How to use the Volatility Smile

[00:00:03.28] - Speaker 1
Good afternoon, team. Welcome. Welcome back. Today we had a lot of live sessions. We're very excited to be here again with Ryan. Welcome, Ryan. Thank you for joining.

[00:00:13.25] - Speaker 2
Thank you.

[00:00:16.14] - Speaker 1
Before we start, let me just put our disclaimer for a few seconds and then we get started. Right. So, Ryan, for those, I think you've been with us live, very different occasion. Right. But for those maybe you don't know, you see you the first time, maybe if you could maybe just give us like, like an introduction of, of you, your experience, what you do while we are working together and then we can kind of get started. The goal of this session is to show you how to leverage volatility to be able to understand what's going on in the market. And we're going to go out and see a few of the new charts that we develop. So we have something here on the screen and we're going to go into some details and then we'll open it up for questions.

[00:01:13.19] - Speaker 2
Yeah, certainly. So my name is Ryan Darnell. I'm the founder and portfolio manager of Cyndical Capital, startup hedge fund that focuses right now on friends and family. And we're, we've just finished our third year of, of management and we're going to be looking to scale up here, you know, at the end of this summer. My background, I spent the last 16, 17 years now trading options. I started off at Deutsche bank in the commodities, energy, agriculture, derivatives and options trading. And I've traded everything from physical commodities to, you know, financing structures on commodities and of course, lots and lots of options. In addition to cynical capital, I also help advise some smaller commodity derivatives trading businesses, help manage an options book on exotic options as well. So I have a lot of experience managing, looking at different options as well as, you know, flat price and taking a view on just, you know, regular futures and stocks and commodities. But options are kind of my passion. So, you know, we're starting Volatility Corner, the an ongoing series, well, where we will talk every couple of weeks about what's going on in options markets and volatility in the overall markets.

[00:02:41.25] - Speaker 2
We're still going to be figuring this out, so we're open to lots of feedback. We want to make sure we're talking about things that interest you, but I'll try to go through every two weeks and hit on the key features for probably the most important indices, particularly SPX and qqq. And then if we have time, we may touch on some futures markets, commodities markets, things like gold, crude oil. And we also want to hear from you what stocks or, or markets in indices trackers do you want to focus on and what do you have questions about? We're going to be demoing the relatively new dashboard here that looks pretty slick. And one of the reasons I've worked with Methor Q for so long here is, you know, one of the challenges I tell people, even for, even for, you know, a small, even for a business, even for a hedge fund, if you're not huge, you know, just getting access to quality data and setting that up is a monumental task. I mean, we've spent a great deal of money and time building out our, our, our, you know, various screening and, and data capabilities.

[00:03:50.00] - Speaker 2
And you know, we wouldn't, we would, we would be a lot further behind if it wasn't for mentor queue. So, you know, this is a great tool. It's the same kind of tool that the pros use and they're upgrading it every day, including with guidance from me on what we like to look at. So without further ado, let's jump in. So, so I'm going to start with spx. It's, you know, just kind of the most popular one I think, to talk about. And I'm going to show you three charts that I would, I like to look at. Kind of the first place that I would start if I'm trying to understand what's going on in a market and what the options market can tell us. So this is my favorite chart, the smile chart or smirk. So these are basically what I'd call an implied volatility slice. This is a little bit of a weird chart until you get used to it. But ultimately what this tells you is what implied volatility is for options at different strikes. So, you know, if we're, if at the money is, you know, around here and you want to buy calls, you're going to be looking at something like implied volatility ranging in this kind of sub 20% range.

[00:05:00.10] - Speaker 2
And if you start buying way out of the money puts, you know, your implied volatility starts to really scale up. So the first interesting thing I want to point out about this one for people who haven't seen this chart before, is you can see the puts are a lot more expensive. The out of the money puts are a lot more expensive in volatility terms than the out of the money calls. And what that means is that, you know, for an equal, you know, for an equidistance from the money call and put, you would actually, you would, if you sold the put and bought the call, you would actually receive premium for doing that trade, you'd be net getting paid to do that trade. Or if you wanted to do it at zero cost, if you wanted to sell a put and buy a call and, and have it be premium neutral, not pay or receive premium, you'd be able to sell a put further away than the call. So, you know, just if we were using 5800 is at the money, then, you know, the fifth, if you sell the 5600 put and buy the 6000 call you're gonna get, you're gonna net receive premium for doing that trade.

[00:06:08.19] - Speaker 2
Because these puts cost more in implied volatility terms. And just a reminder for anybody who's still trying to get familiar with options, implied volatility is effectively, you know, the key. There's three key drivers for an option for option price, you know, how close to the money it is, how volatile the underlying is and how much time you have until expiry. And so that's. And you know, whenever in doubt, whenever I'm trying to remember that for our beginners, I just ask myself, if I owned a call option, what would I like to have? I'd like to have the underlying be higher, you know, closer to my strike or even higher above my strike. I'd like to have more time on my option, and I'd love it if the, the thing that I have an option on starts moving more. So you can always remember those three. But of course, how much time you have until expiry and the underlying are known. So, you know, those things don't change. We can check them and just know exactly what they are. The implied volatility is the missing piece. And that's what we go to look up on a chart like this.

