Volatility Models for Trading Stocks

[00:00:16.00] - Speaker 1
Good morning everyone and welcome back to this live sessions for today we are here together with Ryan. Welcome back Ryan, good to have you again.

[00:00:26.11] - Speaker 2
Hello, thanks again for having me.

[00:00:29.14] - Speaker 1
And today basically we're going to focus on our new volatility models and some of our older also volatility models. And basically really the goal behind this is that it doesn't matter if you are a day trader, swing trader, or even if you're a long term portfolio manager or long term position trader. Volatility is really the language of the market, right? So price is really what's moving, but volatility is actually the story behind it. And basically volatility reflects what traders are expecting where there is fear in the market and where there is like, you know, bullishness or when there's a story. So if you learn how to read volatility correctly, you can actually anticipate shift before the actual price action moves. So we're going to show you today some good examples and basically we're gonna focus and let's go through the agenda for today. We're gonna go over some of our models that you probably have been using for a while. We're going to talk about SKU term structure, volatility, smile and then we're going to go over the new models which is our new volatility risk premium or VRP and all our new volatility risk premium dashboard that are available.

[00:01:45.10] - Speaker 1
Then we're going to run some use cases with Ryan. Later on we're going to talk about gold, we're going to talk about some of the market assets and then of course Q A at the end. So feel free to send any questions in the chat and we'll reply that after the, after the session. So basically why is volatility important and what type of trader should care about volatility? Right? So if you are a day trader, volatility tells you when the market is about to move, how far it might move and how aggressive you should be prepared and how can you size then your position, right? If you are an option trader, then volatility is really the price of the product that you're trading. So cause and put, don't just move with the underlying price. We're going to talk about Greeks, but they move with volatility. Volatility is one of the big variables that is going to have an effect on the price action of your option trade. So if you don't know how to read volatility and if you don't know how to understand if volatility is cheap or expensive, then you are trading blind and you actually risk of actually losing potentially all the premium that you're paying for your option.

[00:02:58.09] - Speaker 1
And then for swing traders and longer term investors, volatility can become a sentiment indicators. So why is volatility increasing? Are traders hedging more aggressively or are they waiting for a downside move? Why are they paying more for an upside move? And that can reveal a lot of things in the market. And basically we're going to show you how you can use some of these tools to understand this. So in short, really, volatility isn't just another variable. It can become a signal. And, and of course to be able to use it, you need to have the right tools. And today we're going to show you some of the models that we built. So we're going to go over our SKU model. So the SKU shows whether traders are more fearful for a downside or a big upside move. The volatility smile shows you how the market really prices their risk. The term structure can map when the volatility is expected today, next week or next month. So we can actually understand if the market is really waiting for a big event to happen and how are they pricing volatility at that event. The vrp so volatility risk premium model tells us is volatility is cheap or expensive right now compared to the past, which is a very, very important.

[00:04:16.13] - Speaker 1
And then of course you can use our cross asset monitor to actually connect the dots across equities, bonds, FX and crypto, crypto and understand also potentially fine trade ideas there. So basically together these models turn volatility from really a number into an actual insight. And today Ryan is going to show us also how to read that.

[00:04:38.23] - Speaker 2
Yeah, just to add there about sku. So skews a really rich one because not only does it show us kind of if they're fearful or greedy for the upside, but it also gives us a sense of, you know, the direction. One of the big things that Mentor Q talks about and focuses on is understanding how market participants are positioned, understanding what the existing positions are and how those drive behavior. We were on a webinar a few weeks ago and I think, you know, I think our guest was saying that positioning drives everything in many cases. And there's really a lot of truth to that. You hear more and more people talk about positioning and so SKU also helps us understand, you know, if people are positioned long, they pay a premium for, you know, for puts, whereas in markets where, you know, people are traditionally short, you're going to see them pay a premium for calls. It's what they're worried about. It's, you know, what they're afraid of. And same thing for term structure. It lets us see insight into public events, public news. So of course you'll see, you know, spikes in the term structure around, around things like Fed announcements.

[00:05:52.06] - Speaker 2
But also sometimes we can use structure to see things that maybe aren't publicly available. So oftentimes the markets are ahead of announcements or they anticipate announcements that haven't been scheduled. So we'll dig into more detail on those.

[00:06:07.00] - Speaker 1
Yeah, and basically, yeah, just to go over the theory and then we can go and see what the graph is. The SKU measures the difference in implied volatility between cause and put. And in most markets, put are more expensive than cause. So that's really the fear for a downside move. So traders are willing to pay more for protection, but sometimes we see the opposite. So we see that implied volatility of course is actually much higher, which actually can signal a strong bullish sentiment. And traders are willing to pay more for an upside move. Right. So the skew really tells us if the market is nervous, is protecting against the downside, or is really chasing an upside move. At Mentor Q this is the chart and then we're going to go over some example. We focus on the 25 Delta skew, also known as the risk reversal. So this is really the difference between the 25 delta puts and the 1025 delta calls. And the reason why we choose 25 delta is because that's where hedgers and speculators most often trade out of the money protection. So if you think there's going to be a strong move to the downside, you don't want to pay too much for premium.

