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2012: A Trader's Odyssey

Tyler Durden's picture


Submitted by institutional trader Paulo Pereira, currently on sabbatical

Global market Musings: Volatility And The "Backstop"

I recently received the following question from a friend of mine and wanted to share my thoughts with my market pals, and throw this out for feedback.  I would be particularly interested in hearing from my derivatives friends who are much more technically informed than I am on the subject.

“I was looking at something today that I thought you would probably have some comment on:  have you noticed how wide the out months on the VIX are versus the one or two month?  How are you interpreting this?”

From my viewpoint this has been a key debate/driver in the equity derivatives world for a good while now (I started having this discussion in early 2011 with some market pals and the situation has only grown more extreme since then).  One excellent resource on the subject I would encourage everyone to follow is the work done by Artemis Capital, a volatility fund run by a fellow named Chris Cole.  His letters are heavily technical but he does a great job of discussing the volatility landscape and market topology.  I know it's a bit of heavy reading, but if you really want to get to the bottom of this, here is his website link: ... Just scroll down the page for the summary of each letter.  Specifically, I would encourage you to read the paper Volatility at World's End from April 2012 (see the chart on page 6 discussing the VIX curve) and the letter Fighting Greek Fire with Fire from Sept 2011 on volatility and correlation.  I particularly like this quote:

"Like terrorism, we've gone from ignoring the left tail to obsessing over it. I'm not saying the world is suddenly a safe place and deflation should be ignored. It is not that I find the fear of deflation misplaced but rather mispriced. Those who defend this cost of insurance will tell you the probability doesn't matter as much as the extremity of the outcome. While there is truth in this rebuttal it still doesn't address what happens to volatility when all these buyers look to cash in on their expensive tail risk insurance all at the same time. The jackpot is a lot smaller when everyone owns a winning lotto ticket. All that expensive protection will likely underperform expectations and in the end you would have done better hedging closer to the odds. It is hard to make money knowing what everyone else already knows.  I'd rather spend my time imagining what unforeseen risks are not priced into the market. Is there something that will be as obvious tomorrow as it is laughable today? I sincerely hope the future vindicates current monetary policy but it is unwise to have blind trust. If global central banks are willing to protect us at all costs against deflation then who will protect us against the central banks?" - Volatility at World's End, page 8

But back to the question – how am I interpreting this?  In my own modest, undereducated opinion, I think the volatility curve reflects two simultaneous dynamics.

The first dynamic is in the long end, in the variance/swap market for longer dated volatility (>1yr) which remains stubbornly elevated in the upper 20s or higher, even though realized vol is nowhere close to this... why?  Yes there are plenty of folks who believe the Great Depression 2 has arrived, but even during the early 1930s, volatility did not realize 30+ except in very short stretches during the decline.  Nobody I know is seriously buying longer dated implied vol in size at such levels, so what gives?  I think the problem is not with demand for long-term protection but with supply, i.e. who would the natural seller of long-dated 30+ vol be.  Buffett?  Insurance companies?  Yale/Harvard?  The reality is nobody in the financial has long-term balance sheet visibility AND security of funding, and I think this is a symptom of how the Fed and govt intervention has farked up everything by preventing the market from clearing through actual price discovery over the past five years.  Few investors fully trust a non-government counterparty to be there to pay out a few years down the road, and private entities struggle to retain the balance sheet funding to commit as a seller of vol and "ride out" the immense carry available (the Harvard endowments should be ALL OVER THIS imho, as you could easily extract double digit returns riding down the vol curve assuming you have the balance sheet to take a MTM hit when "shtuff happens").  Come to think of it, if major technology megacaps can place long term debt at extremely low rates, why not go into the long-term carry finance business by issuing a 10-year 2% coupon and use the proceeds to continuously sell 1-year variance for a low-double digit unlevered return?  I would prefer this to a dilutive acquisition, but I doubt any investors would be pleased!  With capex, staff, and economic outlook being what they are -- what else you gonna do with the money?  Somebody should call Breitburn (Apple's cash manager in Nevada).

The other dynamic is in the short-to-mid market for vol, which remains in severe contango (the premium of VIX futures over spot my friend described).  I chalk this up to the unrelenting efforts over the past three years by policymakers whose third mandate appears to be to stick-save stocks no matter what and “kick the grenade down the road.”  I fear this has conditioned long-biased cash investors that stocks always come back (I have written about the dangers of this psychology in Global Market Musings earlier this year).  But this psychology of "the Big One may come… just not yet" is faced off against the ever present "event risk" – the gap risk that keeps premiums elevated a few months out.  The “system would blow big ...if it does blow...which could be in a few months, but not this week" sort of thinking perhaps?  This has led to an unbelievably profitable "carry" (short gamma) business for derivative dealing desks on the Street these past two years – in fact, of all my market pals, the only ones I know who are having a great time on the sellside are those whose job it is to trade equity derivatives.  They are killing it because ultimately their job comes down to collecting steeply overpriced insurance products…in the short run.  Sure, some buyers of that insurance suffer from what I call the "Paulson factor" (wanting to be the short hero when everyone is long).  Chris Cole's quote earlier about the jackpot being a lot smaller when everyone has a winning lotto ticket is very apropos.  But it also reminds me of a quote I read many years ago: “The moral is clear. When Wall Street appears in genius mode, raking in huge profits on mysterious products and complex trades, the secret isn’t genius at all.  It is that hubris is running wild, and so is risk.  And whether it’s tomorrow or five years hence, risk will jump from the shadows, knife in hand, to cut genius down to size.” (Fortune Magazine, 26 November 2007)