[00:07:08.11] - Speaker 2
We say, okay, what kind of implied volatility are we at? And we can see here, if we kind of drill down, we're going to be looking at, you know, something like 18, 19, maybe 20 volatility, depending on what strikes we're looking at if we're close to the money. So that's the first thing. Just kind of walking through what this chart is, you know, something interesting to look at right here is so look at how this change in the put wing. It looks like suddenly puts got a lot cheaper, you know, right around this, right around the 4, 500 to 4, 800 strikes, a lot cheaper, at least relative to where they were a month ago. So, you know, I think that's, you know, something interesting to keep an eye on. We can talk more about maybe a trade idea for the Week later. But you know, my initial, my initial question would be maybe we should be looking to buy puts somewhere in here and maybe sell a put out here and maybe we can get a little bit cheaper put spread if we wanted to buy some protection against a sell off. You know, often one of the cheaper ways to do that is to, you know, buy an option and sell a further out option to recoup some premium.

[00:08:25.00] - Speaker 2
That's particularly attractive with puts because you can see how the further out you go, the more expensive they get. So just outright buying puts on the S and P gets pretty expensive. And I guess, let me give a little more color of why that is. So one of the things that you'll notice or you know, so one of the things as we're talking about why puts are more expensive than calls, one of the things that drives that relationship, it's really two things you have, you know, empirically, like what happens to the market and then supply and demand. So the first one, supply and demand should be pretty straightforward. Most people are long stocks, most people are long the s and P500. And so given a choice, most people would love to buy protection or insurance on their portfolio. Selling off, that's always one of the, one of the biggest concerns. And so there's just a lot more demand for puts. And as the market sells off and people start to panic, particularly people who might have leverage or need to get out of positions in a sell off, they're going to pay even more premium for that and so they're going to drive demand for options even higher.

[00:09:29.29] - Speaker 2
So that's the supply and demand piece and then the other piece is interior. Empirically, what we expect to happen to implied volatility. Well, when does stock markets have big sell offs? Usually when there's a lot of fear, when there's a panic, you know, big economic crisis, financial, you know, some sort of financial or liquidity crisis, Those are typically the things that cause markets to sell off. And so it's usually volatile as it's selling off because of that panic, because is people don't know what's going on. Markets are making big movements each and every day. Whereas when we're rallying, you know, everybody's happy. The VIX is, is typically falling as the market rallies. You know, while there have been plenty of big up years, when you look historically at the s and P500, you typically see that up years kind of range in that 15 to 30%, but really, you know, more in the 10 to 20%. And when they move, it tends to be a lot more steady on a daily basis when they rally. Whereas when you look at sell offs, I mean, sell offs tend to range from 20 to 50%. Not that it's fallen 50% many times, really only a couple examples of that.

[00:10:40.26] - Speaker 2
But, but we've had quite a few big sell offs. And when they do sell off, the, the daily movements have been very volatile. So that's kind of the two reasons that, that, that the SPX looks this way. Now for an individual stock, you might see things a little bit differently. For example, if you're looking at Nvidia and they have a big earnings announcement or something coming up, you might actually see a more symmetrical smile. You might see that investors are about as equally concerned about a massive or options markets are as concerned about a massive gap higher as they are lower. So that's not uncommon for single stocks to have a more symmetrical smile around at the money and then. But you know, at the market level, as you start to diversify, when everything starts to go crazy and correlations tend to go to one in a major sell off, meaning that you'll see all the stocks sell off at once, not just, not just a few. So that's why you can see a lot of single stocks that are fairly symmetrical or even biased towards the upside, you know, because investors are paying a premium for calls for that single stock, but almost never see that.

[00:11:54.17] - Speaker 2
I'm not sure if there's ever been a period actually where puts have been at a significant premium over calls. So that's, you know, quick overview of the volatility smile. And I love this because it's easy to just get a quick snapshot and understand, you know, a little bit more about that market. You know, interestingly, we have a few markets that are the opposite of spx. One that I wanted to call out today. We don't have the volatility smile on this, but I wanted to call out the corn market because we've seen something interesting going on in corn. Typically corn is the opposite. And I'm always partial to corn because I started out as an agricultural derivatives trader. So typically what we would see with commodities markets, and here's the corn futures.

[00:12:47.20] - Speaker 1
Curve.

[00:12:49.27] - Speaker 2
Typically what we would see is when prices are rallying, that's actually when it gets really volatile. And the reason for that is when you look at things like corn, wheat, soybeans, things get really crazy when there's a shortage, you have a drought. You know, farmers can't get the crop planted because of a late freeze or you know, flooding in the fields. It's usually some sort of extreme weather event and that'll significantly reduce acreage or yields. And when we get that. Yeah, so usually you'll see this kind of, you know, hit to yields and that leads to a big price rally. You know, prices take off higher and when that happens, things get scary. Additionally, in the futures markets where I was saying, you know, for the S&P 500, you usually, most people are long stocks, you know, in your 401k, whatever, people are long asset managers. Everybody's typically long stocks because over the long run, we expect a positive return on stocks somewhere between, you know, 8 and 12 or 13%, depending on what historical timescale you're using. So everybody's long. Well, we have the opposite scenario in corn. So most commodity buyers will buy the corn and hedge themselves by selling futures.

[00:14:08.24] - Speaker 2
And they actually have to post margin on the futures exchange if the market rallies. And so they're often buying calls to protect against a massive market rally that'll require them to make a huge cash deposit on the exchange, which they may not have the, you know, to the cme and they may not have the liquidity to do that. So we see the exact opposite. We see the supply and demand is that, you know, so first supply, we talked about spx, the supply and demand people want to buy portfolio insurance in, in the corn market, we see the exact opposite because people want to buy calls to protect against markets going bananas. Also, farmers don't buy puts because they get revenue insurance that's subsidized by the government. And so that also, you know, makes them not really as worried about buying puts. And then we said empirically, that's the other thing that drives the volatility smile is when you see, you know, in the, in the, in the SPX example, we talked about how as prices are falling, there's a panic, so daily moves get quite large in corners. The opposite. There's a panic because there's a drought.

