them. Each of these flare-ups has unique properties.

What can we learn from April 2^nd to April 9^th, 2025? Plenty. We can observe highly unsettling price action that bears at least some similarity to that experienced during the Covid market shock. I refer to the "liquidation" phase of the risk-off from March of 2020 as the roughly one week period when the stock and bond market crashed together, the dollar surged and assets priced in dollars like gold and crude plummeted. Then, the "system's" demand for cash-like liquidity was so great that even assets like long-dated Treasury securities were no longer considered "safe" securities. Only cash was.

This time around, the sell-off in longer dated Treasuries amidst a sky-high VIX and substantial equity market drawdown was what must have finally gotten Bessent’s attention. Even Trump suggested the bond market got “yippy”. Perhaps the VIXgilantes shouted “yipee ki-yay” on April 9^th, forcing Trump’s hand.

As I tweeted on April 8^th, reaching 50 on the VIX has meant reaching 80 twice (GFC and Covid). I didn’t expect that to occur again because the truly destabilizing conditions of the GFC and Covid were not in place. What was also strikingly different between 2025 and 2020 and 2008 was that this was – again to borrow in ironic fashion from Bessent – an “own goal” risk event. That is, a preposterous by most counts, self inflicted wound that was always only a tweet away from de-escalation. And that’s, of course, exactly what happened on April 9^th.

What prompted the epic Trump climb-down on Tariffs that his Commerce Secretary Howard Lutnick assured us days earlier would be in place for days and weeks? Not just the VIX and a rarely observed joint rally in the front end / sell-off in the back end of the government bond market. But also, the recognition that vol of this magnitude is punishing and causes all kinds of knock-on effects. Margin requirements are raised, OTC swap lines are re-evaluated, hedges encounter all kinds of basis risk, liquidity plummets.

At a minimum, when vol skyrockets, an investor's value at risk does as well. The market made your size larger and as a result, you must sell to get back to the same VaR. It’s also worth commenting on financial product innovation. Today’s markets bear no resemblance to those in which Graham and Dodd would publish their book “Security Analysis” in 1934. The TQQQ – robotically delivering 3 times the daily return of the QQQ wasn’t around back then. But on the 3 days of April 7^th, 8^th and 9^th, this beast saw combined volume of 1bln shares. Predictably, it rose by just about 36% on April 9^th, when the QQQ soared by 12%. Imagine being the portfolio manager for TQQQ coming back from lunch on April 9^th and seeing news of the 90-day tariff reprieve. It’s gonna be a busy afternoon. Everything seems to have made it through this vol storm in tact, but we must appreciate the manner in which products can amplify moves.

Scott Bessent would seem like someone with a fair amount of financial plumbing experience and an appreciation for the reflexive nature of markets. Once ignited, a financial fire takes both capital and will to put out. Mike Novogratz said during one Alpha Exchange podcast, "a crisis event will unwind at a pace that it wants to." I always took that to mean you really have to respect the force of an unwind and that policymakers sometimes may struggle to contain the damage.

In "Too Big to Fail", the amazing 2011 docudrama on the GFC, Hank Paulson (played so well by William Hurt) is hit by significant bouts of insomnia. He rightly recognizes that a crash is occurring "on my watch". Along with Tim Geithner (also played so well by Billy Crudup) Paulson is playing risk whack-a-mole. There wasn't a risk-off that Geithner didn't want to throw the kitchen sink at. Scott Bessent told us that leveraged players in the bond market are experiencing an "uncomfortable but normal" deleveraging. He would seem to appreciate the leverage in the financial system and how quickly out of hand these things can get. It took him too long, but Bessent was finally able to channel more of Paulson and Geithner in recognizing that markets simply cannot self-correct when the forces of deleveraging are set in motion. My view is that he was dangerously close to overseeing what easily was on its way to becoming an epic crisis.

One of the risk indicators telling us as much was not just the surging VIX, but the VVIX as well. This is the measure that helps us quantify the cost of VIX options. On April 8^th, the VIX May 35-36 strangle was quoted and the prices were an eye-popping 15.25 mid market. Let’s consider for a moment what that price tells us. Your break-evens at expiry are roughly 20 to 51. To get those, I am simply subtracting 15 from 35 and adding 15 to 36. I thing most would agree, that there’s a lot of room to make money on this trade at …at expiration.

But, at a time when the SPX was experiencing outrageous intraday swings and losses were fast accumulating for investors in various types of trades, the expiration break-evens were not at all what this trade is about. Being short a straddle on the VIX it to expiry is exceedingly difficult. It is simply the case that vols this high demand a giant distribution of potential outcomes. As I have said before, vol and "vol of vol" are highly correlated.

As things got more and more disorderly in the days leading into April 9^th, for me it became trying to balance the inertia of the VIX and the recognition that unwind events can gather self-reinforcing energy, against the unique nature of this particular episode, which, as noted, was self-inflicted.

The tone deafness of Lutnick and Bessent notwithstanding, one had to believe that government officials were set to blink in some way. The scars from the market chaos of the GFC and Covid will always remain. Talk tough to the market as you might, you simply wind up creating really hard to fix but also urgent problems when markets malfunction.

On April 6^th, I wrote on Twitter that I was in the camp that we were setting up for a nicely tradeable reversal of unsustainably high VIX levels. As always, calling a top was impossible and for me, it was not appropriate to outright short VIX futures or call options or SPX vol. Sure, the levels were eye popping. But the policy incoherence was what got them there. How could one underwrite the risk or even more incoherence?

The beauty of the VIX options complex is that it provides the ability to express a premium contained view on vol going lower through various combinations of puts, 1x2 put spreads, etc. When I say premium contained, I mean you can spend a defined amount of dollars to play for a lower VIX and should the system literally blow up, your loss is limited to that upfront premium you expended.

About Fannie and Freddie, Bill Gross famously said in 2008 as the GFC was heating up, "shake hands with the government and buy what they're buying". I always thought his very public campaign was brilliant on this front. In the days before April 9^th, I thought there was a chance to shake hands with Bessent and sell what he’d ultimately have to sell- the VIX. It was based on a simple, but convicted view that the Administration would not be able to execute on any policy with the VIX in the 40’s and 50’s for an extended period of time. A 50 VIX is a market moving 3+% every day. That reflects an incredibly unhealthy risk-taking and most likely economic environment.

