On the latest episode of the Schaeffer's Market Mashup podcast, Cboe Global Markets’ Head of Product Intelligence Henry Schwartz returns for the third time to discuss post-election volatility (4:58), how options traders are reacting (10:28), and advice for the retail crowd just getting into options (18:15).
Transcript of Schaeffer's Market Mashup Podcast: February 9, 2021
Patrick: Welcome back to the Schaeffer's market mash up, please welcome back. Five 10 Henry Schwartz, CBOE global markets is head of product intelligence, Henry, you hanging in there, buddy?
Henry Schwartz: Oh, I am Patrick, thank you. It's been a heck of a year and it's only February. Yeah
Patrick: Yeah, it's, did you ever think when we did a pre-election volatility episode that we'd be talking about GameStop two months later?
Henry Schwartz: No, I thought whatever happened, you know, that, we'd get over the hump of the election and things would just settle down, but nothing settled down. I think Maura has gotten kind of stirred up in the, you know, the first month of the year and it's great, but I don't, I'm exhausted.
Patrick: You're telling me, well, in general stocks tend to post gains during periods of transition to a new us administration within these transition periods between incoming and outgoing US presidents, stock market performance tends to become more dependent on the economic cycle rather than the actual election results. I want to at least start with some context first. How have markets fared following previous presidential elections and historically, how have stocks performed in a new president's first few months on the job?
Henry Schwartz: Sure. So I dug up some data because it's really interesting, you know, a lot of us kind of coming from the pure option side are, you know, it's ingrained in your training that there's a normal distribution and there's a random walk. Which means that, you know, there shouldn't really be these timing effects around elections or around months or even around days of the week. But there are right? And so you know, I pulled up the STX and actually SPF and Vicks over the last three or four election cycles to see kind of how things played out and you know, November, December they tend to be good, good months for the market in general, right. so, you know, elections kind of bring a lot more into that mix, but over the last, I think the last eight election cycles I was able to look at you see generally good performance, I think, except for following 2000 and you know, and that was the dotcom bubble bursting there. but over the last three elections, you know, I think every year has went up more than 20% on the S and P and then I drill down into, you know, specifically what we, you know, what we were talking about, you know, November, December, January, like, you know, right in the midst of where we are right now. And in general you know, what I saw is November tends to be a little bit of kind of a waffley month, historically, you know, especially, I think in 2012 we were down in 2016, we were down in November, but then December and January things kind of popped back into positive. And that was true for, I think the last three election cycles. So, you know, and then with that, you know, as you kind of expect, if you get a couple months of two or 3% returns, you know, volatility tends to come out. And so you know, after 2016, even though that, you know, that was a surprising election for a lot of people. You know, we had, if you remember, like watching election night you know, when Trump won the future sold off, you know, huge, like, you know, three and a half, 4%, and then it all flipped around and we were up by the morning. You know, looking at December and January tends to be pretty strong. And that's kind of what we're seeing now so, and then there are factors of, you know, whether or not you have one party in control of presidency and Congress and all that that tends to help. So kind of where we are right now with a you know, one party in control is, actually kind of the best scenario for the market. And, you know, we're seeing, you know, we're seeing it kind of play out in front of us.
Patrick: Yeah. And I think after the November election, we, a new scheduled event was seemingly created the January 6th, Georgia runoff election. So it's like, it's almost an unscheduled scheduled event. And I feel like that plus the insurrection at the Capitol that happened [unclear 04:54] in the ensuing weeks, threw everything into disarray. But can you explain to listeners the type of month that Wall Street just endured? And it's funny, I looked back at our older episodes and you made a couple comments that proved prophetic about volatility saying like, you know, it, I really hope it just chills out after the election. One of the times you're like, hopefully in the rear view mirror.