[00:15:16.24] - Speaker 2
So daily moves get quite large, large as you're rallying. But the reason I called out corn today, we're going to jump around every two weeks and talk about something interesting going on in markets is corn is lower and volatility is going up. So you'll see here that over the last month we've fallen dramatically here. We've fallen about 10%, you know, pretty, pretty sizable move here, particularly in the front of the curve in futures markets. So, you know, these are the short dated futures contracts for delivery in like March and May and July. March, May, July, September and You know, when there's a lot of concern that there's not enough to go around, you'll see those go to a big premium over later months. And the reason for that is because in, especially in agriculture is that, you know, there'll be a new harvest, a new crop coming around next. This harvest time for corn in particular is September, October, November is the harvest. So futures prices out there aren't so crazy. But as people get concerned about tight supply, they push this to a big premium. We call that backwardation. And you'll see this in any futures market.

[00:16:31.08] - Speaker 2
So anytime we're talking about gold, crude oil, or agricultural commodities, this can come up. So, so this is a way that the market rations demand. It's pretty cool. You see a big premium in the front versus the back. And that encourages buyers, consumers, if they can, to delay their purchases so they can get a big discount. Look how much that's declined. So look at the green curve here over the last month. So we've had this 10% decline in the front, much less than the back. And now the front and the back are almost equal. You know, the curve's much, much flatter than it was, you know, just a month ago. So you'd expect, okay, people aren't scared anymore. So volume should be going down and it's not. I don't have the historical chart today of implied volatility, but we've actually seen implied volatility go up 3 or 4% for corn and reason, you know, trade, trade, war, tariffs and embargoes, you know, fears around that. So we're having markets sell off as there's an expectation we're going to export less. You know, we're going to export less grain. And a lot of concern over what will the, what will the follow up be.

[00:17:43.27] - Speaker 2
It's very likely that another country will slap tariffs on us. And one of our biggest exports is grain. So we're actually seeing the opposite here. We're seeing volatility spike while markets sell off. And I'm sure, and I'm sure, in fact, I can even say for some of the books that I help with, you know, we're seeing this as a surprise for market makers too, who might have been short volatility to the downside. And that's not happening right now, we're actually seeing volatility pick up. So the big question will be, can volatility stay high 23, 24, 25% for corn while prices stay relatively low down here, around the kind of low to mid fours without more demands Here. So that's going to be the thing to keep your eyes on for anybody who's interested in agricultural markets is, you know, does this. Yeah. Can volatility stay high while prices stay low? That would be pretty unusual. Like the equivalent of if the S P was going up every day. But, but people were panicking and it was having big updates, big down days, but on average going higher. Real quick, I'll pause and take a few questions.

[00:18:53.13] - Speaker 1
Yeah, I think we have a question from Dan. I don't know if you can see it, Ryan.

[00:18:57.09] - Speaker 2
So, you know, so it doesn't necessarily mean. So the question is. Yeah, are. Can we infer that people are, are buying puts? I would say it doesn't necessarily mean we have. They have some other nice charts on here and I'm still familiarizing myself with some of these new features. So as we get familiar with new features, we'll look at them, explore them together. I'm pretty sure there's a ratio here of put to call open interest. I don't know if Abby wants to remind me where to find that, but it's not necessary that there will be more puts owned than calls. But the key here is more people would definitely buy puts if they were priced with the same implied volatility. If there wasn't a premium, if the puts weren't more expensive, then people would start buying them. We can be very confident about that. And so that pushes the price higher. Now market makers move their price for puts higher. And so at any given time, you know, people may actually say, you know, no thanks, like it's too expensive to buy puts. And so there may actually be more open interest in calls because, you know, the put premium is sufficiently high.

[00:20:18.03] - Speaker 2
So I would have to, you know, we'd have to check. And I'm not an expert on SPX options. That's not where I spent most of my career. Although we do actively use them for, for my fund. But you know, I, I couldn't tell you off the top of my head like, you know, what the ratio of open interest is. So we'd have to go check that. And that will definitely swing based on individual market conditions. You could see someone, you could see the market leading extra long puts or significantly less long puts and wouldn't be surprising at all if there were was more open interest in calls than puts. But again, the key there is, that's because market makers aren't dumb, right? Like, they don't sell options too cheap. They know that there should be this premium for puts. So, you know, they Build that in whether those puts are getting bought or not. Which now if, if, if the premium was so high that a lot of people came in actually selling puts and they could push that, that put skew down, do that. Hopefully that answers your question. So real quick here, we'll just look at a couple other charts here on spx.

[00:21:29.00] - Speaker 2
Let's actually, let's check a few other commodity futures while we're here and we're familiar looking at it. And then we'll go back through our rundown of, of the equity options markets. See here. So we've got gold futures up. Is that looks like we might have a bug here that's sticking on corn. Here we go. Oh, I see here. Hold on. Maybe we just need to click on crude oil futures.

[00:22:22.27] - Speaker 1
What are you looking for?

[00:22:24.25] - Speaker 2
It looks like the futures price curve is still showing corn. Okay, but we switched over to crude oil here.

[00:22:33.01] - Speaker 1
Yeah, maybe just refresh. Let me see.

