Cem Karsan, Aegea Capital - 30 Day Vol Tends To Be Overbid And You Have Extended Supply In The Back Of The Curve Historically | #252

Episode Summary

Executive Summary: Jim Carson of Aegea Capital outlines how his firm monetizes structural inefficiencies in equity volatility, mainly through long-vol and vol arbitrage strategies centered on SPX options. He argues that compressed risk premia, Fed-driven liquidity, and retail/derivatives flows have distorted markets, creating both opportunities and fragility. The discussion focuses on election volatility, post-election trade ideas, and the possibility of a regime shift toward higher rates, inflation, and bigger tail risks.

Main Topics: Jim Carson’s background and path into volatility trading (Priority: 4/5): Carson recounts his international upbringing, math/econ education at Rice, market-making in SPX options, and eventual launch of Aegea Capital after years of building market-making operations. Aegea’s long-volatility strategy and toolkit (Priority: 5/5): The firm targets inefficiencies in 30-day equity volatility, especially SPX and VIX-related products, using quantitative models, tail hedges, and structured convexity trades across indexes, ETFs, and options. Why volatility inefficiencies persist (Priority: 5/5): Carson argues that money managers prefer short-dated hedges and avoid holding long-dated vol, creating persistent supply-demand distortions and a kink in the volatility surface, especially in 30-day vol. Regime change, liquidity, and Fed policy (Priority: 5/5): He describes the last 20 years as unusually shaped by Federal Reserve liquidity, low rates, and compressed risk premia, warning that higher inflation or rates could trigger a very different market regime. 2020 market stress, election volatility, and trade ideas (Priority: 5/5): The interview turns to March 2020, the election, and steep implied-vol pricing for December/January, with Carson suggesting opportunities in calendar spreads and value-vs-growth volatility structures. Retail options, gamma effects, and market flows (Priority: 4/5): Carson explains how retail call buying forces dealers short gamma, amplifying trends and helping create unpinning and rotation effects across growth and value stocks. Firm outlook and product expansion (Priority: 3/5): Aegea plans to broaden its directional use of volatility indicators and launch a CTA product, while long-vol capacity remains limited due to liquidity constraints in stress scenarios.

Key Arguments: Long-vol can be profitable because 30-day equity vol is persistently overbid relative to longer-dated curves due to structural demand for short-dated protection. The volatility market is driven by supply-demand imbalances, not just theoretical pricing; money managers and products like VIX reinforce this kink. Fed liquidity and low rates have compressed risk premia across assets, lowering day-to-day volatility but increasing the potential for sharper tail events. A secular rise in rates or inflation could unwind the last 20 years of market behavior and force a regime change in volatility, credit, and equity factor performance. Retail call buying and dealer hedging can create self-reinforcing gamma flows that move markets and increase volatility in the underlying stocks. Election-related options pricing suggests elevated risk for December/January, but the market may also be overpricing the immediacy of a contested outcome. A useful way to express macro views may be through value-vs-growth volatility structures rather than simple directional equity bets. Long-vol strategies are useful as portfolio hedges because they can provide convexity and liquidity when investors most need to rebalance or buy assets in stress.

Data Points: Aegea inception: Late 2011 - Carson founded Aegea Capital after selling his market-making stake and taking time off. Firm operating history: About 8.5 years - Carson describes how long Aegea has been running at the time of the interview. Annual alpha: North of 10% alpha per year - Carson says Aegea’s flagship long-vol strategy has generated positive returns and alpha over the long low-vol period. Average holding period: About 1.5 days - He says most trades rebalance quickly based on implied vol and underlying moves. Minimum rebalance frequency: Weekly - Their distributions are based on five-day/weekly windows, requiring at least weekly rebalancing. Portfolio allocation target: 5% to 10% of a portfolio - Carson frames the strategy as a smaller diversifying sleeve rather than a core equity allocation. Typical long-put expected value: 10% to 20% negative per year - He contrasts the strategy with buying long puts, which he says historically has poor carry. August 2015 performance: About +30% - He cites the yuan devaluation and market stress as a major positive month for the strategy. February 2018 performance: About +30% - Another strong stress period for long volatility, according to Carson. March 2020 performance: Peak of about +50% for the month - Carson says the strategy had an exceptional month during the COVID crash. 2017 downside move: No move greater than 3% to the downside - Used as an example of extremely compressed realized volatility under low risk premia. 2017 equity correlations: Lowest in history by about 20% - He cites 2017 as evidence of a feedback loop from compressed risk premia to low realized vol and low correlations. September 2020 election straddle: About $80 - He says the one-day election straddle is around 2.5% implied move for the SP500. Implied daily move in December/January: $110 to $115 per day - Carson says markets were pricing roughly 3.5% daily moves in the SP500 in the post-election period. Contested election probability in market pricing: North of 65% - His estimate of the probability implied by market pricing. His own contested-election estimate: About 25% - He gives a personal view, with a wide uncertainty range. Long-vol strategy capacity: Around $500 million - Carson says liquidity constraints limit the strategy’s capacity. Current assets managed in long-vol strategy: About half of capacity - He says the book is only about half full. Great Financial Crisis trading result: $2 million to north of $35 million - Carson cites this as his best trade and formative experience. 10-year volatility during crisis: Around 60 in 2008 - He uses this to illustrate how leveraged positioning can force extreme volatility repricing. 10-year volatility before crisis: Around 13 in 2006 - He says the pre-crisis level looks absurd in hindsight, highlighting regime risk.

Pivotal Quotes: "The idea being that there's always opportunities on the curve based on supply and demand dynamics, but intrinsically structuring it with tail and convexity." — Jim Carson: Explaining how Aegea constructs long-vol trades without revealing proprietary details. "If you ever have a system where liquidity disappears, the effects are exponentially worse than they ever were." — Jim Carson: Discussing leverage, Fed support, and the danger of a regime shift. "Be long volatility for position yourself to be able to take advantage of an increased likelihood of something happening." — Jim Carson: His advice on how to think about election-related market uncertainty.

Implications: Listeners should view long volatility as a small but valuable portfolio hedge in an era of compressed risk premia and fragile liquidity. If inflation or rates rise, market structure could change sharply, making convexity and tail protection more important than in the last 20 years.