So the trade I liked best was some version of a VIX May 1x2 put spread. You are expending a little bit of upfront premium and playing mean reversion lower, leaning into the trade by selling twice as many downside puts as you are buying. Now, as you know, “no free lunch” is the cornerstone of my view on markets. They are damn efficient, and as the grifters tell you otherwise, just ignore them. My 1x2 put spread carries two risks. First, if I am spending some upfront premium to implement it, I could lose that if the VIX goes to 100. Second risk is the opposite one. That the VIX collapses, which it kind of has. Because I am short 2 downside puts, at some point, the reversal lower in the VIX starts to hurt me.

Let’s briefly look at two of these trades, both implemented on April 7^th. The May 40-30 1x2 could have been put on for 1.2. Your break-evens at expiration – repeat at expiration only – are 21.2 to 38.8. Boy that sounds good, but it’s a long time to wait and a lot can and has changed. The current MTM price is 1.74. A good trade, but we already have May VIX at 23.5. The delta of this trade is actually very positive right now. In other words, if you have this on, you are rooting for the VIX to go up, not down from here. Remember, your best outcome would be for the VIX to finish at exactly 30.

Let’s now look instead at the May 30-25 1x2 put spread. This came at right around even money on April 7^th…at 7 cents. It closed at 85 cents on Friday April 25^th. This, too has a currently positive delta. Best case is the VIX hangs out in this neighborhood and finishes at 25.

These trades are very difficult to hold to maturity and monetizing them beforehand mostly leaves investors some version of frustrated, angry and railing about how the VIX market making crowd picked their pocket. For those who have this on, it’s not a terrible spot to take some profits. A driving factor behind what motivated this trade idea for me was the sky-high level of the VVIX. In doing the 1x2 you were leaning into the generous option premium the market paid you on April 7^th via this inflated implied vol of vol. The VVIX closed below 100 on April 25^th. Incredibly – at least to me – is that this is basically the same level as it closed on February 19^th, when the SPX was at its all time high.

This level now suggests that the outrageous level of realized vol of vol experienced over the past several weeks is very much behind us. I am sympathetic to that, if only because that's a tough comp, as much of this discussion has highlighted.

Where do we go from here? I’m afraid plenty of damage has been done. Folks as old as I am will remember Gilda Radner and the "Never Mind" bits of Rosanne Rosanna Danna on SNL. We've got 2 of these in the past 2 weeks...April 9 and Trump’s "nah, I won't fire Powell". We've likely moved past peak VIX (50's being a very tough comp). In its aftermath is an overhang of uncertainty that may hamper critical decision making.

To be sure, the earnings engine of the SPX has been formidable. At every turn – through all kinds of uncertainty – corporate America has delivered the goods. But, I see plenty of lingering uncertainties - from the uneven communication from the WH, from the unpriced reactions of our trading partners and from how the market will need to price in the potential economic and corporate profit fallout from the last several weeks.

And some part of this is a function of the reality that "Never Mind" isn't really possible when it comes to markets and policymaking. The inconsistencies, start/stop and incoherence of the strategy matter deeply. In my most recent podcast, Matt King, the founder of Satori Insights, did a wonderful job of laying out the components of the strategy that have reared off course. There’s no crying in baseball. There’s also no take-backs in international trade policy. Almost 40 years ago, Billy Joel told us “It’s a Matter of Trust”. He had personal, not trade relationships on his mind, but it’s an apt statement about the risks that linger from the last few months.

To recap, I, like Scott Bessent, do believe peak VIX is behind us. But unlike him, I do not believe this is a Mag7 problem only. Bessent should follow the advice of one of his predecessors, Tim Geithner, who often said “plan beats no plan”. Markets and trading partners are asking “what’s the plan?”. I think the evidence is mounting that there really isn’t one. And if that is the case, the Mag7 problem is a Maga one as well. And here, markets are vulnerable, to an ongoing overhang of crippling uncertainty.

Let’s finish this discussion with two assets I’ve advocated for strongly over the past several months – gold and bitcoin. I’ve done a number of podcasts on both and I think the thought process is sound and the analysis still highly relevant. Hit up the Alpha Exchange on Apple or Spotify and have a listen. As we sift through the asset price rubble and as the market seeks to get back on its feet, we can glean a good deal of insight from the behavior of gold. It has shined, to say the least. It has emerged in spectacular fashion from what I think we might describe as a “branding exercise”. A financial markets taste test if you will. Over a 2 month period from Feb 19 (the SPX peak) to now, how have sister assets behaved on a relative and absolute basis? This is a period when the VIX reached 52 and the SPX had a max drawdown of 19%. Since Feb 19, the SPX is down 10%, the TLT is flat and the dollar is down 6%. Gold is up 12.5% and bitcoin is flat. If we look at a more narrow slice of time, since April 1^st, the SPX is down 2%, the TLT down 3 and the dollar is down 4%. Gold is up 6% and bitcoin up 12%.

About bitcoin, Mike Novogratz also said about bitcoin "it has value because we say it has value". In a fiat system with more than enough US debt floating around the world, we've come to believe the same about both the dollar and the large pile of USTs already printed with many more to come. The dollar and US Treasuries have value because the world has decided so. While there are powerful reasons to believe this, nothing is permanent.

The recent period has been a totally unforced exercise in negative branding for both the dollar and US government bond market. For the VIX to run to 50 and duration not to rally is a bad outcome, amounting to an asset pricing taste test that went poorly. The TLT fell by 3.4% even as the VIX more than doubled, increasing from 22 to 53 from 4/2 to 4/8. Market prices reflect the experiences of investors. This was an unpleasant one for anyone who thought the bond market was there to provide a flight to safety.

Gold’s ascendancy was some part about its negative correlation to the dollar and some part the manner in which it serves as a placeholder for investors needing to express the view that “all is not well”. It, of course, like bitcoin is a FOMO asset. I’ve likened it to a Giffen good, with a positively sloped demand function. Folks chase the return. Gold also recently benefitted from Trump’s Truth Social rant against Powell, threatening to fire him. Even Trump adjusted, many found this unsettling.

Trump’s Tweets are a component of the branding exercise that has taken place over the last several weeks. It’s one that leaves disciplined assets like gold coming out very strongly. As earning season is upon us, Gold will not host a quarterly call. It has no management team, no guidance to offer. It has a brand that, by virtue of the messy start-stop of international trade policy and the unruly back-end of the bond market, is strengthening by comparison.