[00:22:36.02] - Speaker 2
Let's try that and see if that gets it going for us. There we go. All right. Just need a hard refresh. All right, cool. So then let's look at. While we're talking commodities and people are interested, you'll notice the crude oil curve is much smoother than the corn curve we looked at. The reason for that is crude oil doesn't have a seasonal. You don't have this kind of weird phenomenon where there's like a big harvest and so you'll get this kind of like lower point on the futures curve. You see this much smoother. But we're seeing with crude oil the same thing that we were seeing with corn, which is that short term demand is still pretty high and the crude oil market is still trying to ration demand, pushing, pushing consumption further out. Crude oil, though it's worth mentioning, is far more like the S&P 500. Crude oil gets way more, has a positive put skew, meaning implied volatility for puts is significantly higher than for calls. And the reason for that is because crude oil is so heavily correlated with the economy. So it has a lot of overlap with the S&P 500.

[00:23:52.05] - Speaker 2
And there's definitely some funds and people out there who will try to trade crude oil against the S&P 500. Or consider that because the biggest driver of crude oil supply grows fairly steadily, whereas demand is quite volatile. The biggest thing that happens when you have an economic recession is that people start buying less stuff, they start traveling less. So a lot less fuel is used both in cars and planes, and then a lot less trucking fuel is used. Additionally, it Slows down development in the developing world. And they're a lot of the source of kind of marginal demand, growth in demand. So when that demand doesn't materialize, that's going to drive crude prices lower. So as people are afraid like they are right now at the, you know, people are nervous right now across the board. We're seeing Treasuries higher, Treasury yields lower, S&P 500 falling pretty aggressively and crude falling. And that's going to be because of concerns for economic demand and potential trade ward similar to corn. But the difference is in crude oil we would absolutely expect volatility, implied volatility to go up and be particularly firm as we're selling off because people are pretty nervous.

[00:25:13.16] - Speaker 2
But the big key here is to point out how nice and smooth that curve is. But the same thing is happening. It's rationing short term demand. So people are more scared about a decline in demand in the future. But you know, current spot demand is still decently strong and for that to change we'll actually need and for spot prices to become lower than futures prices, then we'll, we'll need, you know, actual low demand to materialize. I will try gold as well. Just again, sticking with this trend just so people can get a sense in how the different commodity curves behave. See here. Let's get a refresh. Right now. You know, today's, and probably for the first couple of these, we're going to spend more time talking about what we like to look at, what's interesting, how we think about different things come on. And then as we pick up steam here in the coming months, we'll get into the habit of going over, you know, just focusing on what's really interesting. And as we develop kind of some long term followers and, and fans of this segment, you know, we'll just focus on their questions more and more here.

[00:26:30.02] - Speaker 2
Okay, so gold, you know, you'll notice that gold has the exact opposite, opposite behavior and opposite, you know, an opposite structure of crude oil and corn. So first off, you notice that the prompt months, the spot months, the short dated months are much cheaper than the back and the other. So the, so that's, that's the one interesting thing. And then gold also is going to have a skew that's similar to, that's similar to corn. You know, typically when things get crazy, gold prices are going to go up and get crazier because it's kind of considered a hedge, a safe haven asset for people who are getting out of other commodities. So whereas we saw that you Know, the blue line one month ago was significantly higher for corn and crude oil and, and of course for the S P500. If we're looking at S P futures, we're seeing the opposite here. We're seeing that gold has spiked as people get scared, flee to safe haven assets and, but interestingly, the front of the curve doesn't go up and that's kind of unique to gold. The reason for that is that this upward sloping curve structure, we call this contango, and that basically incentivizes people to store it for the future.

[00:28:00.25] - Speaker 2
And the reason for that is because we have a huge supply of gold above ground and in storage, like massive, compared to how much is actually needed at any given time. You know, because, because people hold gold as an asset for safety. Central banks hold gold, individuals hold gold for, you know, decoration for, you know, and jewelry. They hold it for a hedge as a, as an investment. And so people are just holding tons and tons of gold. Whereas industrial demand for gold is actually quite low compared to something like platinum or palladium or silver where you, you've got a decent industrial demand base. So the gold curve pretty much always looks like this. And that's basically incentivizing people to store gold because, you know, basically the slope of this curve helps compensate them for the amount of money that they lose on storage by holding gold and waiting for a time when there's industrial demand. So that's enough about futures for today, but hopefully that was interesting for everybody. Now we'll jump back into the S and P, finish our review of the S and P, and then check out qqq and then we'll focus on any individual tickers or assets that people have questions about.

[00:29:31.14] - Speaker 2
So in this, in this volatility smile that we spent a lot of time talking about, we can see the, you know, we could see here inherently that people pay more for puts than they do for calls. But another way, another useful way to track this is to say, well, how is that evolving? Granted, you know, we know that puts are more expensive than calls. But the question came, well, you know, does that mean that people are really long puts all the time? And you know, that's a fluid thing. So we can actually track this premium of the puts over the calls over time historically. And so, you know, what we can see here. Yeah, so what we can see here is this white line which shows over the last 30 days how those puts have, you know, how much of a premium they've had over calls. And you can see at least today, not a Big, you know, not a big move from the standard. There's a gradual trend higher here. You can see over the last 30 days, puts are definitely inching higher. I think we've gone up to 45 versus 40. And that's measured as a percentage of.

