Hari Krishnan is an experienced money manager and Head of Volatility Strategies at SCT Capital Management. He typically hedges portfolios through a combination of options contracts, long volatility instruments and broad views of the macroeconomic environment. His views on the commodity space and the state of inflation in the global economy are particularly relevant right now and he joins the ETF Think Tank to discuss these topics and more.
As a money manager and commodities watcher, Krishnan says that a primary question he asks himself is “how can I get investors exposure to commodities at a low cost with significant upside using financial instruments?” He originally captured commodities exposure through the VIX and still does this today. He notes that many commodities are in abundant supply and this can be an advantage that often becomes forgotten. The majority of commodities today are still pretty cheap, but that can also create an environment where you need to pay a little more and roll the contracts forward. He says that the bullish case for commodities currently is deglobalization, food security interests and the green energy revolution. Commodities could be in a bull market over the next decade.
While a lot of VIX options traders are focused on 0DTE contracts, Krishnan finds more value in the options with 2-3 days until expiration. 0DTE options are immensely useful for those selling risk to close out positions before the end of the day, but this focus on 0DTEs has also altered the risk profile. We’re seeing a pickup in activity at the 0DTE as opposed to the 1DTE and beyond because this has become increasingly popular. You’re also, however, trying to sell volatility in order to generate some alpha. Eventually, the pendulum swings. Krishnan observes that 2-3DTEs are attractively priced relative to 0DTEs right now.
Krishnan believes that the pressure on traders and hedgers is higher if you’re trying to execute a strategy that’s not built for the environment. 2022 was such a unique year because asset prices fell without a huge spike in the VIX. His firm hedged for three outcomes at the time – 1) a flash crash, 2) a steadily downtrending market and 3) a change in risk appetite (which is accomplished using longer-dated options). Krishnan says that you need to be able to hedge based on the state of the world, but not every strategy works all the time. For him, he’s looking to have strategies and devices available that he can apply to help him get by without adding risk.
Krishnan believes that there’s the potential for much higher volatility around the upcoming presidential election than past ones and he would be tempted to take part in it. There may be some potential in long volatility trades around the election, but it’s hard to say how November will reprice before the event. That’s the biggest danger. We just don’t know how it will play out.
Krishnan’s opinion of the current state of inflation centers around the idea that we’re seeing a lot of Fed jawboning vs. what the data is telling us. There’s this perception that the ship can sail straight, but there are more potentially destabilizing events in the current environment than in the past. He is surprised at how resilient stock prices have been and how low spreads are considering where inflation and market risks are at. Typically, sticky inflation doesn’t support higher asset prices, but some people think this is a “cleaner” environment given the liquidity that is still in the system. High yield, in particular, is more energy dependent and could hold up if the energy sector holds up.
He does believe that there’s a lot of potential in copper, but it’s a tough trade right now. Copper has a strong structural tailwind. As fossil fuels are de-emphasized, more metals will be required e.g. rewiring the grid and electric vehicles. Copper will be in heavy demand. It is sensitive to economic growth, but the bull case long-term is strong.
Other key takeaways:
- Commodities contracts are different depending on who is using them. If I’m a farmer, I need to hedge one-to-one so it doesn’t impact revenues. As a cereal manufacturer, the impact is much lower.
- Krishnan had no position in cocoa and mostly sticks with metals and grains. Cocoa doesn’t have really liquid options and he wouldn’t be surprised if traders just excluded them from their universe.
- If you have 52% winners and 48% losers, you’ll end up doing fantastic as long as you manage tail risk.
- One of the things that’s good about the U.S. is how open it is to innovation. However, there’s a lot of indiscriminate money being thrown at innovation plays that he thinks is fueling over-optimism.
- What indicator is useless. Krishnan used to love the sequencing of events for alpha generation and hedging, but admits it’s become near useless lately. Historically, rates have moved first with FX and then equities following. That cycle has been broken even before the 2020s due to the persistently low interest rate regime.
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