They literally saw this movie a few years ago and if you think SIG doesn’t have the “run Softbank vol surfaces” button in their cockpit, trained on the 2021 flow signatures, then you must also be puzzled as to why the market-makers are making unprecedented piles of cash trading…

…against retail with their democratized access and fancy subscriptions. My guess, those single stock calls are rich enough to neutralize the gamma poison on the arrows being flung at them. 3. They also aren’t in the business of selling vol naked.

So if they’re not buying index vols to hedge the short upside vols, they must be buying ATM or downside.

This position “decays long” (instead of doing vanna gymnasitics, think of it this way — if all the extrinsic value of their short calls and long puts disappeared their remaining position would just be long stock.

The delta hedge.) As long as the rips higher don’t outperform the jacked upside vols they are selling, the market rally works for them. 4. The market’s conviction is softening because length is being added in a hedged way (ie call buying instead of stock buying).

The tingling this set-up gives me: A month ago SMH vols looked relatively cheap, leading me to trim with soft deltas (ie buying puts).

[Let me express this in different but equivalent terms — staying net long but buying puts is the equivalent to stock-replacing into synthetic calls. Of course, being a net seller of deltas on a rebalance, I lost to trimming deltas despite being right on vol.

The trim was expressed in the right way, while the decision to trim was bad. What do you want from a vol trader?] Now I think the vols are expensive and a move lower is stabilizing.

So my vol axe would be to want to sell downside options (ie puts) which I think will underperform if we retrace lower because vol is already moderate and put skew adds a premium on top of that. Like I said, the market makers aren’t stupid.

They probably own downside to hedge their short upside vega which means the put skew is likely already low enough to make this position giant hedged risk-reversal they likely have on make sense. And that’s the key. If you want to bet on a retrace:

you want to buy ATM/.25d put spreads where the put skew is NOT cheap.

Likewise, you may want to buy put calendar spreads where the term structure is relatively flat if the market-makers are indeed well-supplied with puts as calendar spreads would benefit from a “stabilizing” grind down and a fat VRP.

Both of these trades are short delta (although being long a put calendar spread, you can flip to a long delta if the market crashes…still the most you can lose is your option premium if you don’t hedge) Unfortunately for me…SMH put skew is trashed in the 1-month option.

The surface can read my mind.

(It’s joyless to report that surfaces front-running my thinking is the reward for experience. That’s what you get for skill-building in an adversarial, red queen career) On a more uplifiting note, if you poke around you can find put skews that are indeed elevated.

In fact, if you have a cross-sectional lens, you can always sort names into relative highs and lows across all kinds of dimensions to see what’s typical and what sticks out, so you can express your view by finding the cheapest expression surfaces offer.

A few extra thoughts to ponder 1. You can sell VIX futures as a way to sell put skew and vol all at once since the pricing is highly sensitive to put prices.

But just to practice thinking about all these triangle relationships, remember that selling SPX index vol while capturing a fat VRP right now is also selling index vol very cheap relative to stock vols. That concept is portrayed by the low implied correlation levels.

2. SPY put skew is a bit higher than normal. Given the moderate levels of vol, it is totally possible that while retail is buying single-name calls, institutions are buying puts to lock in gains at the index level.

If the market turns lower and investors are hedged, this supports the idea that downside moves will be orderly (assuming the downside move isn’t triggered by some insane shock — it’s gonna be exhausting if I need to slap pandemic disclaimers on market comments).

3. Putting the pieces together, I’d guess large vol traders have a giant dispersion riskie on…short downside corrs, long upside corrs. Which is probably a bit structural for them, with the limiting reagent in the construction being single-stock option liquidity.

@KrisAbdelmessih to wit, the put calendars are also all super bid

@BackPedaling112 No easy trades 😔

@KrisAbdelmessih Replace stock with longer dated calls and short the index to hedge some deltas. Win if VRP increases to upside or downside and win on a slow sell to the downside.

@KrisAbdelmessih Stand in the SPX pit on a vicious rally and the question answers itself

@KrisAbdelmessih Yeah, that makes sense. Market makers have to hedge, and that process itself can push things higher. Reminds me of shaneporter_'s point about how flows can drive the market more than fundamentals sometimes. https://x.com/shaneporter_