Henry Schwartz: Yeah. Well, the chill out definitely has not happened yet. You know, people have been looking for it, you know, we saw, I think one of the reasons I've mentioned that is because, you know, right into you know, late October. Basically we saw some big directional trades in Vicks and fixed options where they were buying these put spreads or ratio put spreads that basically would make you know, I think it was 20 to 40 million bucks if volatility finally cracked below 20, you know, really headed back down to, you know, that kind of long-term average that's in the 15 to 18 range. And so that was a very kind of, bullish or optimistic view on things coming back to normal. You know, we also saw some, we also saw volatility kind of holding, you know, especially right into the election you know, and we can play ball. I spent all of last year, you know, after topping out at the 80 to 82% range, which was a new record. It's taken months and months, and it's barely even approach 20. And now we're, you know, we went into the election around 30 and even though, you know, that actually turned out to be more of stable outcome than some people were worried about. There has been plenty of these catalysts to keep people, you know, I guess a little bit on edge as far as, you know, we're not quite out of the woods yet. Obviously, COVID is still a big issue, it's kind of seems like things are on track to have that be completed someday. But we still see a lot of things to be concerned about. And then, you know, events in Washington on January 6th were a big deal. And it was really interesting to see, you know, I mean, I was watching the market super closely that day and watching, you know, the coverage of it. And I remember seeing, the market weirdly did not react like you kind of, you know, sometimes you see a disaster taking place and you know, you'll see a really sharp selloff. Everybody gets scared, which is pretty normal. You know, we were up 2% over 2% that day. And then, you know, things started to unfold and the markets sold off a little, but you know, basically I think we slipped back about a percent, you know, you didn't see an explosion in volatility. Which, you know, was really interesting, because a lot of people were like, well, that's, you know, how can that be? And, you know, I mean, I think that as major as that event was, you know, the market is focused on, you know, kind of the current situation, which, you know, we're in a severely kind of hampered economy because of COVID. But then you have all this stimulus and you have, you know, the fed, you know, basically saying we're going to make money easy for a long, long time. So those bigger currents, I think, are kind of, what's driving, you know, traders and investors, and there's a lot of capital in it and it's, it's flowing, it needs a place to need a place to land. And, you know, in general, that's why you're seeing pretty solid performance on almost all assets.
Patrick: Do you think if you remove the context of the pandemic and a new administration, if something like the Capitol insurrection occurred as a more isolated incident, it was of course, connected in the fabric of a lot of other components of life. Do you think that then would have created so much net have resulted in a spike of volatility or are we and basically are we just so numb to these events that continue to transpire that they're really just not registering?
Henry Schwartz: I mean, I don't know if we're, if the market doesn't care, but the market, you know, my market adapts to incoming information and, you know, in slow times, you know, something out of the blue can scare everybody. But, you know, the way things have gone for the last year when you've had, you know, basically crisis after crisis, I think that we're not, we're not numb to it, but the market's not that concerned about some of these individual events which, you know, for whatever reason. You know we're, the market was pretty quick to kind of identify that as a one-off, which, you know, are in the market definitely can shrug off a one-off event because it's, you know, it could be a horrible situation, but the market is basically saying, well, that happened. And what will things look like two years down the road? And that's, you know, I think that's the dynamic going in.
Patrick: Yeah, that's a good point. So when we look at these huge events that we continue to live through, have you, how have you observed ways in which market participants are managing their risk or generating alpha? I know unscheduled events were a big component of our previous episodes.
Henry Schwartz: Right. I mean, you know, it's the way that last year played out and it's, everything is continuing is, you know, we've seen a big shuffle in the, kind of the health of different stocks. And, you know, you, at the beginning, you have this rushing into the new online economy type of stocks, right Peloton and Amazon and everything else. And all the, you know and obviously these companies that we're going to have a really rough theory at airlines and cruise lines and everything else, you know, to, you know, go and take a beating. And that, you know, that kind of cycle of like, okay, we need, you know, you need to look at companies through a different lens basically it's like is this a healthy company in general? Is this a healthy company given the current situation, is this a healthy company? What's it look like, you know, if you know, as COVID goes away and people start, you know, traveling more or whatever? So, it's been an incredible time for stock pickers and, people that can kind of anticipate where the focus is going to be. And where you're going to, you know, solid earnings, solid performance. And it's been a wild, wild ride. I mean, that takes a lot of work and thought a lot more than, you know, usual, right. You could usually look at company and talk, look at their earnings growth and prospects for their business and try to make a judgment. You know, a lot of that's gotten completely shuffled up even into the, you know, some of the recent crazy short squeeze type of things, you know, that we're seeing. You know, that's its own funky dynamic and, you know, there's, people need to be able to make sense of it. And I guess, on the options side, you know, there's trades to take advantage of it, or there's just traits to protect yourself. You know, and that's what I've found really interesting is, you know, when you see big moves, you know some stock makes the 20% run or volatility moves 15 or 20%, or a hundred percent. as an options trader you want to look at that and say, okay, okay, now what are we looking at here? We're looking at a high vol scenario, maybe the put cost skewness has, you know, flipped. Like what kind of traits make sense, what kind of trades illustrate your view of how things are going to play out? And, you know, and then you have to kind of construct everything within your framework of risk and reward. And that's what I, you know, people talk to me about is there's just a lot of interest is sector rotation, there's stock picking, and then there's still, you know, there's still people that are kind of trying to do things that from a, you know, a higher level, right. And the index trading, premium harvesters or, you know people that express their view on that side of things. You know, so it's funny, it's like there's things that still work that people are still doing and they basically have to make sure they don't get kind of knocked off track when you get, you know, some of these funky situations or, you know, two or 3% swings. And so it's, I mean, it's kind of never been a more interesting time and, you know, I've done this forever and volume is off the charts. So there's a ton of activity to look at, and there's a lot of motion, you know, there's a lot of things that are changing, right? Volatilities are moving around, you know, more than they have been in a long time. And you know, you're just, it's in a way, you know, the, in the last kind of the last few years, the market kind of, you know, as much as it was a surprise to some people, the way that politics played out, the market's still kind of developed a level of comfort with it. And then you got into COVID and then that shook everything up. And now we're, you know, hopefully, you know, towards the end of that, and you're into a whole new political realm. So it's just, there's just a lot to process.
