Sharing some half-formed thoughts here since they seem fun (these are more just random field notes than a proper thesis).

Anyhow: it all starts with “volmageddon” and ends with a weird, harebrained idea of a phase shift in the market.

Toward increasing chaos.
1/

Okay so first: what was volmageddon?

Well… it was the catastrophic collapse of a short volatility strategy, basically. A bunch of people noticed that systematic short volatility did okay most of the time.

So they piled in.
2/

And for a time the trade was good.

But then, as these things go, it got a little crowded — you hear this a lot about trades; “it’s crowded” or “everyone is on one side of the boat.”

A sort of population explosion within the volatility trade.
3/

Anyhow, short vol blew up and face melted everyone in the trade, and also took the SPY down like 10% in a number of days.

But the volatility theme persisted.

And not only persisted — as people like @jam_crossiant (and others) have noted, it’s now arguably the dominant trade.
4/

What does “dominant trade” mean? That most of the price movements are from volatility these days, with the underlying instrument being sort of an afterthought.

There’s a lot of great work on this, such as the recent piece by @nope_its_lily noting how vol moves markets.
5/

And if you’re going down the rabbit hole here, you’ll also want to read the @SqueezeMetrics piece on the implied order book.

You can find it here:
6/

https://squeezemetrics.com/download/The_Implied_Order_Book.pdf

Today, volatility trading is quite likely the price-dominant form of trading.

This is perhaps accentuated by the rise of passive, since the actual holders of equities are not really participants in a meaningful way, the volatility trade is sort of the main locus of activity.
7/

So now let’s look at something from another discipline, which was first brought to my attention by @equip_operator — it’s called the logistic map.

It looks like this:
8/

This is one of those patterns that is just kind of everywhere.

It’s been used to model everything from population levels to fluid dynamics, and is related to the Mandelbrot Set.

Here, just watch this intro:
9/

Okay hopefully you watched it because it's sort of a lot to tweet.

What struck me in watching this is how broadly applicable the math behind it is for modeling all sorts of things, but especially chaotic systems.

But why would any of this matter?
10/

Well, let’s assume that markets went through a regime shift at some point (around volmageddon), and that regime shift can be characterized loosely as going from an “underlying-dominant regime” to a “volatility-dominant regime.”

What might this mean?
11/

Well… for one thing, the return profile of options is very different from the return profile of the underlying instruments.

You’ll hear this talked about as “convexity,” and it’s got sort of a curvy return profile that’s different than vanilla leverage.
12/

So when you’re trading options, you’re trading a waveform (from a returns perspective) instead of something linear (which is the way the underlying asset moves).

And that’s fine - the original intent of options kind of as insurance, so you want that extreme tail protection.
13/

But what happens to a market where everyone is trading these waveforms — a market where price movements are dominated by convexity?

Well… if the return profile of everything is a waveform, we would expect the market to be more… chaotic (in the mathematical sense).
14/

Because what’s really happening under the hood is that linear-oriented traders are asleep (passive) and the convex-oriented traders are the ones driving the boat.

So trading action might become more like a series of overlapping waveforms — something more like fluid dynamics.
15/

And as this convexity-driven regime amplifies, we might expect to see these replicating waves become more and more prevalent as market features as these chaotic, fluid-dynamics-like price movements become an increasingly persistent feature.
16/

And as chaos takes over, if we squint our eyes just right we might begin to see some old familiar forms...

Enjoy the ride.
/17