While Trump has backed-down from the intense broadside on Powell, we should remember that Bessent has talked about a "Shadow Fed". In a recent Bloomberg interview, he suggested they'd start looking at new Fed Chairs in the Fall. It's hard not to see the Fed's independence subject to increasingly overt challenges. This is just one component of an unfortunate US risk: the erosion of governance. It's not one we can easily and readily measure, but it's in plain sight amidst a potentially weakening economy and a mountain of debt at interest rates that look nothing like they did 5 years ago. The ratings agencies (never anyone's favorites, I realize) are paying attention to our capacity to effectively govern ourselves:

Here's Fitch from its Aug 2023 Downgrade of the US Sovereign: "The rating downgrade of the United States reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to 'AA' and 'AAA' rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions." From Moody's Nov 2023 outlook change from stable to negative: “Continued political polarization within US Congress raises the risk that successive governments will not be able to reach consensus on a fiscal plan to slow the decline in debt affordability.”

As you know, I’ve been a huge advocate for exposure to gold with two trade constructions. First, simply having some delta exposure. It had been a consistently trending asset with low volatility and low correlation to the SPX. As uncertainty started to mount in markets, I saw a second trade in gold – and that was the very long dated very far out of the money call. The logic here was that we had not yet experienced a true “stock up vol up” event in gold but that there was scope for it as the tariff uncertainty increase and as the FOMO aspect of gold started to kick in. The Dec 375 call that I advocated for buying for around 1.2 got to around 7 in premium is now closer to 5.

With both "Never Minds" - the tariffs and the fire Powell threat - the near term upside tail outcomes for both gold and bitcoin would seem lower. So the far OTM option plays resonate with me less now. That said, these assets look quite disciplined set against an unpredictable policy backdrop and continue to deserve some allocation in the portfolio. Having had an amazing run in gold, I'd be a little smaller now. But simply put, gold and bitcoin are different. They represent not a vote for, but a vote against. Against an absurd last month in policy and, as a result, markets.

Last point before I let you go and that is on one of the most prize possessions in the US, our bond market. If this one thing you can count on in addition to death and taxes its sizeable auctions of US government bonds. And it’s not to be an alarmist, but simply to state that these auctions must clear for the United States to run. And the auctions do clear. There’s remains large, global confidence in our debt. But when important folks like Steven Miran, now the head of the Council of Economic Advisors, even socialize ideas like user fees on foreign holders of US Treasury securities or encouraging terming out of debt as a way of offsetting a perceived overvaluation of the dollar, the knock-on impacts could be more than unpleasant. White papers might remain white papers, but they may also become socialized enough as to make their way into how investors price distributions. A recent Odd Lots podcast featured a Virginia Law Professor and was entitled “How Trump could Restructure the US debt”. I think its safe to say that restructuring does not involve giving our existing lenders a better deal.

I’ve said this before, the US Ten Year note, not the SPX, is the risk asset. The real “financial” tail risk (i.e. a resurgence) of a spiral higher in the VIX would seem to lie in the potential that long dated UST yields rise quickly. From a contagion standpoint, the 10y note is the vulnerability. It is not being treated as such.

Well, that was a lot. If you got this far, bravo. These are beyond interesting and important times in markets and the global economy. I am thankful for your interest in the Alpha Exchange and hope you have a fantastic week. Until next time.

On a note unrelated to markets, I’m headed to see Glengarry Glen Ross on Broadway this week. I do love me some Kieran Culkin and Bob Odenkirk. It turns out that also in the play is Michael McKean – you may remember him as Chuck McGill from Better Call Saul – or, if you are even remotely close to my age - as Lenny from Laverne and Shirley. “Hello Laverne!”.

I’m also a big fan of Bill Burr and have seen him in concert countless times. His support of Luigi Mangione is getting to be a bit much, I must add. Still, I’m looking forward to this, even if there’s no “AIDA” – attention, interest, decision, action – from someone playing Alec Baldwin. I’ll report back in short order.

“There are decades where nothing happens; and there are weeks where decades happen.” ~ that comes to us not from Vladmir Putin, but from Vladmir Lenin…at least that’s what is suggested. Like Mark Twain, perhaps Lenin is given credit for a few catchy sayings he didn’t actually come up with. But it’s an excellent turn of phrase. To be sure, it’s impossible to argue that nothing has happened in the last decade. Just ask Vladmir Putin himself.

But, you get the point. And it’s difficult to understate how highly consequential these past few days have been. I’m no international trade guru nor do I have any plans to become one. I’ll leave what will amount to ongoing guesswork to those folks and economist types. But I am engaged in the study of market prices and do so with the valuable benefit of having been in a derivatives seat helping large counterparties navigate each of the market stress episodes over the last 3+ decades. With this in mind, I’ve got a few observations on the price action, many of them through the l of derivatives markets and brought to life through my some of my own catch phrases. I’m a simple fellow and keeping track of my house keys and passwords is hard enough. To understand markets, I need aphorisms, adages, and pithy proverbs. So, let’s get into it.

First, I am reminded of my view that “Realized Vol Rules the World”. Consecutive 4% down moves in the SPX are a rare event. Including this past week, there’s only the GFC (twice, in Nov’08) and Covid. Everything in markets is a reaction to realized vol. Option prices respond immediately, as the cost of hedging delta risk balloons when 10-day realized vol on the SPX goes from 17 to 47 in two days. If you don’t trade options, you care anyway about much higher daily swings in prices. Realized vol spikes of this magnitude make your portfolio much larger, increasing your daily value at risk without you lifting a finger. You want the same VaR? You need to get smaller. The process of de-risking – either through hedging or outright selling - reinforces an already fragile environment. The market can’t withstand many more shock days of this magnitude.

The VIX spent a fair amount of time in the 50’s on Monday, April 7^th. You will recall that while it kind of "flash (up) crashed" to the 50's intraday on Aug 5 of last year, that was a fleeting event. This is not. The precedent for a 50 VIX is rather ominous. it's really just the GFC and Covid that got past 50 and both times we were on our way to 80. To be clear, neither of the motivating, destabilizing circumstances that drove those events is in place now. There is no unwind of a massive mortgage credit bubble with huge vulnerabilities resulting from the demise of Lehman and AIG. With respect to the market storm 5 years back, there is no intentional shutdown of the US economy is present now. So, we got that going for us.

