Macro Macabre: Insights About the U.S. Equity Markets

Posted by Patrick Dugan on Oct 22, 2019 9:38:37 AM


This column represents the opinions and trading strategies of Patrick Dugan, a serial entrepreneur, founder of the TradeLayer protocol, former director of the OmniLayer Foundation. Before working in Bitcoin layer2 protocols, he founded an ag-tech start-up and had a 7 year career in the video game industry. Patrick also writes sci-fi, practices indie game design, and enjoys synthwave music.

The US stock market is a store of value for the American investment class. It is Bitcoin for Baby Boomers. They really believe in it, P/E ratios notwithstanding. At certain valuations, you have to hold your nose and rationalize that there is no alternative. But there is an alternative. EMX is the only exchange where you can go short SP500 and Long BTC. BTC is where the future resides, let’s say, since we’re BTC people. It’s the hottest bull market since the SP500 in the 80s, or gold in the 2000s. Technically, it’s hotter and more volatile. How can we trade this market in today’s age of Tweet volatility?

Every year as summer turns to spring, the governors of the Federal Reserve go on vacation to a place called Jackson Hole, and the chairman makes a speech. Fed speeches are very low on information content and high on psychological conditioning, and Jackson Hole is a thematic, white-water rafting vacation backdrop for that psychology.

This year, a funny thing happened. The President of the United States of America dropped some fire on Twitter. He low-key bullied the academic-styled man who gave the speech, for not being gung-ho enough about America. The President says, Europe and Japan have negative interest rates, US rates should be zero. Then the President ordered US corporations to leave China. When hecklers suggested the President doesn’t have such power, he responded:

Screen Shot 2019-10-22 at 9.12.56 AM

Then on the Monday after, we all sort of pretended it didn’t happen and forgot about it.

Maybe, the President’s policy-related tweets only affect the world during business hours. If it happens at 12:30 am on a Saturday morning, that’s just content. DJT gets to try ideas out in drafts, just like any other Twitter user trying some new memes out.

Engagement is hard.

I was once or twice engaged in Argentina.

While some of my peers were enjoying ripe careers in New York and San Francisco, I was gaining valuable life experience in Buenos Aires, being robbed by wauchos and selling bitcoin for cash to survive from a guy named Dante who later exit-scammed after I left. Capital controls, bureaucratic socialists with perpetual inflationary policies, there was even a never-cited financial terrorism law criminalizing use of dollars. What a fabulous time in my life. Argentina’s inflation rates were 17% when I first arrived in 2007, 23% in 2009, 28% in 2010, 32% in 2011, and presently are around 45-50%, even years after capital controls ended and the non-Peronist, presumably crony capitalist Macri in charge. Macri got the re-borrow going, fresh tens of billions, but then didn’t dollarize, so now we get Cristina Fernandez de Kirchner again.

This process was not a smooth boil. Boiling a frog is gradual, but if you know a bit of physics, you know phase transitions are rather violent. It’s just that the violence is distributed in time and over a volume. In 2011, CFK put on capital controls. In 2014, she suspended independence of the central bank. The CB began issuing high yield, short-term notes to soak up pesos from the street and hammer the USD bulls, temporarily. All kinds of games were played. They were amazing at buying themselves time at everyone else’s expense.


To paraphrase a wise man, Walter Sobchak: “This is what happens Johnny! This is what happens! This, is, what happens Johnny, when you violate a central bank’s independence!”

Argentina is like a beautiful car that has been vandalized.

The USA can suffer the same fate.

“But wait, aren’t you anti-Fed?”

Sure, I like Bitcoin. If you’re reading this, odds are, you like Bitcoin. But let’s say: there are Bitcoin pairs in low-inflation fiats, and Bitcoin pairs in high-inflation fiats. It’s better if the central bank can at least moderate the inflation of a currency, versus extreme printing and spending.

Here’s BTC in Argentine Pesos:


From 10 Pesos in 2012, to hundreds of thousands. That’s what is happening to every currency, but Argentina does it harder. This is why it’s weird that US Fed governors go on vacation to a place called "Jackson Hole." Andrew Jackson was anti-Central Bank, and they shouldn’t be getting into more holes.