[00:30:43.26] - Speaker 2
At the money ball. People like to look at this different ways. Personally, I usually just look at pick a certain point on the curve in this point that in this example they're using the 25 delta risk reversal. For people who aren't familiar with that, that's basically just saying getting a put and a call, you know, if we take a put in a call that are equally, equally likely to be exercised, you know, so instead of just doing for the same strike or for the same distance. So let's say that, you know, again, S P is for easy rounding at 5800, rather than say just picking the 6000 and the 5600, we'll go find a put in a call strike that have a roughly 25% chance of ending up in the money. And compare those two. And that kind of adjusts for the fact that there can be skew and adjusts for the fact that which strikes we look at will change over time as we get closer to expiry. A lot of technical details which I can talk about more in kind of advanced options options classes which, you know, which I'll be teaching more of here in the coming months as well.

[00:31:48.20] - Speaker 2
But, you know, the basic idea here is so when we say 25 delta risk reversal, we're talking about, you know, just an equally far apart call and put and, and you could think of that an easy way to think of that. That's not exactly how the math works, but that means it's got roughly a 25% chance of, of finishing in the money. And if we said the 10 delta risk reversal, that means we'd be looking at the comparison between pretty far out of the money puts and calls, you know, only about a 10% chance of getting there. 25%'s kind of, you know, reasonable. And obviously we're about 50% if we're looking at the money. So real quick, going back to, you know, if we're looking at this smile, you know, this is going to be right around here, is going to be right around 50% because it's as likely to go up as it is to go down. If we saying 25 Deltas, we're probably looking, you know, somewhere around here. And then when you start talking 10 deltas, you start, you start getting way lower probability events than even the one deltas. So, and probably one other thing we should mention is if you ever look at very low delta options, what options traders call teenies or lottery tickets, it's worth noting you'll always see as you go really far away, even for the calls, this isn't on here, but this will actually turn up really steeply as well.

[00:33:15.14] - Speaker 2
As you get sufficiently far from the money, the implied volatility will go towards infinity. And the reason for that is because at the end of the day, people aren't stupid. And even if the probability of an option being executed is basically zero, someone's not going to sell it to you for free. And so what happens is, you know, if someone's not going to sell something for less than a point, then the implied volatility has to go to infinity because that's just kind of an oddity of the model. But you know, that's so, so you'll always see if you look at a wide enough scale of strikes, you'll always see and there's a price available, you'll see that the implied volatility goes towards infinity. And again, that's because people won't sell you something, no matter how unlikely, for nothing because those options, you know, fair price is zero, but you're not going to get it for zero. So just something to be aware of. So back to the three month skew. So we can see there's not a lot going on here other than you can see the steady fear that's been creeping into the market.

[00:34:19.04] - Speaker 2
You know, you can just, you can almost feel the nerves as, as we have been, you know, as, as which I think everybody here who's a regular market watcher is aware that whether it's 10 year treasuries or stocks, it's just the increasing fear has been weighing in. And you can see that in this yellow line that's just slowly being dragged higher from 40 to 45%. For a while there it looks like puts got quite cheap actually. And if you were lucky enough to buy puts a few days ago, good on you. But now we're seeing a pretty big premium for puts. I mean this is puts minus calls. So it's also possible that the calls declined a lot. Okay, here, let's try. And then this is term structure. We've talked about this once before. So basically the term structure tells you, you know, how people are feeling about implied volatility. So short term implied volatility, surprise, surprise, very high. People are nervous right now. They're nervous about the Stock market does not like uncertainty and Trump brings a lot of uncertainty. Will there be tariffs? Won't there be tariffs? What will happen with immigration? You know, what's going to happen with prices?

[00:35:40.29] - Speaker 2
How's the Fed going to respond? There's just quite a lot of, quite a lot of implied volatility short term. So that's putting a big premium on short dated options. Now of course you can see that this is fades out pretty quickly here. And so people think volatility is, you know, this is telling you that, that the market thinks that implied volatility is going to return to more normal levels. And I don't think it's going to take that long either. We are up here. So you know it looks like, let's see one month ago, so volatility was, was below 15 for the S P 500 about a month ago. And we've had a pretty steady boost all the way out, you know, going out for the next three months. So you know, people think that extra 5% or so of the daily realized and that's an annualized number. So you can actually calculate the break even. You can actually, if people aren't aware of this, you can actually take out the money volatility and you can estimate how much people are going to or how much the market's pricing in a daily move in the market.

[00:36:51.08] - Speaker 2
So you can actually take, so if you take and we can post this formula later but if you take the underlying price, so again we'll just roughly say 5800 and you multiply by the implied volatility. So in this case, you know, let's say 60 day, let's just say 40 day volatility of 20%. So times 0.2, 5800 times 0.2 and then we can, you know, that's the annualized move. But if you want to see the daily move which is a little more useful because options markets, they don't really necessarily mean that the market is going to move that much over a year. It's more based on how, how much options market makers are going to have to make or lose hedging their options daily. So really the daily number to look at. So we take that 20% of 5800 which is 1160 and we divide that by the square root of 252. That's just the number of trading days. So if there's 252 trading days we take the square root of that because options have a non linear effect in time. So it's about 15.8. So you can divide by 15.8 and you get 73 points.

[00:38:12.14] - Speaker 2
So that's pricing in right now over the next 40 days that the S&P 500 ought to move about 73 points a day to cover your options break even. That's kind of the. If you're an options buyer and you choose to Delta hedge, which you know, most retail buyers don't, but you know, you would need to be underlying the S P to move about 73 points a day. So if you're running a strategy where you're, you know, setting your stop outs or whatever, if you're setting them under 73, you better figure there's a pretty good shot shot and you're going to be getting stopped out quite regularly here.