I hear all the time on X – that social media platform formerly known as Twitter – that you can’t trade the VIX. Folks get pretty hot on this topic, and I am not entirely sure why. It is true, there’s no security called VIX that you can buy and sell. But you can buy and sell securities that track the VIX with incredibly high precision. And that is, roughly, one month 5% out-of-the-money put vol on the SPX. As I showed on X, these move basically in lockstep. And we know how changes in that implied vol translate to changes in the option price. So, I like to think of the VIX is simply an insurance cost index. If we use 55 as the vol input on a 5% out-of-the-money 1m put on the SPX, we get a cost near 4%.

Now, we all encounter insurance folks in our daily life. Car, homeowner, travel, health, life. You can insure your boat, your pet. Take out an extended warranty on your TV…you get the idea. Most of these feel overpriced. Let's consider the cost of this 5% OTM put on the SPX: you absorb the first 10% of downside. You pay 4% upfront. Oh, and the insurance lasts for a month. Ouch. Financial market insurance is a weird thing. Interest in buying it tends to spike at the wrong time. At some point, the cost of insurance is simply too high, however. And when the overlay hedge ceases to be reasonable, and that promotes further portfolio de-risking.

From a markets standpoint, the higher vol goes, the greater the likelihood that government officials blink in some way. The scars from the market chaos of the GFC and Covid remain. Lutnick's "these tariffs will remain for days and weeks" is far from money good if asset prices plunge and vol spirals higher. You simply wind up creating really hard to fix but also urgent problems when that happens and folks like Bessent know that. I like the quote from Niall Ferguson "the only real law of history is the law of unintended consequences". We live in a pretty interconnected world of international rivalries, debt, trade, asset prices, economies, etc. All kinds of tail probabilities (possibilities at least) become more live when a shock of this magnitude occurs.

I'm in the camp that we are setting up for a nicely tradeable reversal of unsustainably high VIX levels. As always, calling a top is impossible. And I wouldn't outright short VIX futures or calls or SPX vol. but the beauty of VIX options is that you can express a premium contained view on vol going lower through various combinations of puts, 1x2 put spreads, etc.

About Fannie and Freddie, Bill Gross famously said in 2008 as the GFC was heating up, "shake hands with the government and buy what they're buying". There may be a chance to shake hands today and sell what they're selling - the VIX. They won't be able to execute on any policy with the VIX up here for an extended period of time. A 50 VIX is a market moving 3+% every day. That reflects an incredibly unhealthy risk-taking and most likely economic environment.

And that brings me to a second little scribble on my cheat sheet: “Vol Has Memory, Vol Mean Reverts”. We know that vol events tend to cluster. As highlighted, we just got successive 4% down days in the SPX. These episodes of uncertainty also bring big about big up moves. In fact, if you look at history, you will see that the biggest up days in the SPX always occur during the large market shocks. Since 1990, the SPX has had twelve 6% up days, all of which were realized during the GFC and the Pandemic. This is the memory part of vol. When the market is forced to process a sea-change in policy or in its understanding of the state of the world (“subprime is NOT contained”, “a developed market sovereign CAN default”), volatility gathers a dangerous energy. It is this same risk, however, that almost demands policy response from policymakers. Will Trump/Bessent/Powell blink? When the market finds itself short of risk-bearing capital, it is often the case that some combination of monetary policy easing and the provision of public capital/backstop plays a role in arresting the problem, causing vol to mean revert. Some basic “détente” would go a long way towards lower risk premium levels.

I often say that “Risk-on and Risk-off are Curious Cousins”. The mean reversion of vol is nearly guaranteed, even if not easily timed. What was that combination of QE, Fed and Treasury rescue facilities, tax cuts and promises to hold rates at zero that allowed the SPX to bottom in March 2009? It’s difficult to know. With the benefit of hindsight, it’s easy to stitch together the logic that the bottom was in, but in real-time, option prices suggested a more than 50% probability that the SPX could be below 500(!) by the end of 2009 during that March low. However, we should recognize that the history of market dislocations often creates trading opportunities on the long side. When the VIX is at 45, you are getting paid really well to provide insurance capital to the market. Here’s an example: just 2 months ago, the cost of a 2 month, 10% out of the money put on the SPX was 30 basis points. It’s now 7 times that amount, at 210 basis points. So, if you are in the business of collecting such premiums, you raise the same nominal amount and can be 1/7^th the size. That put carries a 38% implied vol and while it certainly can’t compete with the insanity of the Covid crash, it’s higher than anything we’ve seen since the GFC. Remember as well, that policymakers do tend to blink when markets get chaotic enough. You sell vol into these events because you anticipate the (unlimited deep pocketed) government may do so as well. The key is going to be sizing.

Even as we focus on trying to find attractive entry points that are facilitated by some combination of asset price damage and high levels of risk premium, we cannot dismiss that a 50 VIX is a dangerous backdrop. It was Mike O’Rourke of Jones Trading who said, “Broken Markets Break Down”. I really appreciate how efficiently this captures the nature of markets. While a dislocation of this magnitude has historically paved the way to collect risk premiums, we have to respect that things break when market prices move this fast. This is the 9^th 10% drawdown since and including the GFC. At almost 18%, this one is substantial, there’s no way around it. We know that market prices respond first and have predicted 10 of the last 2 recessions, as they say. There are going to be some ongoing sources of feedback. Between asset prices and the real economy (and vice versa), between the Administration and the markets, between the RoW and the Administration, between the Fed and the markets and the Fed and the data (and vice versa).

My own scars from episodes like LTCM, the GFC and Covid are that modern markets mostly, but not always, can self-correct. The old adage, “the cure for lower prices is lower prices”, sometimes does not apply. Markets break. They can topple without backstops. I also point out that the electronification of liquidity provision, an absolute feature of modern markets, is local vol dampening but may leave vulnerabilities to tail outcomes. For example, how did the SPX options market turn so illiquid the way it did on August 5^th, 2024? As we have experienced consecutive enormous daily shocks at the SPX level, what’s the impact on the risk bearing capacity of the system? I’ll note that the CBOE just published a piece in which it found that 47% of all options traded in 2024 had expirations between 0 and 5 days to expiration. These are new instruments in the options market that at least potentially create risk dynamics that we cannot yet fully appreciated.

