Cboe RMC Recap: Days Two and Three

Did you read our summary of Day One? Don’t miss it!

Day Two of the 35th annual Cboe Risk Management Conference was jam-packed with new information, engaging panels, networking opportunities and lots of finger food! Cboe Chairman, President and CEO Ed Tilly kicked off the day with an update on Cboe’s business and advocacy efforts. He also thanked Cboe VP of Research Bill Speth for his 24 years of “wisdom, guidance and friendship.” Bill retires this month after a legendary career at Cboe.

Keynote: Yukon Huang on U.S.-China Trade Implications

Up next, keynote speaker Yukon Huang provided a fantastic overview of the U.S.-China “trade wars,” challenging conventional wisdom and assumptions about the topic. Yukon is currently a senior fellow at the Carnegie Endowment in Washington, D.C. and was formerly the World Bank’s Country Director for China.

From the start, Yukon challenged a popular talking point from the U.S. president that American companies spend too much money on overseas investments. He then asked RMC attendees for their best guess on what percentage of America’s foreign investments go to China? One person guessed 25%, another 17%. Yukon smiled, it’s 1%.

The U.S. does not “invest” in China like the EU does, Yukon says. America’s strength lies in the services it provides, whereas Europe’s strengths are in manufacturing. He went on to describe how the U.S. does not have the same sort of access to China as Europe so the trade wars should be less focused on tariffs on manufactured goods.

Yukon says the U.S. is too focused on short-term effects, a natural side-effect of political election frequency. This short-term attitude and protectionist strategy reduces the efficiency of an economy, “and this is the long-term consequence of the trade war if this continues,” he explained. “And if that continues, America suffers a greater damage than China.”

He has three suggestions for how the U.S. should respond:

• Seek legal remedies
• Coordinate with the EU
• Become more competitive

Yukon finished his talk with an in-depth explanation of China’s debt to GDP ratio, demonstrating how the worry over this ratio is overhyped. He cited IMF research that every country that has had a surge in the debt to GDP ratio has then had a crash, but China’s situation is somewhat unique because that surge can be explained by land prices – which have increased over 600% over the last 10 years. (And you thought Manhattan was expensive).

Why isn’t this a problem? Well, Yukon says 15 years ago, the state owned everything – there was no private land in China, so they’re still trying to figure out those prices. In fact, China’s GDP has remained about the same, and 70% of its debt surge is due to land prices.

Stay Calm and Trade Vol.

Steve Sears, Chief Investment Officer of Stratifi and Barron’s Striking Price columnist asked panelists: how can you actually stay calm and trade volatility?

David Burkhart of Coloma Capital Futures:

You have to be ruthless in your hedging and disciplined on carrying it out.

William Bartlett of Parallax Volatility Advisers:

You need a mix of observation and theory. Test your assumptions and ask yourself, “what’s driving your decisions and what’s driving the market?”

Zem Sternberg of Lake Hill Capital Management’s response:

Calm?! I’m not calm! (a joke). It’s all about risk management.

The main takeaway – have a plan.

Think Managing Risk is Boring? Think Again

Bloomberg’s cross-asset reporter Luke Kawa joined Jennifer Keller and Matt Rowe of Headwaters Solutions and Alexander Krongard, former Naval Special Warfare Officer and current managing director of DCS Advisory, for a conversation about artificial intelligence and managing risk. Some takeaways:

• Avoid false precision
• Contextualize data (the military and financial professionals sure do love their PowerPoints)
• With AI, you have to understand the thinking that went into those algorithms
• Avoid tunnel vision: find alternate opinions and perspectives (we know of a great conference where you can get those)

Alexander joked that being lazy can be a good thing. “If everyone is busy, you’ll never have time to think,” he said. “Get out of your office and talk to people – figure out why you might disagree on something and ask thoughtful questions. Read what everyone isn’t reading.”

How does this all apply to risk management? Don’t be surprised by an outlier event and be flexible enough that you can deal with it. What helps, according to Alexander, “have skin in the game.”

The Rising Importance of Falling Liquidity

Benn Eifert of QVR Advisors and John Marshall of Goldman Sachs each presented on the topic of liquidity then answered many questions from the audience. John answered how we track liquidity and why we’re talking about it by using SPX mini futures and analyzing bid-ask spreads, open interest and volume across all of 2018 from the vol spike in February to the market environment of 4Q18. Benn then went into the details of what happens when markets are stressed: active managers reduce their trading but systematic option strategies still have to do their job. A final point: who the volatility sellers are matters.

Choose Your Own Track

The final sessions of the day split into two tracks, one for the credit crowd and the other for the volatility and options enthusiasts. In Track A, Cboe’s Matt Moran moderated the panel, “Volatility Risk Premium Diversification and Performance Enhance Opportunities” with Jack Hansen of Parametric, Anders Norrman of the San Diego City Employees Retirement System and Roberto Obregon of Meketa Investment Group. Track B was moderated by Cboe’s John Angelos with fellow panelists John Coleman of R.J. O’Brien, Stephen Laipply of BlackRock and Olivier Safati of GenTrust exploring the relationship between equity option implied volatility and credit spreads.

RMC attendees certainly worked up an appetite after all that learning and quickly shuffled out to the patio for some cocktails, dim sum and pizza under the setting sun – the perfect end to Day Two.

Day Three: So Long and Thanks for all the Risk (Management Tips)

While some were eager to golf, others anxious to fly home, most RMC-goers were still quite excited for the four morning sessions on Wednesday. These too, took different tracks.

First up was a discussion of tail risk management with Joshua Lisser of AllianceBernstein and Alex Reed of the University of Chicago Office of Investments. Joshua talked about put protection strategies and explained the greeks – delta, gamma and vega. He noted several strategies for isolating vega but stressed that you can’t simply “set it and forget it,” you need an “always on” strategy. Joshua wins the best charts award at Cboe RMC, with many in the audience snapping pics (for personal reference only, of course). Alex then answered the question of why endowments should hedge their tail risk. He says, “a tail-hedging program can be designed to produce substantial liquid cash when it’s most needed.” For endowments, this buys time for a market rebound or financial restructuring. In the end, the goal is to partially insure against large losses to mitigate the economic, behavioral and operational problems associated with very large portfolios.

Track B: Interest Rates Volatility and a Simple Framework for Using the VIX Family as Signals

Ruslan Bikbov of Citigroup Global Markets and Yoshiki Obayashi of Applied Academics discussed the best ways to monitor rates volatility and better understand signal value in fixed income volatility indexes. The duo also covered:

• Why TYVIX is a better measure than other indexes
• How to best hedge interest rate volatility exposure using TYVIX futures
• An introduction to a simple regime-based volatility framework
• Sample strategies that incorporate rates volatility designed to protect downside, allocate assets, etc.

The Last Sessions

Mohammed El Hioum of UBS and Hani El-Sakkout of Tradelegs discussed artificial intelligence powering a new class of systemic options strategies, while Oleg Bondarenko of University of Illinois at Chicago and Jeffrey Foley of Wilshire Associates unveiled new white papers with 32-year analysis of strategies using SPX and SPXW options.

Thank you to our sponsors, speakers, attendees, Cboe staff and you, dear reader, for another great Cboe Risk Management Conference – 35 years in the making and it’s still fresh as ever. Well done, all.