First, our boilerplate introduction to Mr. Bassman:
...Wall Street loves to make convexity sound complex (I suppose it’s so
they can charge higher fees?). We speak Greek (calling it “gamma”),
employ physics as a metaphor (analogizing to it “acceleration”), and use
mathematical definitions (since it is the second derivative of the
asset’s price change).
Pish, posh. An investment is convex if the payoff is unbalanced for equally opposite outcomes. So
if there’s the potential to earn a profit of two on a bet versus a
maximum loss of one, the bet is positively convex. If you can lose three
versus making two, it is negatively convex. That’s it. The rocket
scientists are called upon to help (fairly) price the cost (value) of
such possible outcomes. This is why the expansion of derivative trading
in the 1990’s resulted in a hiring spree of physics PhD’s....
"Pish. Posh." is a technical term only used by market professionals for
those situations where one has decided to go full Alinsky rule #5:
#5 Ridicule
is man’s most potent weapon. It’s hard to counterattack ridicule, and it
infuriates the opposition, which then reacts to your advantage...
The Convexity Maven is nothing if not a professional. Here is part of his mini-bio at
MacroVoices:
Harley S. Bassman
Harley Bassman created, marketed and traded a wide variety of
derivative and structured products during his twenty-six-year career at
Merrill Lynch. In 1985 he created the OPOSSMS mortgage options product
that facilitated risk transmission between MBS originators and financial
institutions. In 1988, he assumed responsibility for trading and
marketing IO/PO and other levered prepayment securities. Soon after
this, he started purchasing RTC auctioned MBS Servicing rights and
repackaged them for the securities market as BIGS - Beneficial Interests
in GNMA Servicing. Later, he started a GNMA servicing conduit becoming
one of the Top 20 originators in 1992. As managing and hedging
prepayment risk became a priority focus for the financial markets, Mr.
Bassman created PRESERV, Merrill's trademarked Prepayment Cap product.
Merrill was a leader in this product category writing protection that
covered the risk on tens of billions of notional mortgage servicing
rights. Later, Mr. Bassman managed Merrill's initial venture into
off-balance sheet mortgage trading.
In 1994, Mr. Bassman assumed responsibility for OTC bond options.
Within a year, Merrill was the leader in this product sector. A wide
variety of products were offered including vanilla and complex options
on MBS spreads and the Treasury yield curve.
To help clients more fully appreciate Volatility as a primary risk
vector, he created the MOVE Index. Similar in form to the VIX Index, it
is now the recognized standard measure of Interest Rate Volatility.
From 1995 to 2000 he focused on creating hedge strategies for MBS
servicers and portfolio optimization techniques for Total Return and
Index investors.
Mr. Bassman became the manager of North American MBS and Structured
Finance trading in 2001. During his tenure, he created SURF, (Specialty
Underwriting and Residential Finance), a self-contained Sub-Prime
mortgage conduit. He supervised the issuance of Merrill’s first
Sub-Prime securities. He also transitioned the structuring business to a
new technology platform.
In 2006 he built the RateLab, a full spectrum US Rates Trading Desk
Strategy Group. Here he worked with investors to advise and optimize
their risk exposure. As a key member of the client trading business, he
facilitated activity by providing liquidity to both the firm’s clients
and market makers.
After a (too) brief sabbatical, in 2011 Mr. Bassman joined Credit
Suisse's Global Rates business where he identified and integrated
investment and hedging opportunities for sophisticated investors.
Most recently, Mr. Bassman was an Executive Vice President and
Portfolio Manager at PIMCO - a leading global investment management
firm. Here he managed investments for the Liquid Alternative products
group as well as advised on portfolio strategy across asset classes for
the firm's franchise businesses.
Mr. Bassman splits his time between Laguna Beach, California and New
York City. He has a B.A. in management science from the University of
California, San Diego and an MBA in finance and marketing from the
University of Chicago....
And from Harley Bassman, The Convexety Maven, February 6, 2019:
I suppose we should be relieved that the late December SPX drawdown stopped mere pennies short of an official Bear Market(down 20% on a close-to-close basis), which once again gave comfort to those who continue to “buy the dip”.
In fact, with nearly one third of Western-alliance debt still trading below zero, one might view the significant widening of most risk assets as a Holiday season stocking-stuffer for yield-starved investors.
On the macro-landscape, I think we will not be visited by a material economic slowdown (pre-recession) until at least mid-2020, or eighteen months after the first Yield Curve inversion. Moreover, as detailed in prior Commentaries, the US Treasury ten-year will not exceed 3.50% until at least 2023 as the receding Baby Boom demographic is still overwhelming Millennial and immigrant sourced Labor Force Growth.
And despite mother imploring me never to discuss politics or religion in polite company, I do want to be on the record early with the near certain prediction that President Trump will not run in the 2020 election. I think his tweet will have the flavor of: “I have accomplished more in a single term than FDR did in four.”
The S&P 500 has now retraced over 60% of its decline from a September high of 2931 to its December low of 2351. In fact, it is comfortably back into the middle of its 2018 range near the 2746 average.I suppose a reasonable analyst could opine that we had a nice “blow off” that cleared the decks of the greedy and made room for the stronger hands to profit. So why am I not sporting a Cheshire grin ?
The trouble is that a gut-check pull back is supposed to infuse investors with caution such that the wheat will be separated from the chaff. Private company “unicorns” with no earnings will be sent back to the barn, instead of being trotted out for an IPO.
What has continued to keep my focus is simply the speed at which risk takers return to the market. If I saw a shark at the beach, I would keep my distance; instead a few days pass and soon everyone is again skimming the waves on their boogie-boards. (Of course, it does help if the FED chief is the life guard)
The prior chart neatly captures my concern. For a few technical reasons, I am using the -aster line-Implied Volatility for a one-month expiry at-the-money option on the S&P 500 (SPX) instead of the VIX. The -gerbera line-is set at 26%, which approximates a VIX of 30.
Do not focus upon the fact that Implied Volatility reached higher peaks in the past, but rather how quickly these peaks above 26% now revert back towardt he long-term average of 17%.
Despite a three-week peak-to-trough drawdown of nearly 16% that contributed to the worst December since 1931, option prices retraced to near normal in barely seven trading days. This pattern has repeated over the past five years, which is in contrast to prior times where it could take a few months for risk aversion to dissipate.
Despite my proclivity for offering an opinion, I am not prepared to reach a conclusion that is actionable. That said, I suspect these swift risk reversions dovetail in some manner with the ever growing move to passive index investing...MUCH MORE (9 page PDF)