The ETF space has also seen significant innovation. To be clear, “This is Not Your Father’s ETF Market”. Not even close. NVLD, SMST, NUGT, SOXL, YINN, YANG… These are all leveraged ETFs with daily resetting exposures. They have a simple mandate – deliver 2x and sometimes even 3x – the daily positive or negative return on an underlying index or equity. In the case of MSTU and MSTX, delivering 2x leverage on top of the “Michael Saylor Sound Machine”, MSTR, the feedback with respect to volatility was profound back in Nov’24. The key point on these products is that both the leveraged long and short are amplifiers of volatility in the underlying, sometimes substantially so. Let’s look at the TQQQ and SQQQ (3x leveraged long and short, respectively, on the QQQ) on Friday. Combined, these two saw volume of nearly 500 million(!!) shares. TQQQ – the long version – has seen its AuM fall from 25bln to 14bln since mid February. Market risk changes because the products that populate the market are always evolving. There are no CPDO Squareds to look after right now, but there are daily resetting ETFs. Many of these use derivatives, accessing the leverage through a swap counterparty. For TQQQ, hit up the MHD function and see all of the swaps it uses. When vol gets this high, swap counterparties may decide the carry to be earned for taking the financing risk is no longer a good deal. This gets back to “realized vol rules the world”. Fresh decision-making occurs when vol is restruck so much higher. That can create knock-on effects. The mechanical rebalancing that TQQQ and SQQQ had to do on Friday added nearly 20mln shares to sell in a massively down tape.

Let me continue this discussion with some of my observations on specific asset prices. First, let me say that the phrase “My portfolio is more diversified and more liquid than I thought it was.” is attributable to No One, Ever. It’s always the case that investors find themselves too large and correlated during a meaningful risk off.

Of all the market prices I have seen as unsustainable, it has been the level of realized correlation among stocks in the S&P 500. Incredibly, this measure was 12 for all of 2024. The amount of dampening that this never seen before level has exerted on index volatility is hard to understate. Two things matter here. First, investors respond to what they see and experience via market prices. With correlation so low, portfolio moves of any real magnitude have been few and far between. Take Deep Seek Monday (1/27). NVDA plummeted by 17% but the SPX fell by only 1.5% as AAPL actually rose by 3% that day. Thus, portfolios are sized taking this “offset” into account, with investors banking the diversification benefit as if it will always be there. As recently as mid-Feb 1m realized correlation on the SPX was 2%. Today’s reading: 51%, the highest since late 2022. The same forces – financial, monetary, economic, and geopolitical – that make stocks more volatile also make them more correlated. The 10-day realized correlation between AAPL and NVDA has surged to 81% as their realized vols have spiked to 72 and 73, respectively. True diversification is very difficult to achieve, as we saw in the joint drawdown in stock and bond prices in 2022.

While it, too has started to draw down, gold has been a standout source of diversification. It’s certainly not a hedge you can rely on and gold will buckle as well should the vol experienced so far lead to cascading asset prices, a soaring dollar and a rush to raise cash. I’ve described the 3 different kinds of risk-off, which I call “classic”, “taper” and “liquidation”. The last of these – experienced during a terrifying stretch in March 2020 – is by far the worst and no asset except vol itself can survive. But gold does very well in the classic risk off when stocks and rates fall together as a function of growth concerns. I like to say that you can learn a lot about an asset by simply observing how it does on the worst days for the SPX. When we run gold through this exercise, it shines. There are 39 down 4% or more days in the SPX since 2008. Gold’s average return on those days is +30bps. Its correlation to the SPX on those days is just 22%. It’s unrelated to the SPX when you need it to be (except during a true market liquidation when both the stock and bond market crash together).

Let’s put our vol nerd caps on, shall we, and talk about the SPX Vol Termstructure. This maps the implied vol by expiration and will reliably invert when a shock higher in realized SPX vol occurs. “Backwardations” as some refer to the circumstance when shorter dated implied vol is higher than out months, are rare and fleeting. For example, UX1 (front VIX future) > UX2 (second) only 16% of the days since VIX futures began in 2004. Your longest periods of inversion are going to be Sep-Dec’08; Aug-Nov'11; Feb- May'20 (with one day in contango in there). Termstructure inversions are always related to the level of implied vol as well. It's rare (but not impossible) that a termstructure inverts at a low level of the VIX. The typical sequencing goes as follows: market digests new and unwelcome news, realized vol gets shocked higher (10d SPX realized was 17 three days ago and it is now 47). This causes the most gamma-intensive options to surge in demand because they are most reactive to realized vol spikes. Those are the shortest dated options. Every other part of the termstructure lifts as well, but with declining beta to that realized vol surge.

Next, let’s touch briefly on Inflation and Real Rate Curves. The market is fast repricing both the real and inflation component of nominal yields as well as the curves for each. For example, nominal 2-year yields are down 72bps in 2025, even as break-even inflation is actually up 70bps. This leaves real rates 142bps lower. And the break-even curve has, as it did in 2022, inverted again, with 2’s 108ps north of 10’s in break-evens. By contrast, the real rate curve is upward sloping by 145bps. This is an ugly mix. And it speaks to the real challenges that the Fed will have in executing on the dual mandate set against a backdrop of declining growth but potentially a higher short-term inflation environment. One asset pair that has experienced a pretty disparate relative move over two days is crude, down 13.6%, and one-year break-even inflation which is unchanged. This speaks to the market jointly discounting a decline in growth but firm inflation. In his speech Friday, Powell said that the Fed faces “elevated risks of both higher unemployment and higher inflation.”

And finally, a few observations on how the market prices corporate uncertainty. One of the risk metrics that has proven generally impervious to risk-off episodes (like 8/5 and 12/18 of 2024) has been credit spreads. I published a chart in mid Feb showing that both credit spreads and credit implied volatility were mired jointly in 0th percentiles. The idea was that credit hedges really stood out from a value standpoint and that should the market start to price "real economy" risk with just incremental probability, these would work. That's exactly what has happened with both metrics now in 90+ percentiles. There’s a great index calculated by Bloomberg called Global Trade Policy Uncertainty – ticker BBUNTPGD – which explains why credit is now enveloped in this risk-off. The degree of global trade uncertainty is literally off-the charts. Today’s level makes the trade “war” of 2018-2019 look like a shouting match at best. While we have seen a large move in credit spreads in a short period of time, history tells us that further concerns around growth leave more room for spreads to widen from here. Stepping back, the VIX has spiked more on a relative basis than credit spreads have, but that’s mostly a function of the giant successive moves lower in the SPX and how that impacts a short-dated option price measure like the VIX. If we compare the CDX IG to 1 year SPX implied volatility (22.7), it’s much closer to the historical relationship.

The idea will be to share some of the insights I’ve developed over my more than 3 decades in the markets business and on the sell-side. Expect an emphasis on risk. Expect a heavy dose of vol. Expect some war stories and how we can learn the most about markets by studying the periods when things go horribly wrong.

