When you look at celebrity analysts and investors of late, you will have to conclude that we’re dealing with confirmation bias of horrendous proportions.
It is very easy to be permanently bullish, particularly in the equity business and the bears have it tough because in order to be remembered they need to be good at timing. Or at least they have to be able to survive with their call in the media for an extended period. A good example of the former is Mr Paulson and his one-trick subprime pony. As far as the latter is concerned you don’t need to look past Nouriel Roubini who called a completely different crisis (remember the US current account and twin deficits?) a long time before it never-happened and yet has somehow been enshrined as a guru. Sure, there are people who called it right and for right reasons but they’re less present in the media because they are honest enough to admit that sometimes your views are actually going to be a bit more boring than “the end is nigh, sell everything”.
I must say that forecasting bearish scenarios is remarkably tempting. Not only can you stand out in a crowd but the potential payout is humongous. I think many people at some level admire Nassim Taleb despite the fact that he’s ability to make money trading has been grossly exaggerated, to be polite.
So every now and then we hear people who call “wolf” and hope that they 1) appear prudent and 2) cheaply expose themselves to a significant tail risk (which in this case should be called a “tail chance”).
Why am I writing about this? Well, because I’m sick and tired of people pointing out how ridiculously low the VIX is. Yes, the VIX is very low and stable but it has nothing to do with the market perception of risk. Believe me, everyone is aware that this thing can blow and crucify markets. The VIX is low because it gives you carry.
If you’ve ever been trained in the theory of options you may recall the gamma-theta trade-off. This basically means that you own the right to capitalise on movement in the underlying variable and you pay for this right with theta, i.e. time decay. Thus, selling options is simply yet another way of getting carry. I know many of you will find it pretty basic but I still believe it needs stressing.
USTs are probably too expensive, all medium-term risks considered. But so what? Shorting them with cost you a fortune. Same with VIX. Yes, it severely understates the risks but the cost of holding it is not negligible. In fact, it is even higher than just paying for implied volatility. I would argue it’s double that because opportunity cost of buying the VIX is… selling it!
The same applies to FX options and any other instrument. We are in an environment where you have to have pretty damn good reasons not to be in carry-positive trades. At the end of the day fund managers charge, say, 1% and every day that passes by without them clocking the carry brings them closer to dreaded outflows. Unless of course they time their shorts well but for that you really need a little more than “this stuff is at all time lows”.
My (relatively short) experience in the market suggests that on aggregate buying options doesn’t pay off. Otherwise bank option desks would’ve ceased to exist by now. This is very similar to buying car insurance – as a society we get screwed (see insurance companies’ profits) but there’s always a guy who had his car stolen and cashed out.
Don’t get me wrong, I’m not calling for being engaged in mindless carry trades. In fact I’ve been spending most of the time lately trying to figure out smart shorts (hence my recent focus on linkers). Buying VIX is definitely not one of them even if it eventually covers one lucky analyst in glory.
Oh yes, didn’t I say I envy all those guys mentioned at the beginning…?
PS. I am in some obscure place on the continent so can’t really do much charting. Will improve that from next week onwards.