Following the biggest sell-off in the equity market since April 10th of last year and with many investors stunned like a deer in headlights, Dylan Ratigan joins Tom Sosnoff in the tastytrade studios to discuss the opportunities that Tom sees given the present market conditions and where we go from here.

This is a terrific segment and in my opinion, one of the best episodes of "Truth of Skepticism" to date. Throughout this series, Dylan’s questions have provoked a very thoughtful conversation around the tastytrade investing philosophy, and have given traders unfiltered insight into both Tom’s and Dylan’s perspectives on finance and investing.

During this episode, the pair also discuss the recent sell-off in the market, opportunities in fixed income and equities, and finish with an intellectually stimulating conversation reminiscent of classic Dylan Ratigan.

What Can We Expect in 2015?

This market has been a little bit of a surprise in 2015 because it’s been reasonably volatile, but net-net, we’ve gone nowhere. I think the one thing you can’t do is discount the fact that it’s having trouble going higher. You can always argue it’s having trouble going lower, but remember, there’s positive drift in the market. Right now most of the rallies have been met with sell-offs and we’re in a good environment. Bonds are record highs, interest rates are record lows and that should be a reasonably good environment for stocks…. low commodity prices, virtually no inflation, good news from the Fed, and all of a sudden stocks…

On new positions, we’re net short. The market is unchanged and all this means is higher volatility, a lot more opportunity.
— Tom Sosnoff

We’ve seen a strong bid in the bond market since the end of February, and the bond market has also been the subject of considerable debate recently with the prospect of the Federal Reserve raising interest rates.

The Bond Market

For volatility sellers like us, short premium with the price extremes in bonds and stocks right now presents a great opportunity. The opportunity is, 1. There is reasonably high vol, especially after today. 2. There’s price extreme in bonds and there’s a decent price extreme in stocks, we’re just off of record highs. So, short the bond, sell premium in the bond, and short the stocks, sell premium in the stocks.
— Tom Sosnoff

While Tom sees tremendous opportunity in the short bonds and stocks play, throughout history there’s typically been an inverse relationship between these two asset classes. About 80% of the time, when stocks go up bonds go down, and vice versa. While not the historical norm, at the moment, bonds and stocks have a positive correlation. Tom believes that at some point their negative correlation will return, but for now, the short-short opportunity is blatantly obvious.

How Would You Trade That Information?

It’s really simple, short-short. You’re short bonds and you’re short stocks, it’s the only way to play it. You’re selling premium on both sides. The premium is how you improve your basis and how you improve your probability of success and the short-short is your direction. It’s the contrarian play, with the short premium.
— Tom Sosnoff

Everyone understands the directional bias... the market is at all time highs, we’ve been in a very strong bull market, and the contrarian play is that the market goes lower from here. We know that nothing goes straight up and nothing goes straight down and a correction is a reasonable assumption, but why is it that at tastytrade we place such an emphasis on premium selling and using implied volatility rank as a metric? Tom explains…

We’ve done a lot of research with respect to mean reverting assets and mean reverting characteristics of assets. The only true mean reverting measure we can find is implied volatility. So measuring implied volatility against itself gives us an indication of future mean reversion. You can not look at historical prices. There is no evidence, no validation of any kind of historical pricing suggesting that price is mean reverting.

The reason we show where implied volatility is in the underlying, relative to itself is because if something is at 100 (IV Rank) or if something is at 0 (IV Rank), which is as high or as low as it can go, it obviously has a higher likelihood of going in the opposite direction because it can’t go any further that one way. Those are the two extremes. That’s the only reason we feel like we have any edge whatsoever.
— Tom Sosnoff

While traders favor days like March 25th’s one hundred plus point loss in the NASDAQ and double-digit drop in the S&P, it's moves like these that cause the typical investor to question conventional wisdom. Conventional wisdom being that “the trend is your friend.” Dylan Ratigan argues that even though these are painful days for passive investors, it’s these movements in the market that distract passive investors from the longer term upward trends in equities. As a result, this entices them into being more active, leading to missed opportunities in the long term.  

So What About Conventional Wisdom?

Most investors lean on conventional wisdom because it’s all they know. Conventional wisdom is a lack of know-how. There’s no such thing as conventional wisdom. Let’s use “the trend is your friend.” There’s no math model and there’s no history that supports “the trend is your friend.” Markets are random and markets are cyclical. Cyclical in the sense that bonds and stocks right now are highly correlated, this time, and then they won’t be correlated at all. That’s what we mean by cyclicality. There’s a return to normalcy. The trend can’t be your friend if the statistical chance of X going up $10 or down $10 can be measured by the derivatives market perfectly.
— Tom Sosnoff

Our fundamental argument for active investing is that it gives us the opportunity to be above average. Who wants to be average? Taking a look at the market, it’s basically unchanged for the year, but for active, contrarian investors, taking advantage of the swings in the market presents an opportunity to be above average.

To wrap up the show, Dylan makes the point that there aren’t more active investors out there and one of the primary reasons is because the tax code does not facilitate active investing. He argues that the tax code is set up to make it as intimidating and expensive as possible to actively invest and it’s the consequence of a corrupt tax system.

The Current State Of The Tax Code

The tax code is set up, basically, to make it as intimidating and expensive as possible. It doesn’t matter what your politics are, it doesn’t matter what kind of investor you are, everybody knows the tax code is a corrupt swiss cheese rabbit hole from hell.

I can tell you… I have walked inside the U.S. Senate Building and had U.S. Senators point me to the room where lobbyists come with money to purchase tax exemptions. It’s like buying cheeseburgers. When I say corrupt, I mean literally… If you’re the cherry grower in central California and you want a different tax treatment, that’s for sale, you simply have to hire someone. Literally there’s a room, you go in that room, you give the money, you get a different tax treatment.
— Dylan Ratigan

This is just a taste of the conversation, but make sure to check out the full 30-minute episode by clicking the button below.

To see more episodes of Truth or Skepticism with Dylan Ratigan, go here!