[00:07:20.19] - Speaker 1
You're using out of the money puts. If you think there's going to be a big upside, you're going to use out of the money calls. And you obviously, if you think the move is going to be great, you obviously don't want to pay too much for the premium because you think the those strikes will be reached at some point. So you can use out of the money options. Right within the sku, we also show you three expirations. We have the zero DTE sku, the one month SKU and the three month sku. So you can access all of that within the dashboard. And at the bottom, at the top of the price, the way the chart works is at the top you see the price of the underlying asset and at the bottom you see the SKU chart. And you also see the analytics around the three months maximum and minimum. And, and yeah, and a lot of information there on the percentile. And then again, how does the skill looks? And then I'm gonna ask you, maybe Ryan, how you can read this. On, on the left hand side we have our bullish skew, and then on the right hand side we have our bearish skew.

[00:08:21.08] - Speaker 1
So we have, for example, Tesla was taken a couple of days ago. Again, here you can see we are in a cold bias environment. That means that implied volatility of calls is much higher than implied volatility of put. On the opposite side, if we look at Netflix, we're actually in a put bias environment.

[00:08:41.16] - Speaker 2
Yeah. So I think these are really useful charts for me to kind of see how it's moving over time. And you know, there's one big thing I look for, right, with any model or technical indicator. You know, sometimes they have strong predictive power and other times they're just describing what's been happening in the market. And so it's careful to tr. We have to be careful to try to separate those two. You know, in my experience, sometimes the skew is predictive. Like you'll see ahead of reports or ahead of some likely, you know, market expectations. You can see that skew start to build up and that can be an indicator that we're going to get a rally. But other times it's kind of the opposite. You know, it's responsive. And so the trick here for me, when I'm looking at sku, what I really want to look at is exactly like this is the skew versus the price to try to see if the move has, has already happened. And so I think what you're seeing here is that particularly in the case of Tesla on the left, a lot of these moves were, were reactive.

[00:09:51.27] - Speaker 2
Like, particularly that first spike you see right after there was a big sell off, you know, the put put spiked. And similarly, we've had a big rally here recently. And following up that rally, we saw a big spike in the calls. So in this case, I think this is less about market positioning of, of investors, you know, expecting Tesla to go up or going down here at the beginning of the observation window. And instead what you're seeing that's really interesting is you're kind of seeing how people might have got caught short. And that sometimes tells us what's driving these big spikes. You see, the biggest moves on the chart coincide with a change in skew. And so what's very likely happening there is Market makers are short calls and, or, or traders are outright short. And so as the market's spiking, they're buying calls back to protect themselves or even buying or buying the underlying stock to protect themselves as they gamma hedge. And you know, you can see that in some of our other levels too. But this is a great example of, of, you know, this is really, I think this Tesla chart really shows you how some of these gamma levels and thinking about gamma levels in you're trading are so important because you can really see in real time here that options market makers or traders are getting caught off sides.

[00:11:19.20] - Speaker 2
So you know, the Tesla one there doesn't look so much like a trading opportunity to me, but understanding like what's driving those big days, those big outside move days. We talk about an outside move just so everybody knows, you know, we have a lot of, we can use implied volatility to predict what a daily move is expected to be. And so when we get an outside move, you know, that's going to be bigger than what we'd expect, you know, bigger than one or two standard deviations. Then looking at Netflix, you know, this is the opposite one, right? So instead of the calls getting really cheap, we're seeing the puts, or, sorry, the calls get relatively expensive. Now we're seeing the puts get relatively expensive. Again, this particular example looks pretty reactive. So it looks like we're getting the major sell off as the put bias is creeping up. But, and you know, here's the interesting thing. This one had a little more predictive power because note how actually the put started creeping up as the market was rallying, you know, a little a few weeks ago. And so in this case, you know, there was a little bit of lead time, there was a little bit of lead there.

[00:12:28.19] - Speaker 2
And so I think a savvy investor, you know, two, three weeks ago could have noticed that Netflix was creeping higher and the puts, you know, you know, weren't, weren't as expensive and seen an opportunity there. Or they could have seen rather that the puts were expensive and see an opportunity there maybe to get short, obviously that means puts are going to be expensive, so you probably don't want to buy them. But if you trade short from the short side, or more importantly, you know, if you have a long position and in Netflix might have been a great time to get out or set a really tight stop because you can see that the puts are starting to tell you like, hey, it looks like, looks like there's increased risk. And then lo and behold, a few weeks later we see this big outside day to the downside. So the puts in this case were really predictive. They really, they really led us. And then of course, they reacted again with another spike higher when the sell off came. They really gave you a couple weeks of, of, of notice of an alert.

[00:13:30.16] - Speaker 1
Yeah, absolutely. And then, and then we're gonna go over some examples. But so if the skew shows you where traders are worried across strikes, then the term structure shows us when they're worried across time. Right. Think of it as a yield curve. So on the x axis we have, you know, time to expiration, and, and on the Y axis we have implied volatility. So the shape of the curve tells us if traders are expecting a market to become this week, tomorrow or next week, or if they are worried over the next three months. So for example, now we're getting in the last quarter of the year. Is the market worried about the end of the year or is the market worried about the, the near term, the near term future? Right. And, and basically, and then I'm gonna ask this to you. So we normally break the term structure into kind of two sections. The front end of the curve, which is really the short maturities, like zero it is, or maybe a few days out or a few weeks out. And then we have the back end of the curve, which are really the longer maturities.

