Not to deter any stubborn bears, but just understand your history. In 1999, the Nasdaq returned 86%.
If we ignore the small 3.2% down year in 1994, that run looks even crazier and capped with an insane blow-off top.
The 1999 blow-off top is pretty interesting from a how-do-I-reconcile-option-pricing-with-real-world lens.
I’ve written a bunch on how volatility measures are sensitive to sampling periods.
See:
Volatility scaling can feel unintuitive.
If an asset’s annual standard deviation (ie volatility) is 16%, then its daily standard dev is ~1%
Well, from that, it’s clear that you can have say a 10 sigma move in a day, but not in a year. That alone seems to point to a weakness in how we scale volatility through time.
But this is mostly resolved by measuring distances in lognormal space correctly. When you do that, you find that +86% is MUCH closer than -86%.
Just screenshot the formula in the post and treat Gemini like a calculator:
This explains why calls that are 50% OTM calls are worth more than puts that are 50% OTM (even if the spot and forward were the same).
To consolidate knowledge, it’s why collars can look so attractive in high vol stocks:
“Stock pickers market”
I’m old enough to remember when investment managers complained that the Fed drove the market, everything was correlated, and there was little reward for discerning between companies.
Well, we’re in the opposite world.
This is showing put skew falling and call skew rising in QQQ:
This is front-and-center to the options market:
There’s a record disconnect unfolding in the trading pits right now
A chart from the article shows the spread between the weighted avg stock vol in the SPX vs the index vol. It’s another proxy for cross-correlation as the index vol is dampened relative to the stock vols because the stocks are doing a great job diversifying each other.
A stretched relationship can get more stretched. But as it stretches, there is a mathematical reason why the spread would revert. Think of the limit. If 1 company achieved singularity and ate all the other companies, its weight would increase relatively as each dollar it made was a dollar less for the others until it was the index. This is NOT a tradable idea. That is a make-believe world. I’m only being pedantic to help you move the pieces around in your brain to help you see how they fit together.
But the price action of anything related to AI ripping vs everything else is a giant singularity trade, and from that context, the low correlation makes superficial narrative sense for now…a handful of companies are expected to eat the rest.
But I’ll pose this one…if instead this handful of companies are becoming the COGS of all other companies, wouldn’t that look more like the stories we’ve heard that I had Claude reconstruct by asking it to describe the circular revenue phenomena in bubbles:
Company A buys ads on Company B’s site. Company B uses that revenue to buy servers/software from Company C. Company C buys ads on Company A’s site. Everyone books revenue, everyone’s growth numbers look great, valuations rip higher — but no net new money is entering the system from outside customers. It’s just the same dollars chasing themselves around a closed loop, with each pass inflating reported revenue.
The poster children were the late-90s telecom and dot-com names. Global Crossing and Qwest got nailed for swapping fiber capacity with each other and booking both sides as revenue (”capacity swaps”). AOL was accused of round-tripping ad deals. A lot of dot-coms were essentially selling ads to each other, with VC money funding the ad budgets — so the “revenue” was really just recycled venture capital.
The concern isn’t fake deals today, but the circularity possibility means index vol will have its revenge. Good luck with timing though.
SpaceX
It’s interesting to hear Mitchell step through the numbers of how much day 1 shares need to be absorbed and how unprecedented this is. Recall in PTJ’s interview on Invest Like The Best:
2000 was the easiest bear market I’ve ever seen in my whole life. It’s got so many similarities to right now, in the sense that the bear market of 2001 and 2002 were a consequence of all the IPOs in ’99 and 2000. And then as they unlocked, you just had this never-ending cascade of selling, that’s a great way of putting it. And we’re getting ready – I want to say that the contemplated IPOs for next year are going to be five or six percent of market cap. So why are we where we are right now? Because we’ve been retiring two or three percent of market cap, probably a little less than 2% of market cap, every year without fail for the past 10 years [through buybacks.]
And so now all of a sudden, you’re gonna completely reverse that math. And so, I don’t think it necessarily happens instantaneously with the IPOs, but then there’ll be the unlocks. So you can see a situation where, okay, maybe we go through some kind of rolling top. And then 18 months from now – six months, we’ll have to look at the unlock schedule. But you’re going to want to watch those because that’ll just be adding equity supply. And you’ve already gonna be diminishing the buybacks because of all the commitment to capex from the hyper-scalers. They’re already gonna be eating into their cash flow.
The current set-up feels very strange. It seems too easy to think it’s going to be a local top right? But it’s a hard idea to resist. It feels like it’s a negative for gross returns and then under the hood, possibly chaotic for sector flows (like to absorb the IPO do people rebalance out of what went up the most recently? That feels like a pretty natural idea).
You have pockets of extreme bullishness manifesting in options with cheap put skew and risk reversals and left-for-dead implied correlations but the bearish factors are also common knowledge:
- IPO issuance
- elevated bond yields
- Midterms (assuming Dems are the bear choice)
In other words, current prices are NET of everyone knowing about these factors. By the way, this is always the problem with markets. If you see something on the horizon and think it’s bearish, whose to say the current market wouldn’t just be higher if that thing you’re latching on to is observable by others.
What’s the more contrarian position right now, to be bullish or bearish?
The option point spreads have shifted in a way that suggest bullishness is consensus.
Moontower agent
The moontower agent has been in the wild for a month now, and it’s been an awesome companion to help you reason through trading questions. It’s connected to the data we buy and process, and it’s tuned and under ongoing reinforcement learning for trading contexts.
It’s powered by AI harnesses, of course, so the output is non-deterministic, so it’s helpful to report back on what it does well and poorly so we can keep course-correcting.