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Hey everyone,
 
Today, let's talk about what we expect of the market—and then what we expect of ourselves—in 2023. And let's keep it brief.
  1. Strategy
  2. Ambition
 
Strategy
Our last word on Strategy was on December 11th:
Summary: The rise in rates and the subsequent murder of the 60/40 portfolio in 2022 hurt bonds more than stocks, but now that the 60/40 portfolio has been marginally replaced by the "40/60" portfolio (where the "40" is long an SPX risk-reversal), the roles are, indeed, reversed. Bad news for bonds would now hurt stocks relatively more than it hurts bonds.
 
The idea is that, right now, there's a crowded trade out there:
  1. Long bond
  2. Long SPX call
  3. Short SPX put
And if you'll forgive the cynicism, the motivation for the trade is that:
  1. Nobody would blame me for being paid 4.50% in risk-free Treasury yield, and I'll look stupid if inflation is "transitory" and I never got those meaty yields.
  2. I'll also look like an idiot if equities rallied to ATH, so I need to hedge that with calls.
  3. We just had a crash, so we won't have another yet. This is a bear market, not a crash. Besides, a crash would be a "Black Swan," so you can't blame me for that, either.
No doubt these folks will remain "blameless," but hedging one's reputation (or ego) tends to come with performance losses (as most hedges do). As such, in equities, we would expect to see some ineffectual rallies, some searing selloffs, and realized volatility outperforming implied. A failure, overall, for the ego-hedged equity investor.
 
We're going to be watching SPX Net Put Delta (NPD) as closely as ever, and we'll be especially tuned to net selling in 0–5DTE puts, which we feel is especially dangerous right now—near-term put-sellers always get hurt eventually.
 
For us, this all adds up to (A) a bearish bias (if you want a bull market again, you need people to buy puts), (B) a keen awareness of lurking Crash Risk (it's nearby), and (C) a strong preference for long volatility positions (long calls, long puts, long strangles).
 
That's it.
 
But speaking of long volatility...
 
Ambition
We were long volatility through most of 2022 because we felt we had to be (we simply didn't see an edge in being short SPX volatility). But in 2023, we're going to be long volatility because we want to be.

As we discussed at length last weekend, the research from 2022 that really defined our year was the work we did on the Growth-Optimal Option Strike Evaluator (GOOSE). It told us some things that, as risk-takers, we'd already internalized or maybe suspected—but it told us those things very loudly and unequivocally.

Chief among those things: We ought to be trying harder to look for long vol opportunities, because that's objectively how you get better portfolio risk-reward—by buying options. By giving yourself at least the possibility of really really big gains.

But how do you find these opportunities?

Those of you who've been reading these notes for the past few years know that we get warm, fuzzy feelings from selling SPX iron flies and shorting VIX futures. That's our comfort zone. What's more, our work in single-name equities is almost entirely market-neutral long/short (which is great—but it isn't long vol).

Even now, after explicitly acknowledging that the mathematics of portfolio growth dramatically favor long options, the idea of exclusively "seeking out long vol bets" seems deeply un-serious. It's capricious. It's financial libertinism. It's degeneracy. It's gambling.

All we can think of—to get over this priggish predisposition—is to lean into it.

We'll need a sense of play. Of whimsy. We'll need to revisit old concepts to view them through this new lens. We'll need to try out some new things, too: Data and methods. We'll need to talk more about single-name equities, where a lot of these opportunities may lie. We need to be degenerates, but scientific.

So maybe that's it: Our ambition is for 2023 to be the year of Degenerate Science.

Not sure where that leads... but then that's part of the fun, isn't it?

Happy New Year!

The SqueezeMetrics Team