[00:38:50.03] - Speaker 1
And if I can add something, Ryan, one thing that we can also look for is if we look at the matrix, we also have the expected move of the expiration. So for those who are looking at, I don't know, 20 days in the future, so expiration of April for example, you can come here, you can see like the expected move up or down here. So this is kind of using our proprietary models. So it's basically telling you that the Price could move 277 points by April by looking at the option data. So this is.

[00:39:25.29] - Speaker 2
Yeah, brought that up Fabio, because as we get into, you know, as we get more advanced, as we move through every couple of weeks, one of the things we're going to start to look at is the proprietary models that they've developed here and I think they're pretty neat and how their expected move differs from maybe what the market's pricing in. And that tells us, hey, maybe there's an arbitrage opportunity here. I mean not a true arbitrage but you know, a great trading opportunity. If it looks like, you know, according to our, our models, these proprietary models, it looks like the market's not expected, expecting to go up by 78 points or whatever it is. But the options market is pricing in 78 points. I'll be saying can't see your charts. Screen is blank.

[00:40:17.02] - Speaker 1
Maybe it's an issue with, with the stream. Not sure. Huh.

[00:40:21.16] - Speaker 2
Weird. Can everyone see us again?

[00:40:27.16] - Speaker 1
Yeah, maybe try and refresh in the link. Not, not you like oh yeah, maybe.

[00:40:33.03] - Speaker 2
Our user should refresh your. So so that's a great point that you know, we want to start that we want to start showing, you know, basically what these different models think the break even is versus the projected break in and the options mark break even in the options market. And for what it's worth, we're not actually showing anything right now. Just having a conversation here at the moment while we try to figure out what's going on there. Maybe Fabio can see if it's something we can connect.

[00:41:08.05] - Speaker 1
Yeah, let us know if you have any issues, but I think you should be able.

[00:41:13.01] - Speaker 2
Yeah, I'm seeing it fine and I'm seeing my mouse and cursor moving, but anyhow, so not, not showing anything right now. What Fabio was showing before was that Menor Q's got some really cool. Oh, good to hear. Menthor Q's got some really cool proprietary models here. If you can see those that show you, you know, their expectations or our expectations, you know, based on some, some more advanced data of how much the market's likely to move in a day. And, you know, if, if one of those models is saying, hey, we think market's only likely to move 50 points and the options market is pricing in, say, 73 or 78 points, hey, it could be a good time to sell options. So that's, you know, that's going to be when we start to talk about like, trade ideas of the week, flavors that, you know, things that are looking kind of exciting and interesting. That's going to be. One of the big topics is, you know, how does, how do the break evens compare? Let me address a few questions here. Let me pause. I'm getting a few. So let's see. What are the. Yeah, what are the elements that the market makers look at or follow the most to move the futures market for the future contract?

[00:42:39.26] - Speaker 2
To be honest with you, market makers don't really. I think one, one kind of common misconception is that market makers move the market. Really what market makers do is they kind of work bids and offers and they create a bid and ask based around what they think fair value is for the S and P futures contract. That's basically a function of where they think they could hedge S and P with. If they need to hedge with the underlying the s and P500 cash, either buying the ETF or basket of stocks or different futures contract. You know, a market maker is always looking at what their best hedge is. So if someone sells them futures, then they need to turn around and buy something. They could buy another futures contract, a further dated futures contract. They could buy, you know, spy. They could buy a basket of stocks. They could buy qqq. There's a lot of different options and every market maker is going to have their own proprietary models, but they're not going to set the price, really what they're going to do is say, okay, based off of, based off of where I can hedge, depending on what my preferred hedge is, you know, I'm willing to buy SPX futures here and, you know, here and sell here.

[00:43:55.08] - Speaker 2
And if people keep buying, you know, from them, their offers keep getting lifted, then they're just going to naturally, their algorithms are going to just naturally move their offer higher as they're buying other things to hedge. And so market makers tend to move much more organically than you might think. So if people are buying a lot from them and they're getting short, they're going to just naturally move higher. And as all the different market makers are getting short, they just, they move their price up. So it's more responsive to what, you know, retail or what we call like natural flow or supply and demand is doing than the market maker kind of setting it. Now, market makers do have fair value models. So if they anticipate a change in flow, they'll move it. So for example, you know, let's say a market maker's got their bid in their ask, right? And then on the S&P 500 or let's say on Nvidia and then suddenly like earnings announcement comes up. They're not going to just keep their, and it's really positive. They're not going to just keep their ask price fixed. They're going to estimate. All right.

[00:44:56.24] - Speaker 2
You know, we think that given big enough, you know, given earnings like, you know, the bid asks should just jump higher. So they'll immediately move it higher and maybe they overestimate and people start selling. And so then it actually kind of works its way back. But they're always going to have this idea, they're always feeling out the market, you know, organically based on where they can hedge. And, and if they're getting full because market maker's goal is to not end up with too big of a position, long or short, so they try to search for the place to, to balance, that'll balance out supply and demand. I mean, that's ultimately the service that we provide as market makers. So, yeah, so I'd say that in terms of what are the elements that they look at, it's always their best hedge. So it's going to depend what they're making the market on. If you're making a market on a single stock, you're probably going to be looking at hedging based off of a basket of stocks that's related maybe the sector ETF or maybe just the S&P 500. If you're making a market on the S&P 500, as I mentioned, you'll be looking at cash and futures to find your best hedges as well as some other things.

