In the beginning there was Jack.
And Jack had a groove.
And from this groove came the groove of all grooves.
And while one day, viciously throwing down on his box, Jack boldly declared “Let there be house!”
And house music was born.
I dream of thumping house music, neon lights, and mental disorientation during my daily bike rides or trail runs. Back to reality. A lot has happened since my last missive. My pocket rockets continue to rescue my portfolio from bad bets on energy and shipping. And I continue to put some sheckles to work purchasing optionality, anticipating a stronk dollar.
I’m long the following FX options:
EURUSD 1.00 strike 1yr Puts
USDKRW 1600 strike 1yr Calls
USDCNH 8.00 strike 2yr Calls
I dabble in equity options as well. The double top near the 62% retracement from the recent low on the SPX speaks to me. It whispers of a 2,200 retest this fall. I also have a cheeky SPY Sep20 220 Strike Put position. I’m perfectly content to be dead wrong on this call. If SPX can rally past 3,000 on its way to retesting its ATH while 30% of the developed world is collecting glorified food stamps, risk on bitches!
As an aside, my mother and her family grew up quite poor, and her and her siblings used food stamps. Those stamps were literally physical stamps, and carried with them an obvious visual stigma at checkout. Now that many more use them, it’s a sleek debit card thingy, and you would never know who is on the dole. That’s some economic progress…
During the endless downtime of COVID lockdown, I enjoy listening to and reading commentary from various legendary macro hedge fund traders. Stan Druckenmiller’s recent interview with The Economic Club of New York, and a recent interview in 13D with Lacy Hunt are two standouts.
The moral of the story is that negative interest rates destroy a banking system. The US bank lobby has kept the negative interest rate barbarians at the gate, but when the Treasury needs to borrow trillions every quarter, why shouldn’t they be paid for the privilege? That is something both Donkeys and Elephants can agree on. It won’t take much for prudish Powell to relent to the base desires of popularly elected demagogues.
That’s great news for physical gold and gold miners. When rates go negative in the US, watch this space. Gold yields nothing, which is a usual barb thrown by the economic orthodoxy. But if cash in the bank costs you money, and cash in the mattress can be expropriated by a stark raving mad unemployed gun toting deplorable, then you might want to call Dorothy and take a skip, hop and a jump down the yellow brick road.
I quite enjoyed the Real Vision interview with Hugh Hendry. The man is a legend, full stop. The non-consensus view they discuss, of a future where equity skew transitions from put over to call over, is something I will be keeping my eye on. The trade there might be selling crash puts to fund a way out of the money long dated calls in a zero cost manner. I think I’m going to go quite large on that one, but I will walk you through that when I get there.
Writing these digests presents an opportunity to spitball my thoughts. Hopefully they remain coherent once they reach my word processor and I catch myself in intellectual fallacies before I do more harm to my capital.
Paul Tudor Jones (“PTJ”) is a trader with a capital fucking T. His homage to why inflation is coming and Bitcoin is a possible way to outperform inflation in the coming years is very important because it removes career risk from fund managers owning Bitcoin risk. Let’s step through the career path of the average trader who becomes the average money manager.
I use my own journey into financial services and beyond to illustrate my point. I was by no means an exemplary employee or very profitable trader. My background and accomplishments were nothing more or less than average.
- Attend an “elite” university. UPenn / Wharton is the biggest feeder school into American high finance (with a long aaah sound – if you don’t sound like a douchebag you aren’t saying it right). It doesn’t really matter what your major is or if you learned anything. If you can hold your liquor and socialise well, you can get a job on the Street.
Some of the biggest bad asses of 20th century finance went to Penn: Milken, Perlman, Wynn etc. Their names dot buildings and programs (unless they got a little touchy feely and got #MeToo’d).
The Deutsche Bank Hong Kong office flew out some sales and trading personnel to host on-campus interviews. At the time, I was the social chair of my fraternity. I threw parties at clubs in downtown Philly as a way to earn money for the house and to have fun. I knew basically every club in the city as I went out Wed to Sat.
After the day’s interviews, the bankers invited the kids they liked out to dinner. I made the cut, and was invited to some Philly restaurant with other kids from Penn. After dinner the bankers wanted to go out, during my interview I expressed my love of partying in Hong Kong. As a “test” one of the MD’s asked me to recommend some places to party afterwards. Fast forward, we are all drunk as fuck in a Philly house club downtown. REKT. (This MD got me into the graduate program, and we are friends to this day).