I’m going to start by sharing the text from the most recent podcast on bitcoin options: “IBIT…The Hottest Option on the Planet”. Here goes…

My personal market lens incorporates a healthy dose of reflexivity. Prices aren’t just outcomes, they are calls to action. And from this perspective, realized vol is a cause not an effect. Realized vol of 6 causes just about nothing…except inaction. There may be cheap Halloween costumes overflowing the shelves at your local Party City come November 1^st, but you could care less. You’ll wait. Similarly, market insurance may cheapen up when the SPX swings flatline…but so what, you’re in no rush to spend the money on it. I get it.

The quiet at the SPX notwithstanding, other asset classes and securities are moving around, however. I count 4 of them in the 2 Trillion valuation club that sport implied vols north of 45. That includes TSLA, Broadcom, NVDA and the subject of this forthcoming discussion, Bitcoin. Among these 4 beasts, there’s 10T of combined value, running north of 45 volatility. To state the obvious, 45 vol is easy come easy go. The former has certainly been the theme for these 4. Heck, the RICH go screen on Bloomberg has Elon at 450bln. Can Bezos even be in the same room as Musk? Not that Elon is invested in T-Bills, like Warren Buffett is, but the risk free interest on his stack would be 50mln per day. Believe it or not, TSLA is the worst performer of this Fantastic Four, up just 62% in 2024.

That short digression behind us, let’s zero in on the subject at hand… the unbelievable launch of options on IBIT, the bitcoin ETF. What I’d like to put forth is that the financial characteristics of the underlying asset – bitcoin - pave the way for IBIT options – already off to an amazing start – to become a critical industry risk management tool. Next, I want to acknowledge that while the crypto crew likes to HODL, listed options on IBIT will allow them to HUDL as well… that is, hedge up digital longs. C’mon you folks know I’m an acronym-phile. You may never want to sell, that’s fine. But there may be times when hedging makes a tremendous amount of sense and having this new instrument alongside your core long is a wonderful addition to the set of risk management alternatives available.

Let’s talk about IBIT listed option activity so far. One month in and the volumes are absolutely fantastic. On December 16^th, nearly 500,000 puts and calls traded. Citibank – a bank around for a hundred years and with a stock price in the same neighborhood, saw volumes less than 20% of that. The IBIT volumes are leading to substantial levels of open interest, which has reached just under 2mln contracts. Why is this important? When investors have trades "on the books", they become arbiters of the "right price", invested in understanding where a structure might trade. Two counterparties that opened a trade together are well positioned to roll it together as well. Of course, the front months are the most populated, but even out to May'25, there are thousands of contracts of open interest.

Transactions are occurring across the strike curve, not just in ATM or near the money options. In Jan'25, there are nearly 35k calls of open interest with strikes above 75. these options have deltas between 3 and 12 and are roughly 5 cents wide at vols of 80+. having price discovery at these low delta points bolsters the capacity to price spreads and tail hedges. For example, when we have some sense as to where the 80 strike call may trade – because the screens are two-way with posted liquidity at that strike, a counterparty asked to make a price on the 70 strike call will do so with more confidence as the 80’s can be bought as part of the hedge if needed.

Let’s next talk about posted bid-offer spreads. These will surely tighten over time, but screen-based price discovery is already solid. that is, posted interest is often in the 1000's of contracts on both sides of the market and often a dime wide. These are simply what’s posted and trades will mostly occur inside that. Again, there’s an ecosystem of liquidity being built here as more open interest accumulates. The pricing bots at Jane and Susq and Citadel get smarter and smarter along the way, observing where things trade, repricing second by second and building intelligence on the relative levels of premium that populate the matrix we Geeks call the vol surface. There’s a virtuous cycle afoot.

The launch of IBIT options comes not just during a banner year for crypto, but also for financial product innovation in the form of derivatives based ETFs. This also should prove to be a volume and liquidity tailwind as there are already products being built that overlay options on a core position in IBIT. Let’s think about the various risk management objectives one might seek and the overlay structures they employ. First, the broad category of "income" strategies like overwriting will supply vol to the market, typically through the sale of upside calls. Given the tendency in bitcoin for “number go up”, it wouldn’t be surprising to see put write strategies created for income purposes as well. As IBIT has already listed weekly options and implied vols are in the 60’s, one could envision an aggressive income seeking strategy that sells weekly puts. Sounds dicey, but remember, I don’t make the rules, I just work at a podcast.

More fully hedged strategies may use collars that buy put or put spread and sell call. As we have seen, these types of systematic, rules-based vehicles can become extremely large sponsors of the options markets. see JEPI, giant collars and SPX options. There are so many other permutations that consist of a risk management overlay using puts and or calls that may seek to reduce risk, amplify returns, generate income or some combination thereof.

What makes an option contract successful is two-way interest. You need buyers and sellers, hedgers, speculators, vol traders. I can see all of this quickly materializing in IBIT options. Let’s get to why that is. Obviously, you must start with an underlying asset that is liquid and actively traded. In its short time since launch, IBIT already has a shade under 60bln in AuM. Some perspective: that’s already more than the TLT, a government bond ETF that has been around since 2002.

But there are plenty of liquid underlyings that do not spawn liquid option markets. Why the success and promise in IBIT? It is the unique risk characteristics of bitcoin and how they shape the option vol surface in IBIT. Specifically, bitcoin has 3 financial characteristics that pave the way for tremendous option adoption: First, it is a high vol asset. As alluded to earlier, there are few assets with a market cap of 2 trillion moving on a 60 vol. Colgate Palmolive is moving on a 15 vol and seeing about 5k of daily volume in options. Traders like vol. Second, bitcoin exhibits a great deal of vol of vol. Hey now. The vol is high to be sure. The vol is also volatile. Bitcoin goes through sleepy periods and also those when the daily fluctuations are huge.

And the third of the financial characteristics – perhaps the most important of them – is bitcoin’s nearly unmatched propensity for positive spot/vol correlation. The coin is subject to frequent "up shocks", my term for substantial one-day positive returns. To be sure, it has its share of large negative returns as well, but what distinguishes it significantly from an asset like the SPX is that bitcoin can become more volatile as it rises. The SPX doesn’t really do that. If the SPX rallies by 20% over a period of time, it’s a strong empirical likelihood that both realized and implied vol wind up lower than where they started. Not 100%, but a very strong likelihood. This is not the case with bitcoin, and this has really important implications. As an aside, Bitcoin has experienced 216 5% up days and only 193 5% down days since 2017.

