Leaving Las-Vega: Nomura Structured-Notes Head Says Banks Face 'Hedging Squeeze' Amid Booming Business
Structured notes have been booming, with SEC-registered US notes on track to hit about $300 billion this year, up from roughly $200 billion last year. But the demand that had been levitating option premiums has gone, according to Alex Micalizzi, Nomura's international head of equity structured notes, leaving the banks that sell these notes with more volatility to offload than the market wants to absorb.
Asked on Bloomberg's Odd Lots whether the pullback reflected tight balance sheets or nervousness about expressing views, Micalizzi said it wasn't views. "I suspect that to protect portfolios, call options were being bought in the market. And as those portfolios changed and maybe shrank, the need for that went away," he said, adding that "large buyers that elevated option premium disappeared at the same time."
A structured note is a bank IOU paired with options. In the most common yield version, the client effectively sells the bank a put, and the premium funds the coupon. The bank hedges out the directional risk and is left long volatility, or vega, which it sells into the listed and broker markets - typically to S&P market makers - sized to how long it expects the note to survive.
The fastest growth has come in "worst-of" autocallables tied to the S&P 500, Nasdaq and Russell 2000. They pay a richer coupon because the investor takes the risk on whichever index does worst, and they knock out early, returning principal plus the coupon, once even the worst performer is back above its starting level on an observation date. With the Russell running higher in a near-straight line since last year's Liberation Day after years of going sideways, those notes have been knocking out and getting reissued. "What drives volumes in an [autocall] is a knockout," Micalizzi said.
In a rising market that's a "virtuous cycle": trades knock out, new ones come in, and day-one hedges work. Once stocks got choppy, notes that would have knocked out after three months started to look like longer-dated paper, and dealers all needed to sell more vol at once, just as counterparties outside the listed market and interdealer brokers pulled back and demand for that optionality was "fading come August." Dealers ended up with a lot more vega to offload just as market makers grew more reluctant to take it, as Bloomberg's Tracy Alloway put it. "That is very well described, yes," Micalizzi said.
Alloway's next question was whether that limits what banks can sell if they can't offload the vega. "Yes and no. I think there is still a market. There is way more liquidity in the U.S. capital markets than anywhere else," Micalizzi said. What ultimately drives issuance, he said, is the direction of the market: if stocks go sideways or down, "you're just not going to get the demand for more."
The bigger problem sits in the notes already sold. US-registered worst-ofs typically carry three-to-five-year maturities but an expected life of about two years, so dealers hedge them by selling two-year vol as a proxy. If the worst-of index falls, the chance that a note runs the full five years "becomes a real thing," and the dealer, short two-year vol, is suddenly exposed at five years with no new issuance coming in.
The rally side of the trap came up earlier in the conversation: if the indices bounce, notes can knock out within three months, leaving dealers holding nothing but their short hedges. "So there's a situation where dealers can be left short. A lot of vega on the street, just on a small rally," Micalizzi said, noting that "we're not too far from all-time highs as it is."
Alloway asked whether that's part of what Nomura's Charlie McElligott calls the "spot up, vol up" regime. Micalizzi said it's even more pronounced in single stocks, but on the index side "we are definitely seeing that just because of the growth of the worst of and the growth of the U.S. SEC registered notes," in longer-dated options.
On single stocks, where semis and the hyperscalers are the popular underlyings, the product complexity "goes to another level." Coupons can be contingent, paid only if the worst performer hasn't fallen too far, and instead of quarterly checks, the notes generally observe knockouts daily after giving the stocks a month to "breathe." Maturities typically run six to 18 months, maybe two years. Alloway pointed to a CoreWeave-linked note sold in Asia carrying a 40% annualized yield, written up by Bloomberg's Shuli Ren.
"So either I have vol here or I don't, and I'm now observing it every single day," Micalizzi said, describing an "on-off type of market in the single stock names."
The most creative structure he's seen lets each stock in a worst-of basket knock out on its own on daily observations. A stock that rallies 20% early is taken out, regardless of what it does next, so the dealer can end up holding a deep in-the-money put on a name that has since collapsed - a put that vanishes the moment the last remaining stock rallies. "And so I've got this massive vol of vol position where if everything just rallies now, it's done," he said.
For buyers, the ideal is to get in when volatility is high, then watch markets quietly drift lower while the coupon keeps paying, until "the world has become nice again, and I'm left with this really high coupon for as long as possible." Rip higher and the note knocks out early. Plunge through the barrier and, with a knock-in put, the buyer takes the full loss measured from day one, all the way to zero.
For dealers, "there's many ways to die." A slow grind lower can hurt - hedged at two years, stuck with five, while volatility falls and skew flattens. So can a large move that runs past the put spreads and call spreads used as hedges. On a real AI repricing, dealers can flip to short gamma around the barriers, which Micalizzi said means "I have to buy when market goes up and sell when market goes down."
Those barriers haven't been tested in this boom. "In all fairness, we haven't really seen a down market where those puts have been there," Micalizzi said.
Tyler Durden Tue, 11/03/2026 - 15:30
Continue reading...