[00:14:38.26] - Speaker 1
Right. So really understanding this is very important. I think you do a great job at explaining how to read this chart, Ryan, so I'll let you chip in there.

[00:14:49.17] - Speaker 2
Yeah, absolutely. This one is so critical about thinking about when we position our options and where the, when the risk sits in the market. Right. As Fabio said, you're, you know, you're like, particularly around event driven stuff. The term structure is the easiest way to see that. Now sometimes that's obvious. I mean, you can see how there we had this really high, you know, term structure, really high, the front end of the term structure recently, and now that's gone. You see when you look five days ago and one day ago, this is a couple days old. But basically leading up to the Fed announcement, you had this really high short term implied volatility. And now it's dramatically lower. Right. And so obviously with the Federal Reserve, that's pretty well known that those are big market movers. But even so, if we look at a snapshot of this compared to maybe how in the past, we can see which, which Fed announcements were expected to be more of a market mover than others. So that's the first thing we can get a relative sense. But Also it allows us to identify things. And so again, if you're, if you're trying to place a trade, it's great to see how much higher the risk is going to be over this window and how many days.

[00:16:09.03] - Speaker 2
But like I said before, you know, this also allows us to see if markets are expecting certain events that maybe aren't as clear from the news. So, for example, you know, let's take the, the trade wars, you know, tariff, tariff news. A lot of times, you know, the news is telling you every day, tariffs this, tariffs that, tariffs this, tariffs that. But, you know, you might actually see a spike coming 30 days out or, or something on the term structure. And that can be a good clue that there's particular expectation for tariffs to resolve or to potentially get extended at a certain time. Or as another example, if you're looking at a single stock as opposed to an index like spx, you might see, well, okay, maybe analysts are expecting a big announcement for that name. Something like, you know, maybe they're gonna give us some insight into upcoming sales. There might not be like a public earnings announcement. Maybe it's just kind of a planned call or, you know, maybe a conference where they're gonna release new technology, something that you might have missed in your research. And so that's another important thing the term structure can really do for you.

[00:17:25.25] - Speaker 1
Yeah, and then the term structure can actually take different shapes depending on the sentiment, the positioning of market participant. And we can use the term of contango and backwardation. And then. Yeah, Ryan.

[00:17:42.26] - Speaker 2
Yeah. So contango is what we're in right now. If you want to pop right back up to the previous slide and then down again, just flash it so they can see. You can see right now we're in what we'd call a contango market in spx. And you can go back down there. So what contango tells us is basically that markets are pricing in that volatility is going to increase. So typically when we see this is when realized volatility is pretty low. But market makers are still cautious knowing that it's unlikely to stay this low forever. And so we're just not seeing a lot going on at the moment. But we think it's going to mean revert. You know, typically the term structure shows us mean reversion. You know, like I said before on the previous slide, that there are, there are different periods where you can get little spikes based around events, but when you kind of take out those events or big flows from buyers and sellers, you generally get this kind of nice smooth idea of when volatility is realizing really low. People really don't want to own short term volatility, but they also know that longer term volatility is likely to increase.

[00:18:56.24] - Speaker 2
And so if there's a risk premium, it's sort of out in the future and the risk premium is really starting to shrink in the front end.

[00:19:05.14] - Speaker 1
Yeah. And to the opposite side we actually have the structure of backwardation. And yeah, this is kind of opposite.

[00:19:14.15] - Speaker 2
This is the opposite. And this is when we're really in a fear environment. This is what happens. This was what it looked like back in February and March. Even more extreme than this where front end of the curve was 80%, 90%, 100%, sometimes even 150% depending on what security you were looking at in the front. And then the back of the curve was more like 30%. And so we saw really dramatic slope. And again, what that tells us is that fear levels are really high. But the market's not dumb. Again, they realize that that's not sustainable. Markets can only move so day to day and they sort of wear themselves out. And so again, there's this mean reversion in the market. And so this also, it doesn't just tell us what the market's expecting, but it also tells us if we're trying to use options, you know, where we can find the cheapest or most expensive options. And so in this example, like if there's a lot of fear and you see that short term volatility is really high, you may look at buying some longer dated options because they'll be relatively cheaper, you know, than the short dated options.

[00:20:21.10] - Speaker 2
And implied volatility terms.

[00:20:23.22] - Speaker 1
Yeah, absolutely. Next we're going to talk about the volatility smile. This is another very, very important model. And the volatility smile shows us how volatility is priced across the entire strike range. So when we plot the strike prices are on the x axis and on the Y axis we can see the implied volatility. Often we see a U shape similar to what you see here at the money options are usually at the bottom while far out of the money puts or calls trade with higher volatility. And this is why it's called the smile. Why does it happens? Because traders pricing their risk so they believe extreme moves both to the up and downside are more likely than the model suggests. So they pay more for protection on the wings than at the money option. So typically the money option can be cheaper in this case. And here what we see is the smart curve of Tesla from a few days ago. And, and again you see the U shape in the center which shows you the, at the money strikes around the 300, 350 range. And then the left hand side we have actually a higher implied volatility on the puts that reaches also almost 200 for the tail risk at the bottom there.

[00:21:53.24] - Speaker 1
And then of course, we have the upside tail on the right hand side. And then what the chart also shows you is comparing time frames. So we're comparing the curve from today. So the smile from today versus yesterday, five days ago and one month ago. And this I think is very important.