Ultimately what I'm saying here boils down to this: unceasing market intervention has crushed the forward-looking expected returns for pretty much every asset class out there: rates, credit, HY, equities, equity with overlay/protection strategies (calls too cheap), long/short, macro, relative value, you name it.  The Feds have done much more than just peg rates to zero and sit on the yield curve – they have quite literally stripped the investment management industry of most (but not all) alternatives for generating a decent return in the future by convincing the trapezing investment community that there is a safety net.  This belief heuristic pulled investment returns into the present by rallying EVERYTHING.  This is simple math, but hard to stomach for the investor who's career is on the line if he's not “chasing” or “in the game.”

While I remain sympathetic to the left tail of deflation as the probable outcome (the risk is real, but yes the risk has been overpriced by protection buyers for some time now, as Chris Cole points out), I have been thinking a lot lately about something else that's bugging me about the right tail.  I recently went back to my notes from late 2007 and found an old rant that I wrote at Citi where I discussed Bill Ackman's Pershing Square presentation on shorting MBIA and Ambac.  Those were his high conviction shorts on account of their overwhelming exposure to junk mortgages – and as it turns out they were some of the “AAA backstop” to the whole shadow banking system when it came to shoddy mortgage securitizations.  Ackman’s view was, even if subprime is only a $100bln problem that is 'contained,' the claims that MBIA and AMBAC might have to pay out were so huge relative to capital cushions that they would quickly overwhelm the balance sheet and send these stocks from $80 to zero, quite literally on a razor's edge (did I mention these were AAA rated!!).

In recalling this recently, it suddenly occurred to me that we are into something comparable but possibly far more serious today.  The idea of how pressure in complex systems builds up over time... that complexity and connectivity magnifies contagion mechanisms both seen and unseen... and yet asset prices no longer reflect much worry for future risks ... why exactly?  Because the Federal Reserve has become the ultimate backstop, just as the fixed income derivatives guys on the trading floor upstairs thought they could rely on Ambac and MBIA.  I hate that this seems to head down the goldbug rabbit hole, but where else does this go?  The real convexity... the real non-linearity payout today... it's in betting on the failure of the optical backstop just like it was back then – the thinly capitalized, AAA-rated guys who are purportedly smarter than everyone and happily set up a business where they guarantee immense risks and collect what they think is a sufficient premium that turns out to be laughably insignificant.  Today MBIA and AMBAC are no longer in business – by this I mean their "guarantee" is not worth much for any future underwriting.  So who took their place, figuratively speaking?  Whose balance sheet is the ultimate backstop to reckless financial speculation?  Who created Too Big To Fail?  Who says "Hey, I have the ultimate liability here, but don't sweat it cuz the worst case scenario is simply impossible"... do you see where I'm going with this? 

Now to be clear, I have owned boatloads of silver for years on a thesis that has nothing to do with currency failure or printing money or all that "goldbug stuff"... but I am starting to grow sympathetic to their arguments.  After all, what would you own when the market decides to test the backstop on an immense amount of risk, and the backstop turns out to be a guarantee from a thinly capitalized entity that loses its sanctified status in the eyes of the market at the worst possible time?  What's the hedge to that?  I can only think of real assets like gold, farmland, etc.  Frankly, for all this talk about owning equities as a defense to a currency or sovereign debt crisis, I'm not entirely sure that owning fractional shares of American businesses is a suitable form of protection in a chaotic environment where interest rates, foreign exchange, and global capital are flying around like "a loose cannon on the deck of the world, amid a tempest-tossed era" (President Herbert Hoover from his memoirs in 1931, as quoted in Charles Kindleberger’s The World In Depression 1929-1939, p. 148).  After all, equities are as dependent on an internal rate of return in determining their value as bonds are – so how are equities a hedge in all this exactly?  People in equities tell me all the time "don’t fight central banks" – but isn’t that like saying Ambac’s insurance is "money good"?  The Fed may be the biggest bank in the world, but they're still just a bank making a promise.

So back to the short-term vol contango issue... are the derivative dealing desks conducting similar MBIA-style activity in the equity markets?  Selling overpriced insurance for a few months' duration has been a great profit center for them and if current conditions persist, good times will abound.  But if the ultimate outcome is one where we wake up one morning and S&P futures are locked limit down with one contract traded at the limit, then yes, derivative dealing desks might just be the new Ambac sellers of protection for equities, figuratively speaking.  Are the Feds going to take on these liabilities as well?  Is that what “Too Big To Fail” has come to?  I am not saying this is going to happen.  But this is why I presented the possibility back in April that at some point in the future we may see equity markets trade like grain futures, gapping around at the limit while attempting to clear.  Yes, yes, I know the Feds would “never allow this.”  But frankly this scenario doesn’t even worry me so much anymore from a systemic point of view, because how often and to what size do stocks turn up as collateral in another obligation?  The Rate & FX derivatives market is measured in hundreds of trillions, whereas the equity derivatives market is measured in trillions.  Maybe equity protection buyers are operating in the wrong market – maybe the convexity and non-linearity of the payout is in the rate and FX market, not the equity market.  Maybe the goldbugs are on the right track.  But my gut tells me the big Paulson trade is not betting on a stock market crash – because even if stocks were to crash, the protection is so expensive that to bank a 25:1 return means 1987 on steroids in terms of outcome.  The asymmetry is to be found in the markets with the “ultimate backstop”…the Federal Reserve.  Somewhere in there is an Ambac trade.

