The War No One Can Price | The Weekly Wrap – 3/22/2026

Key Concepts

• Dynamic Hedging: The process by which market makers adjust their positions in underlying assets (stocks) to offset the risks associated with the options they have sold.
• Gamma Exposure: A measure of how an option's delta changes as the underlying stock price moves; negative gamma can exacerbate market volatility.
• Realized vs. Implied Volatility: The difference between how much a market has actually moved (realized) versus the market's expectation of future movement (implied/VIX).
• Non-Stationarity: The concept that market rules and correlations are not constant and can change abruptly, rendering old playbooks obsolete.
• Preferred Habitat Theory: The idea that investors have specific preferences for certain types of assets or risk profiles, which dictates capital flow (e.g., capital shifting from biotech to AI).
• The "Awesome" Portfolio: A diversified strategy consisting of 20% each in stocks, bonds, cash, gold, and real estate, designed to minimize drawdowns.
• Opex (Options Expiration): The third Friday of the month when many options contracts expire, often acting as a catalyst for shifts in market trends and volatility.

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1. Market Dynamics and War Risk

The hosts discuss the "willful ignorance" of markets regarding geopolitical events. Jared Dillian notes that markets often fail to price in obvious risks (like the Ukraine invasion or Iran tensions) until they occur.

• Binary Events: Markets struggle to price binary outcomes (e.g., war vs. no war). This creates opportunities for investors who can make probabilistic assumptions before the event is fully "priced in."
• The Fed as a "Normie": The Federal Reserve is described as an institution driven by the "path of least embarrassment." They are unlikely to cut rates while oil prices are high, as it would invite criticism, regardless of the economic necessity.

2. Options Flows and Market Impact

Brent Kochuba provides insights into the "behind-the-scenes" mechanics of the market:

• The Transmission Mechanism: 90% of options trades involve market makers (e.g., Citadel, Susquehanna). Because these firms must hedge their positions, their buying/selling of underlying stocks to maintain "delta neutrality" directly impacts market prices.
• The VIX/Realized Volatility Spread: Currently, the spread between the VIX and realized volatility is at a 10-year high. This suggests investors are heavily hedged, but the underlying market has not yet experienced a significant move.
• Jump Risk: There is a concern that if a 2–5% drawdown occurs, the lack of realized movement will suddenly "snap" into a VIX spike (potentially to 40+), as market makers are forced to adjust hedges rapidly.

3. Biotech Investing: A "Bag of Options"

DA Wallik explains that development-stage biotech companies should be viewed as a collection of options rather than traditional cash-flow-generating businesses.

• Sum-of-the-Parts (SOTP) Analysis: Valuation involves calculating the Net Present Value (NPV) of each drug program, adjusted by the probability of success at each clinical trial phase (Pre-clinical, Phase 1, 2, and 3).
• Capital Competition: Biotech suffered recently because capital flowed toward the "AI narrative." This illustrates Preferred Habitat Theory, where growth investors shifted their risk appetite from speculative biotech to AI, creating a massive headwind for the biotech sector regardless of individual company progress.

4. Regime Change and Adaptability

Jared Dillian emphasizes that the greatest challenge for investors is not the regime change itself, but the failure to adapt to it.

• Correlation Shifts: The post-2020 environment saw a shift from negative to positive stock-bond correlation due to rising inflation. Investors relying on the 60/40 model suffered because they were playing by "old rules."
• The Awesome Portfolio: To combat the inability to hold through 50% drawdowns, Dillian proposes a 20/20/20/20/20 allocation. This structure aims to provide consistent returns with significantly lower volatility, helping investors avoid the behavioral mistakes (panic selling) that destroy long-term returns.

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Synthesis and Conclusion

The episode highlights that modern markets are increasingly driven by derivative flows and shifting capital preferences. The key takeaways are:

1. Understand the "Why": Market moves are often technical (hedging flows) rather than fundamental. Understanding the role of market makers and gamma exposure helps explain market behavior that seems irrational.
2. Intellectual Flexibility: Investors must be prepared for non-stationarity. When correlations break down, the ability to pivot and abandon outdated strategies is more valuable than sticking to a "proven" historical model.
3. Diversification as a Behavioral Tool: Strategies like the "Awesome Portfolio" are not just about returns; they are about "eating your vegetables"—maintaining a structure that prevents the investor from making emotional decisions during market stress.