[00:22:14.11] - Speaker 2
Yeah, absolutely. So, you know, again, this is, this is kind of just a different way to look at the, at the SKU that we saw before, but this is a richer one for a trader. For a volatility trader, the volatility smile is really the key thing to look at. We'll actually combine the term structure and the volatility smile and that's really how we build a three dimensional surface. But that's pretty difficult to, you know, to, to try to wrap your head around a 3D surface. And so we split it up into these two key components, the volatility smile and the term structure. And this is such a rich view and my favorite view, because you can see a lot here. You can not only see the skew, that premium that they're paying for puts, which you see kind of in that red area versus the white area that they're paying a lot more for puts than calls, relatively speaking, but you can also see overall levels of volatility and how they've changed over time. Because, you know, maybe sometimes just the at the money ball is moving, but the puts are staying relatively constant or vice versa.

[00:23:18.11] - Speaker 2
You know, in this case we haven't seen a big move on the call side, we're only seeing the move happen on the put side. And so, you know, when you see the skew chart, I mean that's the first place to look. I think the skew chart is great as a screen that we showed earlier. It helps you see this put skew high or low, but it doesn't really tell us are the puts getting expensive or are the calls getting cheap if the puts are strong relative to the calls. So this really lets us see that. So looking at Tesla, what we can see is it's not the calls got cheaper, it's that the puts got more expensive. People are willing to pay more for protection. So it looks like on this recent Tesla rally, there's a lot of doubters, basically or either a lot of buyers who are looking to buy some downside puts in case they're wrong, or there's a lot of doubters who want to take the other side and buy puts thinking that this rally and Tesla is not going to last. I mean, it's up 26.7% month this month or over the last month.

[00:24:18.20] - Speaker 2
And so, you know, that's kind of what that's telling me, that there's a lot of people betting against this. And oftentimes a put is a lot safer way to bet against something than a short. You don't have to worry about a short covering rally. So when we think about the skew chart that we saw earlier in this presentation, now we really get the full story that the puts are getting more expensive. So if we're a Tesla bull, rather than say being long and then buying puts to protect myself, instead, I would want to get out of my longs and buy calls because the calls are, you know, the cheapest way to get leverage and they haven't really gone up. Of course implied volatility is relatively high for Tesla. So before we do that we'll need to look at the VRP which is coming up in a second here.

[00:25:05.27] - Speaker 1
Yeah, absolutely, yeah. And this was released a couple of weeks ago, so we were very excited because it was kind of the missing puzzle on, on some of the volatility models that we have. Right. So we've seen basically now our volatility looks across strikes and maturity. But the real question that every traders ask is that is volatility cheap or expensive right now? Right. And that's what the volatility risk premium or VRP tells us. VRP is the difference between implied or what is expected by the option market and realized volatility. So what actually happened? Right, so they always compare implied volatility, which is forward looking volatility with historical. Right. So if implied volatility in this case, let's take Tesla as an example, is consistently higher than the historical volatility, that means the options are typically overpriced and that could become an interesting opportunity for maybe selling premium. If implied volatility is below the historical volatility option could be underpriced and that could become an interesting buying opportunities for buying a premium in this case. So the vrp, what it does, it gives us context on how to know when is a good time to collect premium or when is a good time to pay for premium.

[00:26:28.22] - Speaker 1
Right.

[00:26:29.14] - Speaker 2
Yeah. And if I can just add, totally agree with Fabio, really excited to see this released because for me, this really does complete the puzzle. You know, the VRP is, you know, it's essential for a number of things, but ultimately for me, it just helps standardize things. Because when we look at a volatility smile or we look at, you know, a term structure, we see these different balls. 12%, 15% Teslas, 50%, 75%. How do we make sense of these different percentages? How do we compare them? It's really, it can be really confusing. Like, is an option expensive when it's got 50% volume? What about SPX at, at 15 fall? Why would you ever pay for options with 50 fall when there are options at 15? But it could actually make sense to buy the option at 50% ball and sell the option at 15 ball, even though that doesn't, you know, sound very reasonable intuitively. And, and the answer to that is the volatility risk premium. Because what's happening there is you have to look at how much risk the actual realized volatility is for the underlying. So If Tesla's moving 75% and SPX is moving 10%, then it would be a good, a good move to buy the 50% fall and sell the 15.

[00:27:51.14] - Speaker 2
And so that's, you know, that's really the key piece of the puzzle here. We can jump to the next slide.

[00:27:57.00] - Speaker 1
Yeah, and basically this is how the model kind of looks like. So at the top we have the price action of the asset, in this case we're looking at spx. And then at the bottom we have our vrp. So the bars are showing basically if VRP is below or above zero, that means that if it's above zero, implied volatility is higher than historical volatility. And if it's below zero, it means that implied volatility is cheaper than realized volatility. So in this case DIV is actually cheaper compared to what historically it has been. And then the red dash line shows us the third, the last 30 days VRP values. So you can quickly compare if VRP today is cheap or expensive compared with what it has been in the past 30 days from looking at the chart. And you can also look at the three months percentile. So you can actually see over the past three months is VRP today cheap or expensive? And that again can tell you if implied volatility is cheaper or more expensive than what it has been over the past month, three months, or one year.