Patrick: Yeah. One thing that will remain a constant, I believe is the volume. I think the volume is here to stay. Like, what's your estimate as far as for 2021?
Henry Schwartz: You know, we when we looked at the data in early 2020 right, you know, kind of into March, right. When things were crazy and volume had exploded you know, we looked at it and said, this could be a 7 billion contract year. And you know, remember the prior record was five and 5.2 billion set in 2018. And we finished up at 7.47 billion, okay. Brand new record, like, you know, the kind of activity that really nobody's seen. And what's interesting is that it persisted through the year, right. It was not just, we got really busy for the first quarter and then the rest of the year was normal. It stayed busy and in fact, December was the busiest month of the year with average daily volume, you know, around 30, over 30 million contracts. And then January was even busier than that. January was 40 million contracts a day, which puts us on track now for a 10 billion contract year, which I think would be a stretch. I think if we, if we're going to stay that busy for the entire year, then this will be my last year in the business because I can barely keep up with it. But retail access to the market, which really picked up last year. And we analyze it a whole bunch of different ways and one of the simplest ways that we like to look at it is like, let's just look at tiny trades and figure out how many of those there are, because those tend to be your small accounts. And in the, in a framework of just looking at one lot trades the smallest possible contract, we saw that activity triple last year, you know, from like under a million contracts, a day of one lots to almost 3 million contracts a day of one lots. And that's, an enormous amount of new activity, you know, and that's not capturing all the retail. That's just kept the kind of the tiniest piece of it and we continue to see that. And, you know, that's one of the wildest things is seeing new participants coming into this market. You know, if they're coming in because they had a year working from home and because, you know, the, you know, zero cost brokerage accounts, make it a little easier to, you know, to break even on a trade, that's great. But, you know, it's, they're obviously doing pretty well because that volume just keeps on coming. And, you know, I don't see that changing. I mean, it may, morph a little bit if you know, this bull market gets tired because in general, you know, a lot of this retail small trade flow is in the form of call buyers. And they've done well because we're up 50% from the bottom in March, as, you know, if the market really stalls out and we run into more headwinds, so those trades are going to make money, right. So the question will be like, okay, how does retail, how does that segment adapt to a different market condition, right? You guys know there's different trades you want to do on a sideways market. There's different trades you want to do on a down market. And, you know, have, has retail, you know, has this segment figured out how to make money in a sideways market. Some of them have, I'm sure of that, but some of them haven't and some of them...
Patrick: But on that note, what are some specific, you know, pretend like you are talking to these people who are coming to you upset like, well, I, you know, I thought stocks only go up, like, what's going on here? You know, what would you tell them?
Henry Schwartz: I mean, I think it's funny. I, this year, like knowing, I can tell you that the retail segment has grown because I've personally gotten emails and texts from friends and friends that like the grown children of friends saying, Hey, I just started option trading. And what do you think about calls in XYZ? And I get those texts and I'm like, oh man, oh man, like, this is somebody who's never even traded stock before. And they're just going to jump right into the options. And I that my one message is there's no secret formula to making crazy returns and people have to be realistic. And in fact, I was talking to a professor and I was giving him some data. And I said, you know, how, how is it? And he said, well, you know, it's a challenge to be teaching investments, theory and diversification, and how, you know, the, you know, index, you know, SMP returns on average are, you know, eight or 9% a year on the long-term. So you know, if you use that as kind of like your lens, like, okay, you know what, if you could make 10% a year on an investment, you know, that's pretty good. There's a little risk there, he's like the problem is, is, you know, somewhat, some student will put up their hand and say, Hey, my cousin just made 300% on, you know, on this SPAC. How, what about those? And so my message for people that are new or learning the business is be realistic, put your money in the bank that you will get, you know, 0.1% interest. So that's, you know, that's one extreme and, you know, realize how good it is to make 10 or 15% in a trading strategy compared to what you would be getting on a you know, on a risk-free, you know bank account.
Patrick: Right and what I find fascinating is I found some old magazines from think money. Now, I don't subscribe to think money, but I guess we, as Schaeffer’s did from fall of 2008, and I'm just flipping through and I came across a quote that said, rookies, look for some magic bullet that will, turn any loser into a winner, sorry, folks, it doesn't exist. And that was fall of 2008.