What self-respecting trader doesn’t have a core collateral position in BTC that they are trying to grow?

If all the macro traders out there put 5% of their personal assets into BTC and used it as collateral, it would add another 50% gain in price by itself.

Why is BTC the hottest market?

What is the adult, intelligent rationale to explain these numbers? Because the store of value that the prior generation came to rely on, has become a game of jawboning central bank governors. The absurd yet polite game, became a game of midnight tweeting. It’s not just a scheduled press conference anymore, now, it can hit at 12:30 am. Maybe Kim Kardashian says: "Mr. President, positive real-yield keeps the USD a reserve currency." And that’s the moment Trump goes: "After careful contemplation of macro-investment flows thanks to Mrs. Kardashian, I’d like to say to the Fed governor, keep up the good work! I’ve always been a huge supporter of an independence Federal reserve."

How can you make macro bets if you don’t know which timeline we are living in?

Are we living in the timeline where Trump undermines the Fed into following negative interest rate policy? Or are we living in the timeline where Kim K points out how important having one major currency with positive real-rates is to the global balance and the USD’s continued reserve status? Are the top-performing hedge funds going to run sentiment algos that can parse and react to this stuff? Will the most in-demand Ph.D quants be the guys who advanced natural language processing enough to estimate how likely Kim K’s plea for positive USD rates is to influence Donald Trump?

How can you make money from this madness?

Well my friend, I’ll tell you for free. Disclaimer: the price of this advice may be correlated to its value.

First off, like the young man in the background at the Janet Yellen press conference once signaled: Buy Bitcoin.


Second: GROWDL. Bitcoin is amazing collateral. I believe it’s going to become a major wholesale finance collateral to compete with gold, bunds and USTs. Spread trading is speculation for smart people. You’re smart, I mean, you hurdled that text pretty well, so I assume. So you could be behooved to learn how to size up good spread opportunities. Earning BTC from reasonably risk/reward plays on spreads, is a neat way to grow a stack.

Correlation between Bitcoin and the SP500 is sporadic.


These correlation charts are courtesy of - a cool data start-up founded by Nic Carter. The chosen formula for this correlation chart is Pearson correlation, which is more relevant for short-term trading movements because it’s based on literal moves in the two assets.

Bitcoin volatility’s relationship to SP500 volatility is structurally weirder, and biased in an exploitable way. There’s a ton of money selling SP500 volatility. Both at the macro level in the options markets, VIX ETFs etc. but also, at the micro-structural level with algos that are mean-reversion oriented. In Bitcoin, there’s probably more money trying to buy break-outs and therefore contribute volume pro-catalytically to moves, and some wise-guys buying BTC options in one of the many forms, than there are people trying to harvest yield out of the premium. So maybe, you could go short Bitcoin Volatility and Long SP500 Volatility. Presently this would require using BTC Options, but a BTC Volatility Swap may become viable in the near-future.


A quick comparison of the two charts shows how the stock index is inversely correlated to its volatility.

For example, the line for July 2018 has an up-wave for the BTC-VIX correlation, and an inverse down-wave for the stock market’s correlation to bitcoin. This is probably because Bitcoin had a huge rally that month, and so did the S&P, but BTC went up later in the month. So they didn’t move in lock-step, they were uncorrelated, even though it looked like, just from the whole month, that it was a good month for risk assets. Hopefully this helps to read the chart and appreciate the inverse correlation between the stock index and its volatility.


VIX is Orange, BTC is blue. Stock dipped in June, VIX popped. BTC also slumped. Then Stocks recovered, VIX dropped. Then BTC rose. Then BTC sold off violently (recall getting hit by that one), correlations shifted again.

BTC volatility, like gold’s volatility, is positively correlated to its performance.

BTC breaks out into some new range, the market is rampantly and unpredictably bullish, BTC volatility is up. Same story with gold, or funnily enough, the high-flying tech stocks that lead the SP500’s performance. AAPL options, for instance, trade like gold or BTC options. So now it makes sense. Yet because of the abstraction of the SP500 as an index, and the biases of “using” it for hedging, there is skew on the Puts side for SP500 options. Yes, now that you mention it, a hedge fund could have a strategy of shorting S&P 500, buying cheaper S&P 500 calls to make that a synthetic Put for a lower debit, and then selling covered AAPL calls, and have some high-frequency algo trade around the correlations between the basket leader and the basket. But those strategies are tired! It’s time for new strategies playing off relationships between these big, global liquid markets and BTC, the new hotness.