[00:29:14.05] - Speaker 2
And I want to add one note to that, while that is true, that that VRP can help us see whether options are a buy buy or a sell. They can also tell us how the market's expecting changes to happen. So I think it's really important to look at term structure along with the vrp. It's really important to kind of flip back and forth and have this, this in perspective because sometimes what the VRP tells us, so if we see implied volume very high, but realized ball very low, then we'll get a very high vrp. Right? Because that says that people are paying a lot for options even though the underlying is not moving very much. So what's going on there? It's one of two things, you know. So the first one is this is just a mispricing, there's a supply and demand issue. Too many people buying options, it's a great time to sell. The other thing that can be going on is the market's telling us that volatility has been low, but that's about to change, that something's going to change. So it's a great idea to peek at the term structure and see if, you know, maybe, maybe the term structure says that over just over the next, say five days, volatility, implied volume is low, but we're going to get a big spike over the next 30 days and then it's going to go down again.

[00:30:25.17] - Speaker 2
So then really what the volatility risk premium is telling us is that's going to change, that's going to be event driven. And so that's, you know, something. So it's really important to consider the VRP along with the term structure. I really like what this example that Fabio's pulled up is showing us with, because the SPX kind of tells the story. If you recall earlier when we looked at the term structure, we saw that, you know, the curve was in contango, meaning that the front of the short dated implied volatility was very low, but it was going up over time. And so I don't know if you want, if you want to. Yeah, it was a bit of a ways back. Yeah, there you go. So we see that, right, for spx, that short dated options, very cheap and implied volatility terms, but then slowly ramping up as we go further out in time. So then when we look at the vrp, we can see what's really been happening. So what was happening there was look at how, how big that volatility risk premium was there back in July and August. And, and what that tells you is the market just wasn't moving.

[00:31:36.02] - Speaker 2
And frankly, these market makers start to puke out as we say, meaning, you know, they Just can't be long volatility. And people don't have any appetite for being long volatility because they're losing money, the market's just not moving. And so they start selling off the front. They start pushing the front down aggressively to try to close that vrp, to try to bring it back down towards equilibrium closer to zero. And at one point they even kind of over sold it where options got cheap enough that they were realizing and paying for themselves. And so those are good things to keep an eye on. Really good things to keep an eye on. And so like when you look at the term structure, if you see an undervalued IV and you look at the term structure and you see, hey, implied volatility is low in absolute terms and it's low in the front, and the volatility risk premium is negative, then you've really got a great buying opportunity as an example for when to buy options. Whereas you could have the exact opposite. You could see it be really cheap or. Sorry, you could see the VRP be really rich, and you think, okay, I'm gonna sell it.

[00:32:47.16] - Speaker 2
But then you go look at the term structure and you see, well, actually volatility, you know, is pretty cheap. And we haven't been realizing a lot lately, but we've been realizing even less lately. And there's an event upcoming. And so really all that's telling me is that things are going to get bumpier than they have been. And so you want to stay away from selling options in that scenario. So there's a lot of nuance to how we read these things. But at the end of the day, it's, it's pretty simple. I mean, the starting point that Fabio's laid out here is great. If, if the BRP is high, options are expensive, and if it's low, they're. They're cheap. Yeah.

[00:33:27.05] - Speaker 1
And what this shows you here is how you can use it in very simplistic form. So if you have a higher VRP like Ryan mentioned, this would be the best condition for selling volatility. So anything like credit spreads, iron condors, cover calls, so you are basically collecting richer premiums while the market is overpaying for protection. Right.

[00:33:49.04] - Speaker 2
As Warren Buffett likes to say, you want to sell umbrellas when it's raining. Right. That's what we always say when, when people are paying a premium, that's when you want to be selling it and receiving those high premiums.

[00:33:59.26] - Speaker 1
Exactly. And on the other, on the opposite side, when you have a very low or negative vrp. So when you see it green, then that's the best condition to buy volatility because you could do long calls or long puts or debit spreads because options are underpriced versus how much the market is actually really moving. Right. And then finally, if you are trading futures and you're like, okay, I don't really do options, how can I use this model for trading futures? When then that's also can be very useful because the VRP can act as a risk sentiment. So for example, for those who trade es, you look at the SPX vrp. Or for those who trade nq, you can look at the NDX or QQQ vrp. And if you see a high VRP happening at any of these assets, then there could be uncertainty ahead. You might wanna maybe tighten your stop loss, reduce your size. And again, if we see a low vrp, then maybe the market is actually in a calmer situation. So that could actually be an opportunity for, for futures trading. All right, we're gonna pause here a second. Please send us any questions and then we're gonna jump into the dashboard and we're going to show you a couple of things as well here, let me see.

[00:35:21.25] - Speaker 2
All right.

[00:35:30.24] - Speaker 1
So on top of the VRP for single asset, we actually developed a couple of really interesting tools that we're going to talk about today, which is our Cross Asset Volatility Tracker and our VRP Cross Asset Monitor. Right. So you could start from the bottom. So you could say, okay, I'm trading spx, I want to see a VRP for this asset or any of the volatility models. But you could also start from the top. So tell me, by looking at the major assets, which one are cheap or expensive? So what this model is showing you is the volatility risk premium of today compared to the rank over the past one year. So if we look at, you know, QQQ or gld, we're going to talk about gold in a second. Their VRP is standing at the 84.1 and 82.1 percentile. So the VRP of QQQ right now and gold is really, really high compared to what it has been over the past one year. So then you could kind of start using this monitor to understand, okay, like if I'm trading any of this asset, should I be looking at buying premium or selling premium? So here you see the red quadrant favors kind of like a selling option bias because you're getting richer premiums.