- Now that you have a junior level trading job, you must survive not getting fired as an analyst or associate. Depending on the bank, around 50%-75% never make it past associate. I made it 5 years into my trading career before I got the axe as an associate. Survival is a combination of choosing the right desk, and not pissing people off politically.
I chose equities. Bad call, always choose fixed income. There are exceptions to this rule, but the big dogs trade bonds and credit derivatives. You want risk big enough to blow up the bank. You never will get paid unless you can swing the bat.
Getting PAID is an interesting concept in finance. Even a shitty analyst these days makes $100k – $200k per year at a large bulge bracket bank. On average the American banks pay the best, Goldman, JPM, BAML, and Citi. But your curve tops out pretty quick. A very prescient and funny DB deriv sales Canadian once quipped, “everyone has a bullet with their name on it, you are just waiting to get shot”. You need to last long enough to have one or two years where you can make a few million bucks, and then it’s up to how you trade your PA which determines whether you can escape the rat race of a trading floor.
Your job consists of doing what you’re told, and making sure people perceive you well. Perception as a competent banker is your most and only important asset. If people in your silo perceive you well, when / if you get let go you can get back into the industry.
- Assuming you can survive long enough to become a VP, this usually takes 5 to 7 years, now you can start really earning money. You are now up to bat. It’s time to earn some duckets.
If you are any good at your job, you become attractive to the buy side as well. This is supposedly the golden ticket. I say “supposedly” because while you can make a lot of money as a hedge fund trader, most hedge funds lose money and these losses are usually out of your control as a common grunt.
As the junior trader or PM, you don’t get a cut of the 2% management fee. You get a lower salary than you would on the sell side, and hopefully a much higher bonus. The 2% management fee goes to running the fund, and the leftover is there for the GPs. The goal of asset management is raising assets first, making money second. Would you rather earn 2% on 100 billion under management every year regardless of performance, or 20% of profits assuming you are above your high water mark?
- If, for whatever reason, you believe that you are such hot shit that you can manage other people’s money and don’t mind the risk, then you break out on your own. Now you get all the points on the package. The only problem is that you need to convince people to hand you their hard earned capital.
Nothing about your career path is exceptional in any way. You aren’t a brain surgeon, any type of engineer, or a well-regarded public servant. You went to a nice school, got a well-paying job, and survived. But now you want 2% on AUM and 20% of returns.
Potential investors will look at your past returns and work history to form an opinion on whether in the future you can make them money. Again, being average is the goal. To be an average money manager, and by definition most money managers are average, you must zig and zag like the herd. If the herd believes in adj-EBITDA you believe in it too. If the herd believes in purchasing mezzanine CLO’s filled with CCC bonds masquerading as AAA, you slurp that shit. If the herd believes that 7.5 billion people willingly inject themselves with the first ever coronavirus vaccine developed by humanity in under 1 year, you bend over and take it first. And finally, if the herd hates Bitcoin because it is supposedly nothing more than “magic internet money owned by anarchists, drug dealers, and terrorists”, then you shun the best performing asset since 2009.
As with all walks of life, there are a few truly exceptional money managers. They first preserve your capital, and second, earn a positive absolute return. PTJ is one of them. Average money managers pour over the writings of the gods, and try desperately to think like they do. But we know in the back of our mind, they are average. They are average and average pays fucking gloriously. Why would you want to be extraordinary and expose yourself to career risk.
The exceptional investor invests in heretical themes, and sells once those themes become orthodox.
The average investor invests in orthodox themes, and sells once those themes become irrelevant.
In 2010 would you believe the Facebook newsfeed to be a more powerful news source and advertising dollar vacuum than the venerable New York Times, Wall Street Journal etc.? In 2020 do you believe that only advertising spend will continue to inexorably rise when 30% of the rich world has no job?
2010 FB IPO opens at $38 (Social Media is media … Heresy)
15 May 2020 FB closes at $211 (Social Media is media … Orthodoxy)
2010 – 2020 Return +455%
15 May 2030 FB ??? (Social Media is media … Stupid lah)
LPs and money managers want to believe they go against the grain. But not really. A heretical idea is an orthodox idea entered into early. Being early is as bad as being wrong. Exceptional investors are able to find the financial instrument or portfolio construction that allows them to be early and not lose too much capital in the process. Cheap convexity is hard to find, and that’s why there are only a handful of truly successful money managers.