If you could short BTC volatility, it can hedge your spot BTC in an interesting way. Maybe net of the swap payments received, which are synthetically a more modest but less risky version of theta-decay from selling options, you don’t lose as much to the BTC-VIX hedge as to a short BTC futures hedge. Or maybe not!

Then consider, if you’re short BTC-VIX to earn richer premiums, and long SP500 via stop-orders that buy/short a breakout, it creates a situation where you’re more likely to earn short/medium term profits than not. You make money in 2 out of 3 scenarios. Either BTC-VIX swap pays you and nothing big happens with the stocks, or you get a correlated event and make more money between the swap received and the SP500 breakout trade than lost on rise in BTC-VIX.

EMX doesn’t have a Volatility Swap product right now, but it does have the US500 perpetual swap, the BTCUSD perpetual swap and two futures expirations. Going 1x short BTC with futures is like holding a high yield t-bill with the credit risk being the exchange’s custody. I think EMX has a better custodial risk profile than BitMEX, because of their location in Palo Alto. Geopolitical security in the Bay Area is pretty ok last I checked. So you have a long US500 position on EMX, and a synthetic bill position for safety. If your US500 trade loses, the BTC premium can still make you money. Most often, there’s a big macro suck and US500 dumps, and BTC dumps. Sometimes BTC rallies in these moments, as it did during the Twitter-bizarro-world moments mentioned above. But when they trade in the same direction, the “yield” on the futures hedge of your collateral will basically become realizable, and you could buy the future back at par that you sold at a premium.


Now swaps, swaps are the best derivative. I really love them. They power global wholesale finance ya know. Trillions in eurodollars based on them. Bitcoin can do the same. With swaps you get interest rate risk correlated generally to the performance in Bitcoin, but the yield when it’s good can be quite rich relative to futures premiums. So BTC goes up, you’re kind of sour because you’re losing BTC, but because of the high swap rates, you are - as the alt-coin kids used to say in 2017 - “up in USD”. And when BTC goes down, you probably want to close your position and seek another hedge or go to cash, to avoid the negative funding, and to instead take a quick profit buying the swap at a discount.

So if US500 dumps, and you’re in synthetic swap-based BTCUSD cash, instead of the futures version, you’ll be in a position where you’re like, eeeh. Maybe better to short US500 and couple that with the “money market position” of BTC/USD collateralized swaps. Now, you’re structurally aligned, given my 5 years experience with BTC swap correlations to price moves, which may be worth nothing in 5 years. In the scenario where US500 dumps with BTC, cover the swaps at a discount and take profits on the US500 short. In the scenario where US500 pumps with BTC, take a loss, and get compensated in USD by the BTC swaps. Maybe if there were a BTC-VIX swap, you could go long that and end up paying some swap but earning out when BTC rises?

A lot of these correlation plays seem to be game-able on modest timeframes, e.g. 4-100 hours between set-ups and follow-throughs. There are several workable algo strategies to try carving these up on different timeframes. There’s also the more boring, lower margin but more consistently profitable strategy of taking liquidity on S&P 500 or the eMini/eMicro contracts and quoting the same size passively on EMX with their US500 swaps. These are the $20 bills being left on the sidewalk, for now.

Lastly, if the US500 dumps, and BTC pumps, you’re earning nice swap funding whilst earning on the US500 short. If US500 pumps and BTC dumps, hmm, pretty bad. But we assume structurally, that corner of the matrix is less likely?

In the earlier converse configuration, long US500, hedged with BTC futures, if US500 dumps and BTC pumps, not so great either. There have been times. Seems like a slightly more probable scenario than the odd scenario in the above matrix.