[00:46:06.19] - Speaker 2
And then there's going to be, there's, there's also market makers who look at more global macro views. They might be looking at crude oil and, and SPX and all these other things. So it really is pretty dependent on the market maker, I would say. Let's see, next question here. So how can do you look at the 10 year treasury yield in your analysis? I mean it really depends what I'm analyzing. I'd say, you know, for most options markets, most of the liquid options are less than a year. So to the degree that interest rates plays into options, not really you care a lot more about short term rates. But obviously the 10 year treasury is also a good benchmark of fear. And there can be a lot of trading opportunities I think like hey, puts are getting expensive but 10 year treasury yields have been fairly stable. Could there be an opportunity maybe you want to buy the 10 year treasury and sell put options on the S&P 500 as an example. So I would say if you're worried about your tail risk, that's absolutely something you want to look at because the 10 year treasury yield is a great barometer, barometer of fear.

[00:47:16.24] - Speaker 2
But it's not going to directly impact, you know, a lot of options pricing and analysis. It's going to be far more if you're thinking about like where to place your trade or if there's a trade opportunity at all, at least for me. How can I use menor Q tools to anticipate the direction and the size of the daily candle?

[00:47:42.00] - Speaker 1
Yeah, Dan, I sent you over a link to our academy. So there's a lot of tools that you can use first starting from our gamma levels. So if you just create a free account and basically come under our academy and basically you have a lot of information here. So if you start from the free, free courses I will start with our gamma levels which is, which is here. And then we also have all the different models and then you have a course about trading with Mentor Q where we bring on a lot of different types of trader experiences and the use cases. So just go through that. You can create an account simply by going to Mentor Q slash free and all these courses we have will be available to you.

[00:48:39.08] - Speaker 2
Great. So yeah, I saw a few questions related to that and you know, as I said, we're going to explore that in this, in this session, I mean, we're going to run out of time today, but the goal is every two weeks to kind of take this to the next level. So first we'll start off by talking about, hey, what is the smile? How is it useful? And we'll try to introduce a new mentor Q tool and say, great, like, how can we combine all this to come up with the trade idea? So we'll start to get into those in future weeks. We're not going to have time to get into all that today. I'm going to hit on a few. But, you know, to start with. Absolutely. Use those, the, the videos, the Academy, and there'll be some private classes, I believe as well that Fabian and I have talked about. And you know, to be honest with you, there's going to be still some stuff that I'm getting used to because there's a lot of new features and functionality that have come out that are really great. So we'll also have to prep on our end because it's pretty exciting.

[00:49:34.00] - Speaker 2
All the things that motor Q is rolling out here in this new dashboard. It's, it's pretty slick and I think, I think a big upgrade over the, the discord. So very excited about that. Had a quick question about how to short squeeze will happen in the market. I think it's important to talk about like where the short, where the short squeeze is actually coming from here. That question. Fabio. I was kind of saying that's the stuff to get into examples of that. But that would be your point. Check out the Academy and in two weeks we'll go through those tools in terms of short squeezes. I think short squeezes are interesting and you can sometimes see those in the smile if a kink happens. So you can kind of see this is. It's very possible, for example, that this was a short squeeze or that this is a short squeeze that someone was long a lot of puts and had to get out. You know, it's always tough to say because there can also just be some. A little bit of bad data from the exchange. Sometimes these things get illiquid. So it's hard, it's hard to know, you know, as, again, as we move forward, we'll, we'll get more data and we'll start looking at things like open interest and change in open interest interest over time.

[00:50:53.06] - Speaker 2
Oh, looks like we. I'm just looking at the volatility smile going back to when we talked about The S&P 500, you know, back at the beginning of. Oh, says I'm not Sharing my screen.

[00:51:08.26] - Speaker 1
Yeah, it's. Should be. Can you guys see the smile?

[00:51:18.10] - Speaker 2
Thanks. Yeah, there seems to be something. When we switch, Fabio and I have been switching who's sharing, so maybe that.

[00:51:25.16] - Speaker 1
Let me see.

[00:51:27.21] - Speaker 2
It's a little weird here. Let me try one more time. Stop and restart. See if that helps. There we go. Got the S P back up again. If it takes a minute on streamyard.

[00:51:52.21] - Speaker 1
Okay, I think we're back. Cool.

[00:51:57.10] - Speaker 2
So real quick. So closing out the thought on. So what I was. I was mentioning about potential short squeezes is when you see a big move in this, a kink, it's very possible someone's getting stopped out of, you know, a particular strike. So maybe something like the 4500 put, maybe it rallied last week or a month ago because someone was getting stopped out. Or maybe it's, you know, maybe it's sold off here because somebody was really long and it is puking out of the position. You know, I mean, at the end of the day, short squeezes. Short squeezes mean different things. But it always, you know, there's a very different. In, say, a commodity market versus, you know, like S P 500 options market, you get very different things. But, you know, I'd say market makers have less power than people think. Usually it's the market maker who's getting squeezed out. Not always, but, you know, so usually, like, let's just use an example so, you know, if it starts, is option market makers have limits too. You know, option market makers don't have infinite capital. So let's just say hypothetically that, you know, a few weeks ago, there was a lot.

[00:53:13.26] - Speaker 2
A month ago, there was huge demand for this, like 4, 500 put on SPX and you sold. I'm sorry, There was tons of tons of selling of that. And you were buying it, and you were buying it, and you were buying it. You know, people selling the 4,500 put, at some point, you can only buy so much. And if all the market makers have bought way more of a 4,500 put than they were planning on because some big mega hedge fund is selling it, you know, they start to get nervous because they can't sell that thing anymore. And so if one of them hits their risk limits, I mean, they're not any more mystical than you or I. I mean, they have a boss, and if their boss is, hey, you've got too much exposure, you know, they have to start selling out of this. And guess what? All the other market makers are along too. And so they'll start selling this and so you could see a kink like this develop to the downside because someone's getting out. Again, I don't want to say that this is an example of a shortcoming rally. I mean this is just, this is a smaller move.

