trading as a sudoku puzzle
Trailing 1-year inflation per the CPI index has been ~2.5%
Prompt CME gasoline futures (RBOB) are up 80% this year but the curve is strongle backwardated (deferred futures are trading much lower).
Gasoline is about 3% of CPI. If the futures roll up all year to prompt levels, this alone will add about 2.5% inflation for the next year.
The bond market has added 25 bps to the 10-year yield since the start of 2026. It sits at a 9 month high(via CNBC):
The put skew is also starting to kick in with the risk reversals on IEF making 1-year highs. This is the 1-month maturity for reference:
Bonds are in a weird spot. If the economy sputters, you usually want bonds as a hedge but not if it sputters because of supply-side inflation. Kinda makes me want to sell bond vol as they are might whip around but not really go anywhere but even though IEF vol is relatively pumped, how much fun is it to sell 9 vol?
Anyway, all the commotion did get me to pull up TIPs. The 10-year yield is 2%. The purple checkmark is the last time I bought them (and I wrote a big post on that decision and how to understand TIPs generally).
10-year breakevens look a tad elevated but not especially compelling so if you don’t like bonds, TIPs don’t look like an extra cheap alternative.
Been a while since I pulled this up. My TIPs replication “symphony” on Composer comprised of oil + bonds, inverse vol weighted:
The replicator has been underperforming TIP (the TIPs ETF) for years but just “caught up” on cumulative gain thanks to the recent oil surge.
Explained here:
💡Inflation Replicator | 8 min read
Finally, for the yield hogs with a stomach for swings, M1 WTI trades about >3% premium to M2, so if you think the futures keep rolling up, that’s a 36% annualized roll return if a prompt barrel maintains a market premium (formally called a “convenience yield” in futures parlance).
Put skews normalizing and then some
We already saw IEF put skew coming to life.
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Silver put skew is coming back. The 25d risk reversal on 30d options has been grinding back toward zero and is now turning positive.
Gold put skew is ripping higher.
Apparently, no asset is safe. Maybe those private ones that don’t have prices. Oops, scratch that…
Energy and the dollar vs everything else (Street Fighter voice) Ready, FIGHT!
And for the metals enjoyyyers…gold vols are way off the curve after prices crashed 15% in a month (that’s ~52% annualized realized vol but who’s counting?)
Erik (Outlier Trading) and I record a podcast each week. We usually discuss an evergreen idea but we also sprinkle in topical episodes based if something current is on our minds. This is one of those:
I step through my thinking and the price of oil call spreads on the pod but here’s a summary:
If CPI trends toward 5%…
My market on real yields: somewhere between 0 and 1%.
→ That puts the 10-year at ~5.5%, or about 100 bps higher than today’s 4.4%
→ IEF (duration ~7) drops about 7% — which is in line with current higher implied vols in IEF.
→ Jan IEF 90/89 put spread: ~6-to-1 payout
Now the equity side.
Current SPX forward earnings yield: ~5%. If investors accept just 50 bps of risk premium over a 5.5% 10-year, then the earnings yield needs to be ~6%, which implies a P/E of ~16.7. That’s roughly 17% lower from here, assuming forward earnings don’t contract.
→ Jan SPX put spreads at those levels: also ~6-to-1
Both trades land in the same neighborhood.
(You could go to lower strikes for fatter payouts if you think the market is genuinely asleep at the wheel on inflation risk.)
Oil call spreads suggest that the chance of the oil prices rising to current levels through the end of the year are about 25% so you can take or lay 3–1 odds. Steeping through the chain, if there’s a 25% chance of dropping 20% and the current price is fair then the upside to SPX is:
.75*SPX_up — .25*20% = 0
.75*SPX_up = .25*20%
SPX_up = 6.66% which would take the market back to unchanged for the year.
It’s quite reductionist to think this is binary and to reduce the valuation of equity to inflation → higher interest rates → multiple falling, but the art of market-making is essentially sense-making between prices and probabilities quickly.
If there are aspects you disagree with, I’ve shared what some of the prices are in the market so let me know what the trade is.
In the vein of Thursday’s post, you could think about stuff like “Buy IEF put spreads and buy SPY shares on a ratio of X” if you think SPY has more upside because its current pricing is coming from a >20% downside (do you see how that math works?). Trading is like a sudoku puzzle with prices as the given numbers. It’s like you have to find the hedge ratios that solve the grid.
I thought this thread was interesting, but not to scare you, it thinks my downside scenario is quite conservative if gasoline prices stay stubbornly high:
If SpaceX and OpenAI want to go public, I wonder if Elon and Sam call Trump…”bruh you’re ruining our picture”. And then they could all sit down and work something out. Art of the Deal.
You know how in Monopoly when you are a bystander to 2 other people trade you are sad? It’s because regardless of who got the better of it, you know YOU are worse off.