Of course I have to caveat all this by saying if there is one lesson I can take home from the past two years, it’s that the inevitable and the imminent are quite different things.

As always, I would love to hear your thoughts.  With kind regards,

Paulo Pereira


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Tue, 12/04/2012 - 23:20 | 3034594 UP Forester
UP Forester's picture

There's still flesh-and-blood traders?

Tue, 12/04/2012 - 23:28 | 3034618 Mr Lennon Hendrix
Mr Lennon Hendrix's picture

Yes but they are half ape.

Tue, 12/04/2012 - 23:44 | 3034657 TruthInSunshine
TruthInSunshine's picture

I can provide an abridged summation of this article for the TL;DR crowd.

Bernanke broke ALL markets. You can gamble all you want in those extraordinarily rigged play areas, but do not consider yourself as a "trader," "speculator" or "investor" in terms of the former meaning of those descriptions, because they're dead & buried.

Tue, 12/04/2012 - 23:53 | 3034671 Mr Lennon Hendrix
Mr Lennon Hendrix's picture

You have to give it to money managers, who have been in the business for over 20 years.  They must feel like war heros.  They have kept their investors in the markets through highs and lows and kept their dreams alive. 

They are either really good liars, are extremely gulliable, or really stupid.

Wed, 12/05/2012 - 00:15 | 3034719 Dr Benway
Dr Benway's picture

Correction: they are all three

Wed, 12/05/2012 - 00:48 | 3034771 rocker
rocker's picture

Absolutely, there is no Free Market. It is all manipulated as the powers to be at the FED will have it. Price is Not Truth.

They make it what the want to serve the bankers. Which happens to the be the primary function of the FED.

Wed, 12/05/2012 - 02:01 | 3034846 old naughty
old naughty's picture

but the Space version, a celestial new baby was born!

Don't we get one?

Such is hope. We need it.

Wed, 12/05/2012 - 07:55 | 3035000 GetZeeGold
GetZeeGold's picture



Buck up amigo.......they only hand out trophies to movie stars.

Thu, 12/06/2012 - 01:13 | 3038293 old naughty
old naughty's picture

I get it...

Teleprompter 4ever.

Wed, 12/05/2012 - 10:51 | 3035470 Common_Cents22
Common_Cents22's picture

Toll booth collectors are selling themselves short.  Instead of collecting $3 per car while getting paid $15, they could be collecting 2/20 on a billion or two.

Wed, 12/05/2012 - 00:53 | 3034780 forexskin
forexskin's picture

or even more simply, the too biggest to fail put is good until it isn't. we need when for the money shot.

oh, and the only bombproof anything has to be no one else's liability. now, lemme think....

Wed, 12/05/2012 - 04:51 | 3034922 Daily Bail
Wed, 12/05/2012 - 07:52 | 3034999 BigJim
BigJim's picture

LOL, talk about a distorted headline

Wed, 12/05/2012 - 07:58 | 3035008 GetZeeGold
GetZeeGold's picture



What was the subject again?

Wed, 12/05/2012 - 01:43 | 3034834 Unprepared
Unprepared's picture

Despite the fancy language, I still give this guy credit figuring out, however late to the party that might be,  the huge fault-line we are sitting on from reading market pricing topography. The Bernank putz now apply to the global paper-priced markets and not only the TBTF's.

So if everybody is BTFD like there is no tomorrow and at the same time buying expensive Chairsatan-approved Indulgences for Judgement Day (this shit is indeed of Biblical proportions) which is as everybody knows is the day after tomorrow, what would happen when everybody realizes that actually the Singularity is ocurring on a non-Business day, that their Messiah's bread-multiplication trick doesn't work anymore, that their PDGW (people doing God's work) have no underwears under their robes, that the ever-wider inverted pyramid couldn't be kept on its head any longer and just been sucked to the ground?


I tell you what, make sure you have enough bread, an extra pair of underwears and plenty of physicals when that day comes.

Tue, 12/04/2012 - 23:44 | 3034659 ACP
ACP's picture

As is Obernankape.

Here's a video of when he discovered how to bludgeon the middle class:

Wed, 12/05/2012 - 00:00 | 3034690 HungryPorkChop
HungryPorkChop's picture

Wait, is that my mother-in-law's photo that was used?!  Not cool Zero Hedge, Not cool... 

Wed, 12/05/2012 - 06:38 | 3034966 NoClueSneaker
NoClueSneaker's picture

( ... another keyboard wrecked ... ) 

Tue, 12/04/2012 - 23:45 | 3034664 PeteJE
PeteJE's picture

The algos make this so much easier for those of us that never consider anything but price patterns and footprints; they tend to leave easy clues.