These 3 factors – the vol, the vol of vol, and the tendency for positive spot/vol correlation - lead to a regular repricing of options that make vol traders interested in trading them. Since IBIT options have only been around for a month, let's use BITO to make the point on vol of vol. 2m implied vol on BITO has gotten as high as 105 and as low as 35 since launch 3 years ago. In comparison, NVDA, one of the most successful single stock options ever, has had a high of 75 and a low of 33 over the same period. Swings in implied vol add a dimension to pricing risk that attracts attention. The implied vol becomes an asset that can be range traded.

The empirical distribution of bitcoin returns matters a great deal as well. bitcoin has proven to "gap up" many times. Is there an asset in the world that inspires the imagination more than bitcoin? Is there one that creates the fear of missing out more? as mentioned, very low delta calls are already being priced and traded. as I have shown a few times on Twitter, the call skew tilts up, reflecting the demand for far upside exposure. This is to say that out of the money calls carry a higher implied volatility than those closer to the money, something you almost never see in the SPX. Assets that exhibit upward sloping call skew also often experience "stock up, vol up"...that is, unlike a broad equity index like the SPX, bitcoin can rally and bring its implied vol up along with it.

Let me repeat that. Bitcoin can rally and bring its implied vol up along with it. Let’s consider this statement from both the call option buyer’s and option seller’s standpoint. If I buy an out of the money option, I’m clearly rooting for the underlying asset to rise. I need it to reach a certain destination by a certain time in order for the trade to work. My mark to market profit is going to consider how far up the asset went and how long it took. And my option will also incorporate any change in implied volatility. If the vol is rising as the asset is rising, this can add meaningful addition value to my position. To distinguish again, from the SPX, when one buy an OTM call, it’s often the case that you can be right on the direction, but experience some drag from volatility along the way.

From the hedger’s standpoint, being short upside calls on IBIT can be complicated, for the same reason the other side of the trade benefits. The option seller needs to manage the delta risk accordingly and appreciate the way in which a rising level of implied vol can add additional delta to the call option beyond that which results simply from the rising level of IBIT.

In equity land, we don’t see this often. But for certain single stocks – we can put NVDA and TSLA in there as examples, “stock up/vol up” has sometimes been a thing. And when you see that positive reinforcement of price and vol, there’s nearly always very heady activity in the options market. The 2021 Meme stock episode with GME was the ultimate example, and, of course, that period was associated with an absolute surge in option volume.

Let’s think about how bitcoin’s tendency for up-crashes and the realized and implied volatility statistics that emerge. Traditional assets like the SPX tend to take the escalator up and elevator down, as they say. The force with which the market can move lower exceeds that with which it can move up. In bitcoin, not only are the price shocks well distributed across both the upside and downside, but so too are the volatilities. Going back to 2019, let’s examine rolling one month periods and isolate the top 25 to both the upside and downside. Some of these may be overlapping, but we get more data doing it this way. For the downside sample set, the average loss is 38%. The average increase in implied vol, using the BITVOL series, is 44 and the average increase in realized vol is 59. These aren’t too surprising considering the magnitude of the losses in just a month’s time.

What is more interesting is the up sample. Here, of the 25 moves, the average increase in bitcoin is 66%. That alone is remarkable. The average increase in implied vol is 27 points. And the average increase in realized vol is 14. That’s a very distinguishing characteristic. Sharp rallies in the underlying met not just with an increase in realized vol, but an even larger increase in implied vol. This empirical observation gets to the heart of what makes bitcoin a unique asset, the view that the upside can be unbounded. It’s not tethered to some valuation framework. It doesn’t need to meet of beat a whisper number on the quarterly earnings report. It’s price action gets our attention and via, folks like Michael Saylor, Bitcoin’s unpaid head of investor relations, captures our imagination.

Now, these stats are backward looking, to be sure. It was easier for bitcoin to surge from 8k to 12k in a few weeks in June of 2019 then it will be to shoot to 150k now. Or at least I think so. But, the underlying characteristic of bitcoin – to gain momentum on the way up, be subject to incredible FOMO and to experience a positive price/vol spiral, remains. Because of this last point, the call skew – especially for very out of the money options, is going to be very well bid. And to restate, when you have price discovery at very low delta points, the entire vol surface is fortified, paving the way for all kinds of trade construction.

Let’s finish this podcast with some discussion of what I see in the landscape of current price on IBIT options. The quick skinny: implied vol is high, the call skew is bid and, curiously, the termstructure is upward sloping. I say curiously, because it’s generally the case that when implied vol is high, the termstructure is flat to downward sloping. Here’s an example. The recent breathtaking rally in TSLA has lifted both realized and implied vol. The result is an inverted termstructure. 2m vol is at 77, 6m at 68, 1y at 64 and 2y at 61. That makes sense. The market is essentially paying respect to the value in owning short dated options in a stock that is realizing 83 over the last 2 months. But, that’s a difficult level of realized to sustain. And so, further out options incorporate the view that realized will mean revert lower.

In IBIT, we see a pretty upward sloping termstructure. 2m implied vol is 62. But one year is 70. 2 year is slightly higher than that. It’s unclear how much you could actually trade out one year, but that’s at least the starting point. is this too high? should 2 year be 10 vols over 2 month? Listeners to this podcast will remember my analysis of vol going into the US election. I explained the vol premium for options that expired just after November 5^th as mostly a function of the withdrawal of supply of optionality ahead of an event that few felt comfortable handicapping. Less supply raises the clearing price. I think longer dated vol on IBIT fits this category. There’s not a lot of natural sellers ready to bear the vega risk, perhaps especially given the high vol of vol I’ve discussed earlier.

That said, I did some back-tests on systematic vol selling strategies in bitcoin, again using the BITVOL series. This series, built by Simon Ho of T3, uses the CBOE VIX methodology and is designed to approximate where a variance swap would trade on bitcoin. If we go back to 2019 and systematically sell 1m variance, the results are outstanding. This is to say that the Vol Risk Premium in bitcoin has been consistent and high. As I stare at these longer dated vol levels especially and as I hear BlackRock now suggesting that bitcoin can constitute a 2% portfolio allocation, I wonder if this asset class will mature and stabilize, leading to lower vol? The Nasdaq VIX, the VXN, was in the 60’s in 2001. 4 years later it was at 15. These are interesting questions to ponder. An emergence of systematic VRP strategies in IBIT would be another addition to the ecosystem of supply and demand for optionality.