Suppose you would try to add leverage while adjusting risk by sizing your US500 position to fit the BTC position, and bet on the correlation more directly. If BTC moves 2% for every 1% US500 moves, size 1⁄2 USD notional on the BTC bet. Now we’re not layering in the fixed-income plays that BTC derivatives enable, but rather, simply betting on the spread. Directional long BTC, directional short US500. In the right size and looking at a ratio chart, the risk can be managed:

The Average True Range on a 14-Week Period showed a high of ~10 on the chart, which represented 23.7% in the closing price for February 2018, and is presently 12%; while the ATR(14) for Bitstamp:BTCUSD closed Feb ‘18 at ~24.3% at the average prices for the quarter. So the numbers do stack up, cutting this whiskey with coca-cola does slightly reduce the volatility of the BTC exposure. Now, you may say, it’s sacrilege to mix cola with good whiskey, but let me tell you: this is not triple-malt aged Scotch, BTC is Jack Daniels. It’s relatable. If you want fine Scotch, you can buy some BSV, which I imagine stands for Bitcoin: Scotch Version.

The volatility reduction isn’t so great that this merits significant leverage. 1x dollar-equivalent positions are probably a good place to gain experience, if not remain. Nobody really uses the Kelly Criterion but if they did, the ideal sizing wouldn’t be too much bigger than 1x. It would be one-point-something-x. You just don’t want to be choking on too many x’es in this business.

Ultimately for BTC/US500, how many US500 units does 1 BTC buy you, is dominated by BTC’s moves largely because it is still uncorrelated. But it’s like Dark Energy, lots of little quantum bips add up to the slow, gradual expansion of macro-voids and superclusters diffusing. So some days BTC is 0.1-0.2 correlated to US stocks, some days it’s the opposite. It trended up the same years S&P 500 trended up, out-performing it, but on a month by month basis it often zigs while S&P 500 zags. It’s interesting for traders because the correlation is such an unpredictable element. Over time we expect the macro to “place” BTC and in the process, value it much higher. Maybe volatility will be lower then. Correlation to S&P 500 will probably be higher as BTC reaches its mature position in the procession of the macro.

I looked at the ATR for S&P 500, it’s 2.66% now and was ~5% in the pit of the crisis in December. So it’s much lower. The ratio is about 5-8x. It’s such a big volatility gap with BTC vs. gold. Sizing BTC shorts in particular, at smaller than the S&P 500 exposure, to account for the volatility, is a good idea. Maybe just avoid >1x BTC short positions. Sizing longs smaller leads to under-performance vs. the significantly larger performance averages in BTC. Don’t miss the forest for the trees, use SP500 behaviors to stack the odds for sat stacking.

Volatility isn’t really those fast moves from the top of the range to the lower half. Sorry you got snookered on that trade, I know it was a fast move, but the magnitude was actually smaller than the previous moves recently, and the shock-and-awe had more to do with your leverage. No, real volatility is: violent, aggressive, range-breakout moves with sharp retraces that are re-retraced for a continuation almost as fast and so on, with an unpredictable top-range destination, and a slightly more predictable but slippery future range average. When BTC was breaking 3k, I thought it would come back to 3k on a “wave IV” and I was sort of right about that. It was a modest, mildly useful guestimate. But I surely did not predict 19 thousand, six hundred and sixty six as the top. Those old Goldman guys, at it again!

Volatility begets out-performance because it is trending range expansion where the real upside surprise brunt of volatility lives. Volatility is really about the confusing, adolescent feeling of price discovery, and resulting speculative inflation of the valuation of the thing that is trending. Swap premiums, options premiums, uncorrelation, hedge funds looking at that and contributing the next seismic wave of cash bids, all of it, is a derivative of that energy. See the big picture, don’t get it twisted.

Practicing bad risk management is a great way to get into the hole. What you really want to do is to remain whole. Every algo trader and manual arbitrageur wants to climb the mountain of their own uncorrelated equity curve, not descending into any significant-sized holes. Dips and dives, sure, that’s just topology. But if you are going to descend into some hole, at least it won’t be to make a speech about monetary policy and then get bullied by the president.

Stay safe, trading people.


Information on these pages contains forward-looking statements that involve risks and uncertainties. Markets and instruments profiled on this page are for informational purposes only and should not in any way come across as a recommendation to buy or sell in these assets. Traders should always make sure they carry out their own research before buying any idea given. The views expressed in this article are the author’s and may not represent the views of EMX.

Topics: Macro Macabre