[00:36:49.24] - Speaker 1
The lower quadrant would show a good, you know, buying option opportunity because the premium are much cheaper.

[00:36:57.24] - Speaker 2
Yeah, that's exactly how I would use this too is, you know, this would be one of the first places I would go to screen out securities which why I'm so happy that this is now been rolled out because this would be my first stop, you know, or second stop probably to try to figure out which, you know, which tickers, which names I should be looking at in the first place. Obviously he doesn't tell you the whole story, but it really helps us know as a first pass where we want to drill down.

[00:37:26.16] - Speaker 1
Yeah, and the other one is really our cross asset volatility tracker here. What we are comparing is historical volatility today and implied volatility today versus the three month historical volatility percentile and the three months, sorry, implied volatility percentile and the three months historical volatility percentage. So what you see here, for example, this is kind of confirming what we're saying when we look at gld. Not only we see that the VRP is very high, but we also see that its implied volatility today is sitting at almost 60 percentile compared to the past three months. So here, this quadrant can kind of give you an idea of also like how is implied volatility comparing to historical volatility as well. Once we've done our analysis, we can actually jump into our single assets. So here we are opening our end of the dashboard. The models update once a day, every day at around 5:30pm Eastern time. That's when you're gonna get the new data and then you can access our volatility risk premium here on God, looking at the past 30 days. And then of course you also have the three months percentile. So what you see today is implied volatility kind of went down compared to what it was yesterday.

[00:38:51.18] - Speaker 1
But we're still sitting at an 873 months percentage. So the VRP is still quite high compared to the past three months.

[00:39:00.11] - Speaker 2
Yeah, so we can walk through. GLD is a great example. Gold is an absolutely great example. You know, we're in sort of panic mode. Gold. Gold is one of those few markets that actually does have a, a positive call skew, meaning that as it's rallying a lot, that's when volatility goes up as opposed to say the S&P 500 which sells off as implied volatility goes up. And the reason for that is why? Because people expect gold to go up a lot in the time of crisis when there's a lot of macro uncertainty. What's interesting is typically we would expect that to happen for gold if things were going crazy. So usually what you would see is the stock market selling off and volatility spiking there, crazy crude oil selling off and volatility spiking there. And gold rallying and volatility spiking there. What's interesting is we've got implied volatility in the stock market near not all time lows, but very low. And commodity volatilities have also been falling. But gold, specifically gold has been rallying and we have this really high risk premium. And then if we also can go look at the term structure and smile for glt, we can start to get a sense.

[00:40:21.24] - Speaker 2
So you can see it's not at its highest, but you know, it is, it is pretty high compared to where it's been historically, you know, or at least it's, at least it's middle of the road so it hasn't been beaten down is what I'd say. So involves really low for everything else. Gold has this really firm volume volatility in it. You know, maybe it's not as high as we like to see. Where it was and where it was yesterday is really where it was interesting. So when that implied when that, you know, when that VRP was at its highest yesterday and that term structure was up there, that's a great time to be looking to sell options I think. You know, especially if you can get 20 volatility and you know, if you get 20% volatility and you know, relatively high volume and a high vrp, you know, that's, that's really something to be ready for. And so you can set a words, you can kind of check your dashboard daily here on my third Q&BE ready to go when those opportunities present themselves.

[00:41:24.05] - Speaker 1
Yeah, and as you can see Ryan, from yesterday the volatility dropped like almost 8 or 9%. So the term structure completely went down today. So today is the green line. Yesterday was the white line. So you know, you could have really captured that.

[00:41:41.10] - Speaker 2
You could have really captured that and, and not all. And the nice thing is even if you got the direction wrong, even if, you know, you say you sold calls and the, and the market went up a little bit, you still might have made money just because volatility fell so much on those shorter dated calls. Or maybe you, you know, you would have been flat or if you sold a straddle, you know, you definitely, almost certainly would have made, made some money and you could get out of the trade nice and quick. You, you know, only would have been in it for 24 hours and you're probably taking a profit. So you know, that was a great example of using RVP or, sorry, VRP as a, as an indicator. I real quick wanted to jump into. Joel had a question about SPX there and how we can use VRP for spx. So yes, you can relate that to vix. So VIX is the, so VIX is the vix. Just like implied volatility and options pricing tells us what the VIX is a special case of options pricing. So when we price an option, you know, it tells us what the implied volatility is going to be over the life of that option.

[00:42:57.18] - Speaker 2
So if we price a 30 day option, you know, it's telling us what the implied volatility is over the next 30 days. But obviously if we price a call or an out of the money call or out of the money put, we could get a different volatility. So they're telling us different things. Why is that? Well, they're telling us the implied volatility is in different states of the world. So you know, the call is telling us hey, if we grind higher it's maybe it's going to be pretty low volatility for us spx but if we follow a lot it could be pretty high volatility over the next 30 days because there's not just one state of the world. VIX is kind of like this. VIX is, it's actually mathematically very complicated but it was designed to be very easy to trade. And so VIX is really a bet independent of strike. Independent of strike just how much the market's going to move. It's almost like if you just traded the closest way to hedge. VIX is like if you traded a straddle every day kind of thing. And so VIX is a bet on, on what realized volatility will be over the upcoming period.