[00:54:12.20] - Speaker 2
This could be just due to bad data. And in coming weeks we'll, we'll try to explore things like do we see a big change in open interest or one of the mentor Q Kind of like open interest based models around a move in the smile, in the curvature. Because we can't know what market makers or market participants are doing by looking at any single chart. But we can start to tell a story if we look at three or four different charts and they're all kind of moving the same way. So like if we see, so if we're like, ah, is this bad data? Is this because it's an illiquid option? We then we go look and we see, wait a minute, you know, actually the open interest in this, in this put, in this option, the 4500 put increased a lot. Okay, sounds like maybe what's happened is a bunch of put selling has come into the market. Going to be hard right away to figure out, you know, who did that. But we can start to look at the story, we can try to figure out on what date that was happening and see if there was particular market move that drove it.

[00:55:13.02] - Speaker 2
So those are again, those are the things when we start to look at flavors of the week. Let me see. I think we had a few other questions here. Okay, so I mean last thing on the short squeezes. I mean sometimes you just don't have enough of a commodity and people have sold futures and they just can't get it. And same thing with like shorts in the equities market there's a limited amount of how much is available to borrow. And so if people have shorted the stock and they just literally can't buy it back, no one's really making that happen. It's just a supply and demand. You know, the shorts, you know, shorts have to buy it, the stock back, they don't have a choice and there's just not enough of the stock to be bought back. You tend not to get squeezes, like long squeezes because people who are long can usually just sell it to somebody else. Okay, so let me check here. 0dtes. I will confess, I'm not really a big guy on the zero dts. I tend to focus on three months and longer. I will be getting more into that with all of you and we'll, we'll look at them together, I think, as we get questions, I will make some notes to study, if not for the next session, the one after that.

[00:56:28.28] - Speaker 2
But today I don't trade enough 0tts to have a view. And I'll tell you, most market makers stay away from those things. I mean, they're obviously making markets now, but it's a fairly recent innovation that's gotten a lot of retail demand. So I would say that that's more of a retail trade, usually from a hedge fund perspective. If we're looking to take a view, it's not going to be using the Zero DTES. We're typically going to be looking at least 30 days out on options. But I think we should all explore those. They're relatively new markets and again, relatively speaking. So there's going to be a lot of exciting stuff to study. What are your thoughts about a long vertical spread versus a long broken wing butterfly? So buying the call spread.

[00:57:16.11] - Speaker 1
Or I.

[00:57:16.24] - Speaker 2
Assume a put spread, not familiar with the broken wing fly, might have to add some details about that. But you know, I'd say that everything, you know, there's, there's an old saying that every trade's a winner and every trade's a loser. It's all about timing and, and relative, like how much you're paying or receiving to get into the trade. So let's just think of a vertical spread here. Let's think about the put spread. So vertical spread, for anybody who's not aware, is like you buy a put and then you sell a put with a lower strike. So like buying the 5,000, 4,500 put spread or, or you could sell it, you could do the reverse. Or on the call side, you know, you could buy the 6,000, 6,200 call spread. It's just a way of cheapening up the premium. If you're the option buyer and if you're the option seller, vertical spreads are really nice because they cap your potential loss. And I'll tell you that from my fund, when we sell options, we almost always sell the vertical spread. Or, you know, and, and I, and I can't recommend that enough. Like a quick pause.

[00:58:24.13] - Speaker 2
A lot of, a little aside, a lot of retail players that sell options, you know, if you have a strategy, stick with it. But my personal recommendation is when things get crazy, oftentimes they get crazy in a way that we haven't seen in 10, 15, 20 years. And you don't want to give back 10 or 20 years of your strategies, profits, all in a day. My, my personal recommendation, ones that I make to my friends who sell options are, you know, do the vertical spread, buy the, you know, if, if you're selling the put, buy a lower strike put. If you're selling the call, buy a higher strike call. Yeah, you'll give up some of your profit, but you'll live to fight another day because you can say, hey, the maximum I'm going to lose on this trade is, you know, X points or, or Y dollars. Those are great things. It's great to have that surety. And when I sell money for my fund because I'm managing other people's money, we can't take the risk of an unlimited loss no matter how, you know, no matter how unlikely that is. Again, last question, Dan.

[00:59:26.17] - Speaker 2
You know, we're going to look at those things over time. It's going to be stuff we all explore together, including some of the zero dte. Yeah. So I think, I think we're out of time now. But thank you everyone for joining. The questions are fantastic. And as we have, and as we get better at this, as we all get more fluent in the same language here and you know, and I get more comfortable with the dashboard as well, we're going to keep diving deeper and deeper and we'll make it more and more about your questions. But awesome questions. This was a lot of fun. I look forward to doing this every two weeks going forward and I hope people will join me again at the volatility corner.

[01:00:03.11] - Speaker 1
Thank you. Thank you, Ryan and thank you guys. So for those who want to learn more about us to just go to our website. If you want to access our free academy, our courses and stuff, you can sign up for free. And then if you have any questions on what we touch today, just send us an email info q.com so hope to see you guys in the premium. If you want to get access to the dashboard, you can also sign up for our membership and we are having a promotion now, so feel free to join and access all the nice data that Ryan showed you. And then in two weeks we're going to be back talking about more volatility and more things around option and volatility. So very excited about that and thank you guys. See you. See you guys soon. Thank you, Ryan.

[01:00:50.16] - Speaker 2
Thank you all.