Tue, 12/04/2012 - 23:21 | 3034595 wee-weed up
wee-weed up's picture

The superior monkeys of Wall Street!

Tue, 12/04/2012 - 23:25 | 3034601 francis_sawyer
francis_sawyer's picture

Itz a 'Blue Danube' waltz into oblivion... Might as well face it... [KING] Dave...

Tue, 12/04/2012 - 23:26 | 3034612 fonzannoon
fonzannoon's picture

"I hate that this seems to head down the goldbug rabbit hole"

The coke and hookers rabbit holes days are numbered.

Tue, 12/04/2012 - 23:33 | 3034626 CunnyFunt
CunnyFunt's picture

Enter bathsalts and toothless crack hoes.

Tue, 12/04/2012 - 23:50 | 3034677 Karlus
Karlus's picture

Dont talk down either until you have tried them.

Tue, 12/04/2012 - 23:33 | 3034628 akak
akak's picture


Now to be clear, I have owned boatloads of silver for years on a thesis that has nothing to do with currency failure or printing money or all that "goldbug stuff"...

Because currency failure, printing money, or all that other "goldbug stuff" simply can't happen here ... right?  Right?  Exponentially rising governmental debt, and concurrent debt monetization, always ends in good times, right?

Tue, 12/04/2012 - 23:40 | 3034644 fonzannoon
fonzannoon's picture

Akak it's the end of the steakhouses and backslapping that he fears most.

Wed, 12/05/2012 - 02:10 | 3034853 asteroids
asteroids's picture

Let's flip this around a bit. Based on the last 100yrs, what is the risk of owning silver? Zero. What is the risk of a market implosion? Unknown but significant. What would you perfer to own?

Wed, 12/05/2012 - 08:03 | 3035014 Cosimo de Medici
Cosimo de Medici's picture

Thank you for that bit of clarification on risk, Mr. Nelson Bunker Hunt.  Sorry I forgot the card for your 100th birthday.

Tue, 12/04/2012 - 23:38 | 3034630 Godisanhftbot
Godisanhftbot's picture

   How is silver gonna help you when all the smart people will be looking to sell silver to all the dummies who don't have any, or anything to trade for it?


  What you need are 16Oz bars of Hershey's. Or maybe a collectors tin of Twinkies.


 **** NEWS ALERT ****

The sperm count of French men fell by a third between 1989 and 2005, a study suggests.

The semen of more than 26,600 French men was tested in the study, reported in the journal Human Reproduction.


Tue, 12/04/2012 - 23:44 | 3034660 UP Forester
UP Forester's picture

Lemme guess, you were the fluffer for that test, eh?

Wed, 12/05/2012 - 00:07 | 3034707 Godisanhftbot
Godisanhftbot's picture

Lemme guess, you're French!

Wed, 12/05/2012 - 01:04 | 3034796 CPL
CPL's picture

Could you recognize him by his penis if he were french?

Wed, 12/05/2012 - 09:42 | 3035179 Cypher_73
Cypher_73's picture

I could.

Tue, 12/04/2012 - 23:45 | 3034661 TwoShortPlanks
TwoShortPlanks's picture

They always said the Frogs would go first

Wed, 12/05/2012 - 00:32 | 3034747 palmereldritch
palmereldritch's picture

The key is to boil them slow.

I think there's an App for that

Tue, 12/04/2012 - 23:46 | 3034667 Glass Seagull
Glass Seagull's picture

In totally unrelated news:

French men decide to take on a second mistress as the probability of getting her pregnant is lower than originally thought.

Wed, 12/05/2012 - 00:09 | 3034710 ISEEIT
ISEEIT's picture

Thanx for that..Truly good news is not common in these times.

Wed, 12/05/2012 - 05:30 | 3034942 bobthehorse
bobthehorse's picture

Investing in canned food and ammo is the way to go.

The sky is falling.

Don't put your hope in money.

I see war in the future.

Tue, 12/04/2012 - 23:37 | 3034634 magpie
magpie's picture

I hope i fucked up tptb's day enough by their stophunting from 129 to 131 EURUSD

Tue, 12/04/2012 - 23:45 | 3034665 Mr Lennon Hendrix
Mr Lennon Hendrix's picture

The only way to kick tbtf in the balls is to buy silver.

Tue, 12/04/2012 - 23:47 | 3034670 Karlus
Karlus's picture

My thoughts? Double long Gold, bitchez

Tue, 12/04/2012 - 23:48 | 3034672 So Close
So Close's picture

Where can I buy long dated VIX coverage on treasuries?  And who will backstop it?

Wed, 12/05/2012 - 01:06 | 3034802 CPL
CPL's picture

Right now?


It's anybody's guess.

Wed, 12/05/2012 - 10:54 | 3035488 Common_Cents22
Common_Cents22's picture

The eagles answered your question to counterparty risk.


"You can check out any time you like but you can never leave."

Wed, 12/05/2012 - 00:01 | 3034674 tickhound
tickhound's picture

 Everyone buys the "kick" not the "grenade"

 Good article. 

Tue, 12/04/2012 - 23:56 | 3034687 Mactheknife
Mactheknife's picture

Hey Paulo...just keep on thinking out're getting there!  Good stuff!

Wed, 12/05/2012 - 00:02 | 3034698 ReactionToClose...
ReactionToClosedMinds's picture

again .. thank you ZH ...... another insightful post & assessment.