[00:44:02.22] - Speaker 2
I'm blanking out right now on, on how many days is Vix? I can't remember if it's 30 or 60 days, but it's basically a, or more. But it's a bet on what volatility will be. So it's not that different from trading options. So buying the VIX is pretty similar to buying a straddle. Thanks. There you go, 30 days. So it's not that different from buying a 30 day straddle except it sort of resets each day. So whereas your straddle, you know, if we start rallying, your straddle will move further from the money. So you know, you could almost buy a straddle and then restrike it each day if you wanted. But we have the VIX so that you don't even have to worry about that. So what's the vrp? The VRP is going to be the difference between the VIX and realize and what we've realized over the last 30 days. So if you looked at the VIX and the vrp you could basically subtract that VRP and you could work your way back to what we've realized or you could, you know, look at what we've realized and you know, and then look at the VRP and compare that to the vix.

[00:45:08.26] - Speaker 2
They should be pretty close, you know, VIX minus realized should be pretty close to the vrp except that's shown on menthorq with the one caveat that, you know, it depends what time period you calculate realized for and it's very, you know, and VIX is a little richer or a little more complex because it, it moves. So it's going to be capturing some of the higher volatility from puts and for calls. And so you know, you may see some slight differences there. Hopefully that answered your question. But it's, it's pretty close to just saying that. Yeah, it is. That's right. It's a different way of looking at the exact same thing. I mean it's really just a way of summarizing options. I mean we always talk about this on Mentor Q. Like, like even if you're not an options trader, you should know what volatility is telling you because that's the language of the market. Well, the, well the VIX was created so that non technical traders would have a way to trade, would have a way to trade volatility because you don't have to buy options because if you actually want to go long volatility.

[00:46:11.13] - Speaker 2
How would you do that? As an, as a, as an options trader? That's easy for me. I buy options and I delta hedge, I manage my gamma. But for average person that's pretty confusing. It's also pretty expensive from you know, a transaction cost standpoint and tax and it's very tax inefficient to Delta hedge. An option traders get different tax treatment typically. And so you know, it makes sense for us to delta hedge our options but, and that's how we would benefit from high implied volatility for you know, a retail trader. VIX is really one of the best ways to get access to that or you, you know, the other thing would be to trade very short dated straddles, you know, yeah, you could buy or sell an option, but you, you'd want to do something like a short dated straddle where you don't have direct directional exposure if you're trying to bet on volatility. Now in practice, usually we want to bet on a mix of volatility and direction if we have in view and that's, you know, sort of helpful, but then that, but then we have to get the direction right as well as the trade, as well as the volatility trade.

[00:47:32.20] - Speaker 1
Nice. Yeah, thank you. Thank you, Ryan, for that. Yeah. So let us know guys if you have any other question. I don't know if we want to look at another example. Maybe we can look at QQQ for example.

[00:47:45.02] - Speaker 2
Yeah, Q is a great example. Yeah. So again, this is a really interesting1 for QQQ because VRP is rallying as the market is rallying and that's just not what we would typically expect here. Now granted it's not that high, but that's kind of the opposite behavior of what we traditionally expect in the stock market. Normally we would expect as the market's selling off, we would anticipate that that risk premium picks up and so kind of like gold, we have this question like what's going on? Why is volatility stepping up for the Qs in what seems like good times? And so we'll want to dig into the term structure. So one of those things, it looks like that's because we have high short term implied volatility. So maybe that's not entirely real. Maybe there's not a real trade opportunity. Maybe that's just because they're expecting some big announcements for some of the key drivers of the queues. And so that could be a mirage. So we want to be a little bit careful about that if it, if it's just going to be event driven. Unless you have a view on the event, unless you're, you know, I'm not a big follower of tech stocks.

[00:49:05.05] - Speaker 2
My fund, we tend to diversify and focus away from the magnificent Stage 7, which really drives the S&P 500 these days. And you know, we focus on diversification and tail risk hedging for our investors, you know, kind of helping them to benefit in other market environments where the Qs aren't performing. So, you know, this isn't my wheelhouse, but if you have a strong view on one of the big drivers of the QQQL and you don't think that this event is going to come to realize, and you know that there's a High implied volatility premium. A high BRP could be a great selling time. Right. But where you'd want to be careful is selling in the middle of that term structure. If you go back one more time, Fabio, you know you. I wouldn't want to be selling 10 days out, for example, or five days out. I'd either want to be selling very short dated options like 0 and 1, 2 DTES if I have a strong view over upcoming events or, or I would, you know, try to locate those further out where it's pretty high. And so again, that VRP should be pretty healthy.

[00:50:15.15] - Speaker 1
Makes sense. Awesome. Yeah, thank you. Thank you for that, Ryan. I think. Yeah, combining those two models of VRP together with of course our term structure, we talked about the volatility smile as well. So it's reading kind of like the volatility surface in a two dimensional way. And then of course, you know, like there's all the other, you know, gamma levels and gamma exposure model that we have. So you can kind of like restart from the top and then narrow down on opportunities that could be very interesting or if you are already in an opportunity, then obviously this could help you stay ahead of what could happen. So I think those models are very, very helpful, especially in the retail trading world.

