Talk Your Book: Protecting the Tails

Episode Summary

Executive Summary: The episode features a discussion with Simplify CEO Paul Kim about SPYC, an ETF that pairs mostly S&P 500 exposure with options-based tail hedges on both the downside and upside. The hosts explore why structured option overlays may become more useful as volatility rises, how the strategy works mechanically, and why packaging it in an ETF could make sophisticated protection easier and cheaper for advisors and retail investors.

Main Topics: Introduction to SPYC and convexity investing (Priority: 5/5): The hosts frame Simplify U.S. Equity Plus Convexity ETF as a novel equity product that keeps most money in the S&P 500 while using options to protect against major losses and capture extreme gains. Why options-based protection is gaining appeal (Priority: 5/5): Paul Kim argues that low rates, expensive equities, and expected volatility make options a more compelling substitute or complement to bonds for risk mitigation. How the ETF uses options (Priority: 5/5): SPYC holds about 98% in S&P 500 exposure and uses the remaining budget to buy out-of-the-money calls and puts, aiming to protect both tails while preserving core equity exposure. Tradeoffs and costs of insurance (Priority: 4/5): The conversation emphasizes that tail protection is not free; in calm markets the strategy can lag, but its cost is intended to be modest enough to remain viable through bull markets. ETF wrapper as a solution to accessibility (Priority: 4/5): Kim explains that an ETF simplifies implementation, rebalancing, custody, and tax handling compared with advisors trying to build the same overlay manually. Market structure and future product expansion (Priority: 3/5): The guests discuss how changes in regulation, liquidity, and options usage may allow similar strategies across other benchmarks, though the S&P 500 is the easiest starting point.

Key Arguments: The strategy is designed as a core equity replacement, not a tactical trade, so it should remain usable through both bull and bear markets. Buying tail insurance through out-of-the-money options can be cheaper than many investors assume because extreme moves are rare and the strikes are placed far from spot. Protecting only downside risk can be incomplete; upside volatility also matters because major market gains and melt-ups can materially affect returns. The ETF structure is valuable because it packages a difficult, operationally messy options overlay into a single, low-cost, hands-off vehicle. In a world of low yields and constrained bond protection, options may provide a more effective alternative source of portfolio diversification. The fund is systematically rebalanced and includes monetization rules, so gains from large volatility events can be captured and recycled rather than left unmanaged. The product may appeal most to advisors because it is sophisticated, rules-based, and solves implementation problems that are hard to manage client by client.

Data Points: S&P 500 exposure in fund: 98% - Paul Kim describes the core allocation of SPYC as essentially S&P 500 exposure via IVV. Options budget in fund: 2% - The remaining portfolio allocation is used as insurance premium for tail hedges. Quarterly options spending: Roughly 0.5% per quarter - Kim says the 2% annualized budget is effectively spent over the year in quarterly purchases. Out-of-the-money strike distance: 25% to 50% out of the money - Kim says the fund uses far-out strikes to maximize protection per dollar spent. Illustrative downside hedge example: 1% in 30% out-of-the-money puts - He cites a model where a small put allocation could have provided protection comparable to a 60/40 portfolio in Q1 2020. 2020 peak-to-trough S&P 500 drawdown: About 35% - Used as an example of a sharp crisis drawdown that the strategy is intended to help address. Balanced portfolio comparison: 60/40 (SPY/TLT) - Referenced as a traditional hedging approach that SPYC aims to compete with. 10-year Treasury yield: About 70 bps - Used to illustrate how bond hedging power has diminished in the current rate environment. Estimated annualized equity return: 11% - Kim contrasts historical equity returns with bond returns when discussing tradeoffs. Estimated annualized bond return: 8% - Used in the discussion of historic return differentials between stocks and bonds. Average annual drawdown in S&P 500: About 13% - Kim cites this to argue volatility is normal and should be expected. Bear market frequency: About once every four years - He notes that 20%+ drawdowns have historically occurred roughly every four years. Options market volume: About $250 billion traded every day - Kim uses this to show the size and liquidity of the listed options market. At-the-money SPX option notional: About $335,000 - Used to explain why direct implementation is difficult for individual investors or advisors. At-the-money SPX option contract price: About $7,000 - Included in the explanation of the cost/complexity of implementing options directly. AUM of PIMCO ETF platform: A little over $20 billion - Kim references his prior experience helping build PIMCO's ETF business. AUM of Principal ETF business: About $3.5 billion - Part of Kim’s background before founding Simplify.

Pivotal Quotes: "positive convexity basically means an investor may profit more as prices go up and lose less as prices fall" — Paul Kim: Definition of the strategy’s central concept during the explanation of convexity. "We're not interested in picking up the nickels and dimes in front of the bulldozer." — Paul Kim: Distinguishing Simplify’s long-options approach from typical option-selling yield strategies. "If something can't survive a bull market, it's not going to be there for you when you need it." — Ben Carlson: Closing endorsement of the idea that hedging products must remain viable in normal markets to be credible.

Implications: The episode suggests a growing role for ETF-based option overlays as bond diversification weakens. For investors, the key tradeoff is paying a modest insurance cost for smoother equity exposure and rare-event upside participation.