All any of us can ask is for an adequate thought process ... after that we are all on our own ....


Wed, 12/05/2012 - 00:07 | 3034706 Whiner
Whiner's picture

Derivatives: the ultimate fiat. Sell em if you gotem as long as you can. They will never payout during the big cascade house of cards. Garner them premiums, blow the coke and do the ho's, for tomorrow you're dead.

Wed, 12/05/2012 - 10:57 | 3035495 Common_Cents22
Common_Cents22's picture

Popeye's Whimpy was the original derivatives inspiration.


"For a cashburger today, I'll gladly pay you on tuesday, 2067, or not."

Wed, 12/05/2012 - 00:08 | 3034708 fourchan
fourchan's picture

the re-exaluation of all value, the most terrible process a man can face.



its comming.

Wed, 12/05/2012 - 00:10 | 3034713 Godisanhftbot
Godisanhftbot's picture

  The best thing would be to die of old age a day before the Krapp hits the fan.



Wed, 12/05/2012 - 01:12 | 3034805 Bear
Bear's picture

Having sired or birthed no children or having any friends or friends who have sired of birthed children

Wed, 12/05/2012 - 12:04 | 3035808 Canucklehead
Canucklehead's picture

Are you saying you sire children of the world?  Are those kids the collective responsibility of all those walking the face of the earth?

Do you teach your children any sense of responsibility?

Do you simply indulge them in any craving they may have, physical and metaphysical?  Do you simply rely on the social safety net to provide for their needs as you have decided "I'm out of here"?

Wed, 12/05/2012 - 00:44 | 3034760 jballz
jballz's picture

jesus fucking christ that was a long winded piece of tripe.


Vol contango is better understood from the perspective of the seller. If you back out of this clusterfuck and view it from the shoes of we who are short long term volatility, it doesn't take a thesis paper to explain.

You think I am going to sell you VIX at 15 6 months out, ever?

Fuck no. The floor is the floor. We've been on the floor for months because every market has been lateral for months.

Why would I sell the back at the floor when the only two outcomes are flat (in which case I shave a couple points in bleed) or higher and potentially much higher.

It's not worth buying, and it's only worth selling unless you hedge. The cost of hedging short vol is the premium priced into the back months. There's a little edge but hardly worth the risk. That's it, that's the whole fucking story here.

If you want to buy protection. left tail risk in your geeksplanation, find a contra-correlated market. It isn't that hard in most cases.

The same people buying long term VIX protection are the ones who buy CDS on US treasuries. Absolutely fucking brain dead eggheads with too much OPM.

Wed, 12/05/2012 - 02:05 | 3034852 ebworthen
ebworthen's picture


Thanks for that.  +1.

Wed, 12/05/2012 - 00:52 | 3034779 q99x2
q99x2's picture

Let the FED buy all the treasury crap. After it is over the government can change the laws and arrest those fools.

Wed, 12/05/2012 - 00:52 | 3034781 MyBrothersKeeper
MyBrothersKeeper's picture

As Kyle Bass and others have stated frequently, volatility is being majorly suppressed by central bank controls.  IMO, what it will take for volatility to really be a player again are unforseen, uncontrollable events.  The huge Vix jump in summer 2011 was largely due to US debt downgrade after Tim "I knew about the libor manipulation and did nothing about it, but don't call me Joe Paterno" Geitner said there was no chance of a US debt downgrade...until it happened.  Since then most of the problems in the world have been pretty much smoke and mirrored away by central banks, politicians, and sheepish media. Again, as stated by many, their goal is to smooth out the business cycle to prevent boom/bust types of events that rattle investor confidence....and to their credit they've done a good job convincing almost everyone that better days are just around the corner. The perception that the debt crisis is contained is based solely on the goal of preventing anyone from all costs.  The perception that the world is safe is based on the goal of keeping conflicts within countries and not against other countries. That unemployment is contained as long as the official rate stays within a psychological margin.  But as fundamentals continue to erode those perceptions, it becomes harder and harder to keep the dam from breaking. Once it does all those who created this mess will be the ones spouting that "nobody saw this coming".

Wed, 12/05/2012 - 07:30 | 3034986 Howdan
Howdan's picture

+1,000,000 Wow. Great comment - You sum up EXACTLY what the current (farcical) situation is. My view is similar to yours that they can only keep "stuffing the bad news under the carpet" for so long until eventually it all erupts from underneath them in a massive tidal wave (market crash).

Trouble is, who knows when that will happen and what the catalyst will be to cause the fundamentals and market prices to reconnect again?

Wed, 12/05/2012 - 12:17 | 3035858 MyBrothersKeeper
MyBrothersKeeper's picture

Exactly.  My personal bout with volatility. I made about 100% return on leveraged Vix products last year.  I sold out and waited until it dropped to around it's 52 wk low this spring and went back in. And have lost the position including last year's gains because the powers that be, especially in an election year, were sure as hell not going to let implied/actual volatility get out of hand.  Had I been wise enough to see that the central bankers/politicians would sell their souls and their countries to the devil to prevent political fallout and/or losses by bankers I would have stayed long the XIV (inverse volatility)....which is now up about 275% since last November's lows. Conversly, I could have held SPXU (3x bear SP 500) and only be down a fraction since it's actually tied to an index.  My point is the same as the article states...if you are going to be a bear look more at specific company's/sectors.....although you would probably be ok doing a long straddle on something like the vixy around artificial deadlines because those tend to make the market spike for a afternoon or day.