The last point I want to make is around that term, HODL. Mike Tyson told us, everyone has a plan till they get punched in the face. I say, everyone’s a HODLer until faced with a positive return outcome they couldn’t possibly have imagined. If the price/vol spiral that underpins so much of what makes bitcoin interesting actually kicks in, even Michael Saylor is going to contemplate buying puts. This way, he can still HODL. But IBIT options will allow him to HUDL as well.

Well, that’s about all I’ve got for now. If it’s not been abundantly clear, I am very excited about the IBIT option launch. I’m also very excited about 2025 and connecting with new guests and bringing those insights your way. And I do love Larry David, but I will say it again, Happy New Year!

Amidst the punishing sell-off in markets, there is active discussion about the VIX and whether it is high enough. We argue that the index is too low and in doing so, we assert that the price of insurance does not adequately reflect the combination of how options are carrying in real time and in the set of financial tail risks that may emerge from the Fed’s inflation fight.

What Drives Index Volatility?  Revisiting the “5 C’s”

There are a myriad of factors that impart upward or downward pressure on implied volatility. A short-hand for these factors is the “5 C’s” framework – carry, credit, calendar, concern and capital. Among these, the most prominent influence on the level of implied vol is how options carry. And on this measure, a metric often cited is the premium of the VIX to realized.  With the VIX at 29 and 1m realized volatility at 29.6, the spread sits in the 12th percentile over the last decade. Using the last 2 years, when options have carried particularly poorly, the spread is in the 9th percentile.

Looking Beyond Carry…Have VIX Hedges Worked?

If owning options on implied vol is a logical hedge against a market drawdown north of 20%, logic has not prevailed recently. A simple strategy of buying and holding 20 delta calls on the VIX in 2022 is down 7.5% and has lost money every month but for January. Favorable comparisons of implied to realized volatility notwithstanding, the ineffectiveness of using VIX calls to play defense argues against the notion that the index is too low. Trades that work – both on the short and long vol front - invite sponsorship. Levels of both VIX call option volume (3m average is in the 24th percentile over the past decade) and open interest suggest a lack of interest. Vol of vol books do not appear to be especially large.

Carry Matters, But So Too Does Capital

There were long stretches in the post-Pandemic period when equity index option carry was awful. Sharpe ratios on vol selling strategies were excellent in 2021, by some measures approaching 3. The height of the implied to realized premium was on GME day - 1/27/21.  Then, the VIX was 23 points above concurrent 1m realized. Why? The explanation here provides some clues on what may be under appreciated in the current environment. The VIX reached 37 when the “GME VIX” exceeded 500 because option demand greatly outstripped supply.  This is the 5th pillar of our “5 C’s” – “capital”.

But SPX 1m realized vol was only 14!

Why were investors willing to pay so much for an option on 1/27/21 amidst so little index movement? The answer lies in the massive widening of the distribution of lower left outcomes that the GME price spiral imparted on markets. This was insurance pricing similar to that associated with the precursor of a contagion event.  Recall that the VIX spent a bunch of days in the 30’s in immediate aftermath of the Lehman bankruptcy. Sometimes, the risk measure needs time to catch-up. In 2008, as more evidence emerged on the severity of the issue, the VIX got into the 40’s and 50’s.

Drawdowns, Realized Vol and the VIX…Some Historical Perspective

How does the current SPX drawdown compare to prior periods of weakness in the context of realized and implied volatility. The table below looks at DD incidences of 15% or greater over the past 2 decades. While the GFC and Pandemic are uniquely severe risk episodes, it becomes clear that the VIX is currently low when set against its level at the bottom of other meaningful sell-offs (far right column).

40+ VIX, Three Episodes to Consider

In 3 prior tail events when the VIX got to the low 40’s, LTCM in 1998, the telco bust in 2002 and the Eurozone sovereign crisis in 2011, 1m realized volatility also surpassed 40. Those periods saw not just several 4% one-day moves in the SPX, but 5 and 6% moves. These contribute a tremendous amount to a realized vol series. In 2022, we’ve seen some very large daily swings, but nothing more than 4% so far.

Modern Markets Are Vulnerable to Toppling Over

Have the tracks already been laid for a 40 VIX? There’s an argument to be made and a risk to be considered. That risk results from the reality that modern markets are not built to self-correct, especially from price shocks of this magnitude. In assessing what is coming next for the economy, the impact of the wealth destruction that has already materialized may be important. This same wealth destruction matters in a financial sense as well.

What we observe is the tendency for spill-over events to occur when asset price damage gets significant enough. Markets become more illiquid, collateral requirements are tightened and there is stress on basis relationships. To wit, the BoJ’s “cornering” of the CTD contract in the JGB market and the resulting impact on the cash/futures basis. Risk taking is compromised when market prices deteriorate and liquidity strains emerge.

Sources of Spill-Over

De-risking in one area of the market may have knock-on impact. There are several places to look: crypto, USDJPY, JGBs, Italian sovereigns, energy and the back-end of the US yield curve. These are among the fragile assets that could become a more central part of today’s dynamic, effectively widening the distribution of potential outcomes for equity investors. Underpinning each of these factors is the Fed’s inflation fight and a dual mandate that is conflicting for the first time decades. Risk managing inflation from above, the Fed has been forced to turn vol buyer. The result: excluding the GFC and Pandemic, the highest rate vol in 2 decades.

Reflexivity Redux

George Soros once said, “price is the only fundamental.” This is especially applicable today. In this rendering, price is a proximate cause, sometimes a positive agent that enables growth of the system. The risk now is the reverse of this.

The VIX Is Too Low

The previous discussion is meant to highlight 3 overlapping factors that play a role in setting the VIX. Carry, Concern and Capital. On the isolated merits of carry, the VIX screens favorably. Beyond the comparison of realized to implied, there is currently insufficient pricing in the vol surface of deep left tail outcomes. This pricing was prominent in 1998, 2002, 2011 and during the GME episode of 2021. Today’s ratio of the VIX to 1m ATM implied vol on the SPX sits in the 2nd percentile over the last 10 years. Such a low reading illustrates the “disrespect” being shown the deep OTM puts that play an important role in the VIX calculation. Simply put, there is not enough concern reflected in the market price of convexity relative to the set of risks that may already be in motion. If market participants are forced to more fully contemplate these sources of spill-over, demand for tail protection will rise and the forces of supply and demand (capital) will push the VIX higher.

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