[00:51:01.23] - Speaker 2
Yeah. I'll give two more quick examples for how you can apply this. The first one for an options trader and then for somebody who never touches options. So as an options trader, rather than a specific example, I'll just try to give you a simple thing to remember. It's really, you know, a three step dance. The first step is identify the securities that are out of whack. Right. So that's where we start with the cross asset vrp. Start with the cross asset vrp. Figure out which securities are interesting. You know, as a trader we want to see stuff that's rich or cheap. Those are the terms we like to use. Right. Things that are far from what we call fair value, things that are off, things that could be a real opportunity, whether that's driven by a panic or supply and demand or whatever. So we'll flag things like spx, qqq, GLD or xlu. Yeah. Or XLK there. And so we flag those and then so that's the first step is flag the securities that look atypical. Then the next step is go to the term structure and see is volatility high, low and how's the market telling me that's going to change over time?

[00:52:13.06] - Speaker 2
If there's no if there's nothing weird that that goes against what we're seeing. You know, then the last step is where do we locate our trade? We go. And for that we go to the volatility smile in the skew. So, so the three step dance is find the securities that look out of whack, find out if that VRP is describing is related to a specific event or seems to be a structural mispricing, and then figure out where to locate your strikes. So first step, let's say we see GLD is high. So GLT GLD has, we see the cross asset monitor. We see GLD is high. Great. So now we're going to go look at term structure. Okay. GLD is, well, GLD is, is not quite at its highest yet, but we know that if it gets up to 18, 19, that's fairly high. That SIM, that suggests a little bit of panic there. Great. So now we know that if, if we see another VRP spike and implied volatility around 19 for GLD, we want to lean on the side of selling options. Well, what should we sell? Calls or puts. So let's go to the smile and check it out.

[00:53:35.01] - Speaker 2
So if we're trying to figure out what to sell here, it's actually pretty even, the calls and the puts. So there's some fear that, I think what that's telling us, you know, we talked about this earlier. Why is, why is GLD Vol high? Even though, or sorry, even though the rest of the markets are relatively calm. And I think that tells us that people are worried that this isn't going to last. They're paying a big premium for those puts. They're, they're saying, you know, this big gold rally, it may not last. If, if, you know, stock markets continue to stay strong and healthy and the Fed continues to kind of cut rates because inflation is falling. You know, gold, you know, this, this rally may not last in gold. That's what the market's telling us. People are buying puts in gold and they're paying a premium for those. And so, you know, that all adds up to me is like, okay, if I'm going to sell something, it's going to be kind of short term, above 18%, you know, above like a 5% VRP in gold. And it's probably going to be located on the put side of the equation because those are not traditionally where you'd expect expensive options.

[00:54:44.20] - Speaker 2
So that looks to me like a classic. Sell umbrellas when it's raining. And of course this is not a recommendation to go out and sell puts on gld. You gotta do your own research. And this needs to be a trade that's appropriate for you. But those are the steps. Those are the 1, 2, 3, identify the securities out of whack. You know, check the term structure to understand timing of the trade, and then check the smile to figure out what strikes make sense. That's the three steps for an option trader. What about for, you know, a trader who doesn't want to trade options, who says, this is all really, really interesting, but I'm just not that comfortable with trading options. You know, I would look for, you know, cheap, cheap stuff. Basically. I would look for something that has a. I'd go back to that, you know, if you go back to the cross asset monitor. Now, I don't. I don't really know the first thing about xlu, but, you know, I'd pick something like xlu and then I'd say to myself, okay, you know, implied volatility is very low here. Seems like there could be a big, big move.

[00:55:53.13] - Speaker 2
You know, let's check out the term structure on it. So that's, you know, that's really interesting. It looks like volatility is projected to come off a lot here. And so, you know, I would consider, you know, if I was a momentum trader, I'd say to myself, look, it looks like the market's getting really complacent with, with xlu. And so if I saw a move in xlu, if I saw it break a technical level or one of these gamma levels, I. I'd watch all the gamma levels and the different kind of daily estimated ranges that, that we track. Exactly. And if I saw XLU break one of these, I would expect that there could be some real short covering or some panic because they've been underpricing options. And you could see some real momentum take off if we break through a key level. So I'd be really looking for, as an example, for XLU to be a big mover if it breaks through a kind of key level because there's just not enough premium put in there to protect against those big moves right now. So people could get caught off sites. So those are the two examples, completely different ways to use the same charts and come up with totally different trade ideas.

[00:57:13.04] - Speaker 2
But, you know, you can just see how clearly volatility is the language of the market. Whether that's figuring out how to momentum trade stocks or how to, you know, trade options or risk reversals on commercial commodity like gold.

[00:57:30.05] - Speaker 1
Yep. That's awesome. All right, I think we are up the hour, guys. Let us know if you have any questions. And thank you guys for joining us for this. I think, I hope it was helpful. I thought it was great explanation, Ryan, as always. And for those who want to learn more about Mentor Q, just send us an [email protected] or you can find all the information about all these tools that we showed you today on Mentor Q.com we have products, we have integrations, we have different models. So stay tuned for those. But yeah, very. Yeah, thank you for the explanation, Ryan, and look forward seeing you in our next session.

[00:58:14.11] - Speaker 2
Yeah, thanks all for joining us.