In the big picture, as you state, what form the black swan takes is the unknown.  I suspect a major unexpected attack on Israel, a cyber attack of epic proportion, a non-Greek country defaulting, a major earthquake in US....I don't know.  But it would have to be major and unexpected as the bankers and politicians are constantly refining their spin to ensure that almost nothing causes panic. So I suspect most of the forecasters will be right about 2013...the markets will be up 5-6% but the fundamentals will continue to worsen and the math challenged will wonder why they can't afford to go to Disneyland AGAIN this year and everything will be fine....until it isn't.

Wed, 12/05/2012 - 11:00 | 3035508 Common_Cents22
Common_Cents22's picture

so basically, we are getting pissed on and told its raining.   Got it.

Wed, 12/05/2012 - 01:00 | 3034787 chump666
chump666's picture

The 'real' human traders, mostly larger players are getting played by the HFTs that have supported all the moving averages, and yes the machines at this point in time have kept a lid on volatility.  The nerds programming those HFT have possibly updated the algorithm, made it smoother.  But it is an illusion, it's like long positions on top of micro second scalpers are asking for a ball rip.  And it will be juicy... 

Wed, 12/05/2012 - 11:03 | 3035526 Common_Cents22
Common_Cents22's picture

HFT are no more than toll collectors with little or no risk.   Skimming a transaction fee out of the market every millisecond all in the name of liquidity!


Here's a liquidity scenario explained as a boxing match.


You got one boxer who can punch/duck 10x a second against a boxer who can punch/duck 3x a second.    One will never land a punch, the other will never get hit.    But look at all the additional liquidity punches!!!!


Wed, 12/05/2012 - 01:18 | 3034811 freedogger
freedogger's picture

So what's the issue then with buying VXX leap puts durring a downturn? Seems like a sure thing from all the research I can find.

Wed, 12/05/2012 - 08:15 | 3035021 Acet
Acet's picture

The secular debt cycle has peaked (thanks to Central Bank intervention, said peak was much higher than ever before).

The USD is the World's Reserve Currency but is tied to a country which is has entered economic, military and social decay (i.e. falling empire) and is also the target of most monetary abuses (money printing, huge irreversible deficits) so there is a huge risk of a great unwind if the USD stops being the World's Reserve Currency.

Hence there's a non-linear set of outcomes long term in the current situation with regards to any USD-denominated paper assets and derivatives:

  1. A slow, proacted downturn - stagflation - with near-zero economic growth and the dollar (and, thus, dollar-denominated assets) loosing most of their value (i.e. the FED "solving" the debt problem by inflating away the value of the currency)
  2. A sudden unwind and systemic crash (think Treasury fire-sales and multiple simultaneous bank failures).

In the first scenario, your VXX leap puts are going to be worth very little in real terms if and when you exercise them and in the meanwhile your money will be locked in a dollar denominated asset. Remember, puts have a limited upside (i.e. max profit is the VXX being zero).

In the second scenario, your VXX puts will be out of the money, since volatility will go sky-high. Even if you had calls, most counterparties will likelly be bankrupt anyway making them likelly worthless.


Wed, 12/05/2012 - 02:03 | 3034849 ebworthen
ebworthen's picture


Wed, 12/05/2012 - 02:22 | 3034858 resurger
resurger's picture

Volatility suppression by Fed trading Desks, i got sick of it .. VXX , VIX i dont buy that any more, all rigged

Wed, 12/05/2012 - 02:22 | 3034859 Island_Dweller
Island_Dweller's picture

First Buffett's Gen RE says: “We hope that this analysis is wrong. We fear that it is not.” and now Paulo Pereira says "I hate that this seems to head down the goldbug rabbit hole, but where else does this go? "


I think we're getting close to the next stage of this bull market......

Wed, 12/05/2012 - 03:30 | 3034892 ebworthen
ebworthen's picture

The markets are a Ponzi.

Reading this is like listening to a gambling addict make a confession about how they bet the horses or teams.

Wed, 12/05/2012 - 03:42 | 3034896 IridiumRebel
IridiumRebel's picture

Fuck trading.

Long metals.

Wed, 12/05/2012 - 04:13 | 3034906 mt paul
mt paul's picture

fuck a 32 yr old hard body

long metals...

Wed, 12/05/2012 - 04:19 | 3034911 Rathmullan
Rathmullan's picture

It's a good sign if your short. Says the morons who pumped this market on light volume in response to tax cuts, "stimulus" spending and quad b's QEs to infiniti know the statists are out of bullets. But now they're trying to bluff one another out of that last nickel. Booking 2012 performance combined with a recognition that the community organizer lame duck in the oval office has a  point to make and that the republican leadership couldn't negotiate a fish into water tells me this Hindenburg redux called the stock market is about to light up (and succumb to gravity). "Oh, the non-humanity!" 