[ H/T ZeroHedge ]
Structured notes have been booming, with SEC-registered US notes on track to hit about $300 billion this year, up from roughly $200 billion last year. But the demand that had been levitating option premiums has gone, according to Alex Micalizzi, Nomura's international head of equity structured notes, leaving the banks that sell these notes with more volatility to offload than the market wants to absorb.
Asked on Bloomberg's Odd Lots whether the pullback reflected tight balance sheets or nervousness about expressing views, Micalizzi said it wasn't views. "I suspect that to protect portfolios, call options were being bought in the market. And as those portfolios changed and maybe shrank, the need for that went away," he said, adding that "large buyers that elevated option premium disappeared at the same time."
How The Hedge Works
A structured note is a bank IOU paired with options. In the most common yield version, the client effectively sells the bank a put, and the premium funds the coupon. The bank hedges out the directional risk and is left long volatility, or vega, which it sells into the listed and broker markets - typically to S&P market makers - sized to how long it expects the note to survive.
The fastest growth has come in "worst-of" autocallables tied to the S&P 500, Nasdaq and Russell 2000. They pay a richer coupon because the investor takes the risk on whichever index does worst, and they knock out early, returning principal plus the coupon, once even the worst performer is back above its starting level on an observation date. With the Russell running higher in a near-straight line since last year's Liberation Day after years of going sideways, those notes have been knocking out and getting reissued. "What drives volumes in an [autocall] is a knockout," Micalizzi said.
In a rising market that's a "virtuous cycle": trades knock out, new ones come in, and day-one hedges work. Once stocks got choppy, notes that would have knocked out after three months started to look like longer-dated paper, and dealers all needed to sell more vol at once, just as counterparties outside the listed market and interdealer brokers pulled back and demand for that optionality was "fading come August." Dealers ended up with a lot more vega to offload just as market makers grew more reluctant to take it, as Bloomberg's Tracy Alloway put it. "That is very well described, yes," Micalizzi said.
"Peak Vega"
Alloway's next question was whether that limits what banks can sell if they can't offload the vega. "Yes and no. I think there is still a market. There is way more liquidity in the U.S. capital markets than anywhere else," Micalizzi said. What ultimately drives issuance, he said, is the direction of the market: if stocks go sideways or down, "you're just not going to get the demand for more."
The bigger problem sits in the notes already sold. US-registered worst-ofs typically carry three-to-five-year maturities but an expected life of about two years, so dealers hedge them by selling two-year vol as a proxy. If the worst-of index falls, the chance that a note runs the full five years "becomes a real thing," and the dealer, short two-year vol, is suddenly exposed at five years with no new issuance coming in.
The rally side of the trap came up earlier in the conversation: if the indices bounce, notes can knock out within three months, leaving dealers holding nothing but their short hedges. "So there's a situation where dealers can be left short. A lot of vega on the street, just on a small rally," Micalizzi said, noting that "we're not too far from all-time highs as it is."
Alloway asked whether that's part of what Nomura's Charlie McElligott calls the "spot up, vol up" regime. Micalizzi said it's even more pronounced in single stocks, but on the index side "we are definitely seeing that just because of the growth of the worst of and the growth of the U.S. SEC registered notes," in longer-dated options.
The AI Names
On single stocks, where semis and the hyperscalers are the popular underlyings, the product complexity "goes to another level." Coupons can be contingent, paid only if the worst performer hasn't fallen too far, and instead of quarterly checks, the notes generally observe knockouts daily after giving the stocks a month to "breathe." Maturities typically run six to 18 months, maybe two years. Alloway pointed to a CoreWeave-linked note sold in Asia carrying a 40% annualized yield, written up by Bloomberg's Shuli Ren.
"So either I have vol here or I don't, and I'm now observing it every single day," Micalizzi said, describing an "on-off type of market in the single stock names."
The most creative structure he's seen lets each stock in a worst-of basket knock out on its own on daily observations. A stock that rallies 20% early is taken out, regardless of what it does next, so the dealer can end up holding a deep in-the-money put on a name that has since collapsed - a put that vanishes the moment the last remaining stock rallies. "And so I've got this massive vol of vol position where if everything just rallies now, it's done," he said.
Many Ways To Die
For buyers, the ideal is to get in when volatility is high, then watch markets quietly drift lower while the coupon keeps paying, until "the world has become nice again, and I'm left with this really high coupon for as long as possible." Rip higher and the note knocks out early. Plunge through the barrier and, with a knock-in put, the buyer takes the full loss measured from day one, all the way to zero.
For dealers, "there's many ways to die." A slow grind lower can hurt - hedged at two years, stuck with five, while volatility falls and skew flattens. So can a large move that runs past the put spreads and call spreads used as hedges. On a real AI repricing, dealers can flip to short gamma around the barriers, which Micalizzi said means "I have to buy when market goes up and sell when market goes down."
Those barriers haven't been tested in this boom. "In all fairness, we haven't really seen a down market where those puts have been there," Micalizzi said.
Tyler Durden Tue, 11/03/2026 - 15:30
Continue reading...
[ H/T ZeroHedge ]