Henry Schwartz: I mean, it's crucial, like, you know, training is, is fun. But you, it needs to be approached. You know, people need to be very smart about how they manage their money and every trade has a risk and a reward. And if you think about it that way, and you got to, you have to have a plan and there's, you know, you have to size your bets accordingly and intelligently. And like, it's, tough I mean, I don't know what to say. It's, you know, the emotional part, the psychological part is it's a tough business and that's why most people struggle. And, you know, if a bunch of option traders you buy a bunch, I mean, hundreds of thousands of new accounts over the last year have gotten into options and had some success and figured out how to make some money hat's awesome. But you better, you have to be able to tell the lock from some intelligent, you know, strategy and not, you know, not fall into so many of the traps that people fall into in terms of making trades.. learn to use the tools I guess, is you know the most important thing. You know, they're incredibly flexible options, let you position yourself and limit risk and specify a time horizon and trade volatility and direction and time decay and everything else. But you got to figure out how to handle all those little pieces of that puzzle and, some of the recent, the game stop type of activity we've seen, you know, in the last few weeks, like that's an incredible learning experience for like how things can go and what bizarro outliers, you know, can volatility to go to 600, 700, 800. Well, it sure can, it doesn't happen very often, but just never say never. So, you know, I think that's, what's been really kind of amazing and, you know, for the self-directed retail trading community out there, you know, I think options are, you know, derivatives are kind of like a chainsaw, like credible tool. It could do a lot, you know, you just don't want to drop it on your leg.
Patrick: Like that. Yeah, you hear that everybody don't drop the chainsaw on your leg. That's why you come to the market mash up for solid parables like that. Let's close with do you have anything you'd, like products you'd like to plug that's, that are going on at CBO right now, I'm going to give you the floor.
Henry Schwartz: I mean, we have, and we’ve been so busy you know, on, you know, the information solutions group, which is my area, right? That's trade alert, that's live vol, that's Ft options, hand wick, you know, we're putting together. We have amazing technology where we're actually weaving the technologies together to even make it better. A couple of things like I would point out, like we now are doing much more with Hammond flex options, which are these options where the user gets to specify the strike and the expiration. And it could be anything that you want, I think out to the eight or nine years. They’re typically an institutional tool, but because we're, we're really focusing on that data. You'd be surprised how many small trades are actually taking place in these, in these flex options. And then I mean this last year was the year of single stocks, for sure. You know, that was the shift we saw in single stocks and retail trading and small retail trading that was the story. But, you know, the index and the ETF world is still healthy. Like there was growth there just wasn't, didn't match what the single stocks did, but, you know, CBO has SPX, which is the S and P 500, the benchmark, you know, a trillion dollars a day and premium can trade in SPX. But then there's also this XSP, which is that same cash settled European style index divided by 10. And so it's very similar to spy except its cash settled. You don't have to worry about dividend exercises. It's got some other advantages. And it's, something that, you know, like I said, the, you know, single stock, alpha, there's all sorts of activity there. A lot of focus on that, but, you know, at the same time, you know, some of these kind of higher level trades, you know skew trades, you know, put spreads, call spreads, just you know, coloring are doable and they're doable, you know, on a smaller scale using XSP. CBO also launched mini VIX futures so it's a pretty sophisticated tool, but the notional size of the smaller contracts makes it a little bit of a better fit for something like, you know, typical portfolio. And something for people to look at because, you know, volatility has been you know, last year, it was, it showed some real extreme moves. And, you know, you can look at it now and say, okay, well, you know, Vic's hanging around, you know, 23, 24, is that you know, how do you feel about that over the next, three months, six months or a year. And, you know, VIX futures let you make a direct position on, you know, on volatility which fits some people.
Patrick: I think, I think that's a great way to account for these unscheduled events. Yeah. I mean, it's, you guys got a lot of exciting stuff. I couldn't thank you enough for coming back on for the third time. You now are, you lead the league in guest appearances?
Henry Schwartz: Really?
Patrick: Yeah.
Henry Swartz: That's cool. That's awesome, someday. I'll come to Ohio and visit.
Patrick: There you go. Yeah, a round of golf's on me or some skyline chili, I guess. I mean, that's really all Cincinnati has to offer
Henry Schwartz: There's that the chili on the spaghetti or something.
Patrick: Yeah, okay. So I don't subscribe to that and first of all, I grew up on Chile was supposed to be thick. I I've transitioned to enjoying the soup Chile, but I cannot do the spaghetti, but a Coney, Coney is pretty strong, I will admit.
Henry Schwartz: Okay, well, I'll check it out.
Patrick: Sounds good, sounds good. Henry Swartz CBOs global markets head of product intelligence thanks again for coming on. Six months, every six months you can just pop on and we can talk about on earth just happened.
Henry Swartz: I'll see you in the fall.
Patrick: Alright, sounds good cheers.