Wed, 12/05/2012 - 07:19 | 3034954 falak pema
falak pema's picture

In the race to the bottom behind the Oligarchy curtain; where these US hedge funds drill holes into the hull of the very Titanic on which they sit, here is what happens in this mad game of Casino Capitalism gone cannibalistic for compulsive reasons of short term greed; the very essence of US capitalism today :

The European Comeback Crushed Hedge Fund Manager John Paulson - Business Insider

Enjoy the HF plays on Japan and China, and then on Municipal USA and fiscal cliff disarry; when you eat your own tail you are truly the snake that mutates into snail. 

Not that Eurozone is any better; land of blatant corruption gone viral; both on continent as is City-shitty tower of fiat babel. 

La corruption continue de faire des ravages en zone euro

Grande-Bretagne: Osborne va admettre que la rigueur peine à porter ses fruits

Considering this very well written article its a true Odyessy and a pleasure to read and ponder over.

Just a remark : Michael-Angelo portrayed in his Cinemascope representation of the Sistine Chapel, his masterpiece for the ages, that art was ALSO the language of the Gods, as of Man, and although he was no philosopher and mathematician, like de Vinci, he was a humanist whose contribution to human progress could be summarised in one phrase : when theocracy progresses human chronology regresses. For Man to progress he has to abandon the theocratic world of dogmatic certitude, but not its spirituality which is by definition uncertain, eternal quest. It was true then, it is true today in Moslem world. It created then the war of religions as neither Pope nor Luther got that message, until Enlightenment emerged and made them both relatively irrelevent to western progress.

Today in the post modern world the Market is the the Economy and thus new God. And we see the same theocratic battles between supply side and demand side or PM side theocratic schools. Its stifled the flame of innovation.We need more TRUE Michael Angelos today.

As the article rightly points out we need philosophers today to unravel the theocracy of current economia,  based on unlimited debt, global networking  and consequent higher societal risks into something more simple and local. Where humanity is the focus not post modern theocracy of risk asset pumping into the deflationary hole; that age gave us Erasmus and Thomas More. 

To push the Renaissance age analogy to its geo-political conclusion : the universal Empire of Charles Vth failed then, beacon of globalisation, like that of rival Soliman the Magnificent of similar bend. The nation states of Europe emerged, they were more manageable from a risk-return perspective. We could probably learn from that today!

Pax Americana unravel....

Wed, 12/05/2012 - 06:19 | 3034958 chump666
chump666's picture

some messy profit taking on the EUR...

Wed, 12/05/2012 - 06:42 | 3034965 DollarDive
DollarDive's picture

I've been following this blog and Tyler's thoughts for some time.  I used to be in the business and left in 2008 - on my own.  I walked away from a lucrative business - because I thought that it had become a complete farce.  I couldn't keep clients in the market -  given what I believe about the future and how markets should truly operate.  That being said...... the question in my mind that I can't answer revolves around Japan.  Think about Japan and how they've been broker than broke for years.  They had their market collapse - yet they continue to print and print and print... and it has somehow worked for them.  They are still here.  

What does this say about financial markets in general ?  Failure of the system is just a perception.  The next day does come.  Markets continue to operate as long as we permit the FED to print money endlessly and set the rules to the game.  We all know in our guts that FED has made the rules as they've gone along.  This has been permitted.

Why ?   How does an organization like the FED get the free pass to change assumptions, make rules, and print money to buy our bonds to keep the game alive ?   

I can't answer this question, but it bothers me.

(I just read the following article on Japan- funny - I read this post prior to reading the next article)... My thoughts exactly.  I guess that our equity markets will follow Japan until we stop the printing of money and return our capital markets to what they used to be.

Great article Tyler.

Wed, 12/05/2012 - 06:45 | 3034970 luna_man
luna_man's picture



Well, this just goes to show you, not even the most astute, know how bad it's going to get...


Don't even, hope for the better!...PLAN for the worse!!

Wed, 12/05/2012 - 08:00 | 3035009 Cosimo de Medici
Cosimo de Medici's picture

Because some risk can be hedged, markets assume all risk can be hedged.  Grain farmers and General Mills, however, are the exceptions.  AIG is the norm, writ large.  The derivative bomb is floating about looking to alight in the lap of the most foolish, most brazen, or most well-connected.  That risk does not go away, and it can't be fairly priced at anything except full value.  It's the Old Maid.  When the last card is drawn, someone is left holding it.  Booms in a fiat/fractional reserve world are merely periods of mispricing risk.

Wed, 12/05/2012 - 08:07 | 3035018 overmedicatedun...
overmedicatedundersexed's picture

in the art of war deception is key: managed information is so easy today... you can only invest if you are in a position to know the direction of the deception, profit is then certain..fix the horse race and you know the outcome.

H Paulson, Ben, Timmy, Greenspan, Bush, Obuma..who would you trust your child to?

Wed, 12/05/2012 - 09:20 | 3035111 riphowardkatz
riphowardkatz's picture

That is easy, Bush or Greenspan,none of the others.

Wed, 12/05/2012 - 11:08 | 3035553 Common_Cents22
Common_Cents22's picture

Exactly, but its real tough to figure out the deception direction on a daily basis.


It is similar to poker, don't play your hand, play the players.  