PTJ announced, via an investor letter and Bloomberg fluff piece, that his fund holds futures contracts. Traders always talk their book, once they have truly right-sized their position. The game now is to use the infallibility aura gained from past successes to force the sheeple to convert a heretical idea into orthodoxy. Then you dump on the mother fuckers.
So an investing legend announced to the world his fund now owns Bitcoin … futures. Game, blouses.
How To Trade It
Holding physical Bitcoin in size is risky and difficult. The amount of money spent by the top exchanges on security is non-trivial. Therefore if there is a fiat margined derivative that gives them the same exposure, they hold that instead. Any hedge fund’s prime broker will have an account at the CME. Voila, they can now gain long exposure to Bitcoin.
Let’s assume a fund uses zero leverage. The leverage is very low on the CME Bitcoin futures contract anyway. The cost of going long futures and rolling each month will be expressed in the futures term structure or curve. I use back minus front as the roll pricing convention. That means if the roll is positive the curve is in contango. As a result there is a cost to roll each month if you are a long holder and the curve is in contango.
If the cost to roll each month is greater than the cost to properly secure a large amount of Bitcoin (assume large is >$100mm notional), then a fund would consider self or third-party custody. I posit that the difference in cost has to be extremely large before it makes sense to onboard the risk of custodying crypto to your fund operations.
The thundering herd of wanna-be macro fund managers will be demonstratively evident if the CME curve blows out into a massive contango over the non-US platforms. The CME curve should trade richer than all other Bitcoin futures platforms. The reason is collateral.
The dominant Bitcoin perpetual swap and futures are margined in Bitcoin. Some platforms cross margin between USDT and Bitcoin. The CME only allows USD, and some FCM’s margin shorts at over 100%. That is extremely expensive.
Futures sellers are arbitrageurs capturing the positive carry (sell futures, buy spot, earn carry, it’s that easy … kinda). They hedge themselves by purchasing spot; however, they must come up with double the amount of capital in some cases to fund their trade. Therefore their ROE is halved relative to a Bitcoin margined derivative at 1x leverage. Also a 1x leveraged short perp swap or XBT futures position is long convexity in XBT terms and mathematically cannot be liquidated regardless of how high the price rises.
When the CME allows Bitcoin to be used as margin, the dislocation should lessen but will not disappear. I doubt the CME will lower initial margin from 40% to 1% to match BitMEX and other platforms. Therefore the short side will demand higher and higher premiums to supply the incoming macro hedgies their long Bitcoin exposure.
If indeed PTJ nudged his average brethren to follow in his footsteps, any meaningful portfolio allocation will appear in rising CME open interest and a steep contango curve. If PTJ isn’t enough, maybe a few other legends will catch the Bitcoin bug and come play in our “magic internet money simulacra”.
Average Ain’t So Bad
Being an average fund manager ain’t a bad gig. If you know how to shake your rotund Dorsia-fed belly correctly, 2% of billions can fund a very nice lifestyle. The average fund manager who just bought the index outperformed all the so-called contrarians. That is why many of the greats of yesteryear shutdown. The problem is when your skills are average but your ambition is greatness. That is the definition of career risk. Stay in your lane, and financial services is a kind mistress.
Don’t let my musings on my portfolio confuse you that I have any deep insights into the future. I approach my PA as an exercise in intellectual gambling. It keeps me interested in the markets and gives me something to talk about. There is nothing better than finishing a day shredding Hokkaido Jay Pow, and relaxing in the onsen with your boys talking stonks while sipping on a Sapporo Classic.
Now let’s get back to business…
And, in this house, the keeper is Jack.
Now some of you who might wonder,
“Who is Jack, and what is it that Jack does?”
Jack is the one who gives you the power to jack your body!
Jack is the one who gives you the power to do the snake.
Jack is the one who gives you the key to the wiggly worm.
Jack is the one who learns you how to walk your body.
Jack is the one that can bring nations and nations of all Jackers together under one house.
You may be black, you may be white; you may be Jew or Gentile. It don’t make a difference in OUR House.
And this is fresh.
See y’all mother fuckers at the Clerrrbbb!