Wed, 12/05/2012 - 08:26 | 3035034 ZeroPower
ZeroPower's picture

Fixed income trader here, just chiming in.
Good article Paulo. last paragraph is fucking SPOT ON about the supposed convexity traders are hunting for In the completely wrong markets. People assume that because 2009 is so recent, as well as the flash crash, and then the swoon of 2011 with Europe (almost) blowing up, that the markets most affected are stocks (more particularly, e-minis). These are the same retail traders who literally watch cnbc for stock tips thinking the info is still fresh once Pisani or whoever spew it our of their mouths.

I'd like to point those very people to the Euribor, Eurodollar (rates, not FX!), short stirling, etc markets. Those things have all been near 0 for the past little while now, due to the ridiculousness of the US - sorry - the WORLDS central bankers. Once there's any real hint of Inflation seeping in, these products are going to move and move big. Will love to see who the "smart" people were on the Street who have been collecting small (but often) in this new environment and who will blow up à la MFG once CBs can no longer handle the pressure and are forced to rise. The market is smarter, and will price this in at least a few months before it actually is announced. I suspect, even before "late 2015".

I have nothing to add about vol markets since you did a good job in your article already, and ditto to the reason why vol is steep in the back and at totally unrealistic (unrealizable!?) levels - lack of inventory.

Wed, 12/05/2012 - 10:13 | 3035214 DollarDive
DollarDive's picture




This is the same thing that everyone is thinking...nothing new here.  

When rates go up... they will go up.  So what.  Do you think that the Central Bankers will let that happen while everyone is watching their screens tick by way.

Rates don't have to go up in order for you to lose everything....think about it.  Spike in rates would be disastrous for financial markets, derivatives etc.  That's why it's not going to happen that way.

Rates can be kept low as long as you have Central banks that will not stop at printing money.  

What's going down every day, but is not seen on any charts is everyone's standard of living.  It's happening drip by drip day after day.  Rule of Law is fading.  Individual Rights.  Big Brother getting Bigger, Endless spending, Wars we shouldn't be involved in.....Inflation is already here.  Just being hidden (same prices - fewer ounces).

Central Banks tell us all is OK with markets.  Just because markets are solvent - doesn't mean all is OK.  Markets used to be a means for economies to raise their standards of living.  No more.  GONE, are those days.

What's happening is that standard of living in US is declining rapidly.  Healthcare, Pensions, Incomes etc.

Everyone is busy doing their jobs waiting for the "Big One" - hoping to cash in.  Well IMO... it's already happening. It's just a little bit taken away every day.  There's never going to be a calamity that will cause markets to stop. FED won't let that happen.  FACE it.  It ain't happening. 

We are paying.

There's no chart that shows how fucking bad this is becoming.  

Instead - what's happening is the gradual erosion of our daily lives - stadnards of living.  Work more, longer, for less money.... fewer jobs, more regulations higher prices.  This IMO is the failure.

Wed, 12/05/2012 - 11:17 | 3035593 Common_Cents22
Common_Cents22's picture

Yes, low rates are killing us softly.   Robbing seniors/savers fixed income, propensity to save.   Inflation #'s manipulated while real tangible prices go up in energy/food etc...Even if "prices" don't go up, look at the evolution of package/portion size for the same price, it has dropped 10-20-30% and more in some cases.

Low rates encourage malinvestment, especially by friends of DC, "bankers", insiders etc...  The low rates are only available for all those same slime balls in cahoots w/ the FED and DC elites. 

Try and get a mortgage. 

If you are a small/medium business, try to get a bank loan, LOC, etc....its nearly impossible.   This is the death sentence for America.   Small/med business who are our way out are being bled to death and won't expand or hire anyone.

The real America is being strangled.   Or being boiled slowly like a frog.  Peope sense it but can't put a finger on it because they are so brainwashed and distracted by the propaganda media.    Hey look!  Fiscal clifff!!!!

Thu, 12/06/2012 - 08:01 | 3038682 Cosimo de Medici
Cosimo de Medici's picture

Not sure if there is an Ambac or MBIA or AIG trade, but thinking it all over the risk now sits with insurers, as in life, property and casualty.  Consider their business in a ZIRP world.  They cannot make the returns they need to cover their exposure.  The premiums they must demand the longer ZIRP and sideways markets stays in effect asymptotically approach their contractual payout, or even exceed it if one considers their administrative costs.  If they fail to raise premiums commensurate with exposure, then they simply cannot pay out should the need arise.  A bigger Sandy, a major earthquake, a 1918 Spanish Flu-type event wipes out everyone from MetLife to Swiss Re.  Blame ZIRP.

It might even be the insurers who are selling tail risk and CDSs on Treasuries, since for them it is the nuclear option:  they get paid if it's unnecessary, and if it's necessary, they're dead anyway.

Pensions are there, too (ZIRPed).  It will show up (pension-wise) in Japan, since they have the head start on the rest of us, and Japanese accounting peculiarities have already robbed them of any actual gains in, for example, JGBs, over the last two decades.  Oh, and banks such as Tokyo-Mitsubishi, who holds $485 billion in JGBs, have already run the JGB cap gains through the much of their half trillion dollar portfolio is on the books at market.

Fri, 12/07/2012 - 08:24 | 3042047 overmedicatedun...
overmedicatedundersexed's picture

cosimo, that is on point..perhaps they Ambac aig get to go to the discount window and Ben covers it.

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