On Sizing Options, The Fed and The JPY

Core view: the rally under the hood is broader than it looks, and central banks remain behind the curve. Peccatillo argues that using the S&P 500 or Nasdaq as an equity-beta proxy is misleading now that both have become AI-momentum factors. The real signal, he says, is the equal-weight S&P (repeatedly making highs with no real drawdown), European stocks, and bank equities globally. European banks are up 22.5% year-to-date on a total-return basis. Donnelly notes the unusual composition of this rally: retail participation has been essentially zero after a string of "bubblets" (crypto, quantum, outer-space stocks, then gold and silver) burned buyers, so animal spirits have rotated into what Peccatillo calls "the boring factor" — value, banks, Japan — rather than into speculative names.

Mechanism: policy stays loose even as central banks talk tough. Peccatillo's framing is that the Fed has run core inflation above target for 63–64 consecutive months and hasn't hiked in two meetings; the ECB and BoJ are similarly behind. Germany is running a primary deficit of 2.5–3% of GDP. In the US, nominal growth of roughly 6% sits against a 3.5% cash rate and a 7% fiscal deficit — conditions Peccatillo reads as still expansionary regardless of rhetoric. He runs an internal "monetary and fiscal credibility index" scattered against curve steepness across the UK, Japan, Canada and Europe, which fits an R² of about 0.8 — except the US, where he says the long end is priced too generously (curve too flat) given the fundamentals, implying term premium is underpriced relative to how "behind the curve" and fiscally loose the US actually is.

The pair also revisit the recent volatility episode — a large leveraged position unwind they describe as reminiscent of past blow-ups (Enron, Amaranth) — and note the odd initial market reaction: a dovish, hesitant Fed chair (Kevin Warsh, referenced as "Warsh"/"he") failed to deliver hawkish follow-through, and stocks initially sold off rather than rallied, which Peccatillo attributes to a spike in long-end yield volatility rather than a rational read of looser financial conditions. Once that vol subsided, stocks resumed higher — the response he'd have expected from a dovish, behind-the-curve central bank in the first place.

On the yen, Peccatillo dismisses the market's framing that the BoJ is suddenly hiking "like an emerging-market central bank." The actual catalyst was Treasury Secretary Bessent reshuffling the $20 billion non-dollar cash balance in the ESF — previously roughly $14 billion euros and $6 billion yen-equivalent — toward a more equal-weighted composition. He calls this a modest technical rebalancing, not a policy signal, even as it's been read as one.

What has to be true for the soft-landing/goldilocks call: Peccatillo expects the Fed to do nothing through year-end. The case rests on the labor market staying calm and core inflation settling near an effectively-revised 3% rather than reaccelerating. He also flags a fiscal air pocket: the stimulus impulse was largely exhausted by June, no reconciliation bill is expected before Q1 2027, and only modest agriculture/military spending fills the gap — meaning less fiscal juice between July and the midterms. Both note the low-inflation-transmission puzzle: floating-rate mortgage exposure is under 10% of outstanding balances in the US and Europe, insulating consumers from Fed moves in a way that clearly wasn't true in Canada, where the 2022–23 hiking cycle visibly crushed housing. Donnelly separately flags that AI capex growth's pace may have peaked even as absolute spending keeps rising, a potential 2027 watch item, while near-term growth data stays firm (Atlanta Fed GDPNow Q3 estimate 5.9%; core real consumer spending running near 2.5%).

Gold/silver framework and positioning implications. Peccatillo's model for these "bubblets": momentum runs, deleverages violently, then chops in a tight, low-realized-vol range for three to six months while both bulls and bears get chopped up paying for options that bleed against low realized vol — before a cleaner trend can restart. Silver, which spiked toward $120 earlier in the year, round-tripped to under $60 and has since ranged roughly $55–70 for the past three months with realized vol very low; he says allocator interest in gold/silver has largely evaporated, even as headline catalysts (Strait of Hormuz reopening chatter, a non-hiking Fed) still produce sharp 4% pops. Both agree the post-burst phase argues against buying options — Donnelly: once vol has collapsed, if you're bullish, it's a delta-one trade with a stop, not an options structure, since implied vol won't reward the trade unless you're positioned before the burst.

Options sizing. Peccatillo's fund ran an internal study comparing option versus linear (delta-one) implementation of the same macro view, using equal-vol-contribution position sizing across the book. The finding: traders systematically buy too much size in low-delta (10–20 delta) options, understating how infrequently those bets pay off on a probability-adjusted basis, and then face an unmanageable position if the option's delta explodes toward being right. Donnelly, whose average holding period runs about 10 days at roughly $300,000 risk per trade, says he sticks to his inception risk/reward rather than constantly rebalancing mid-trade, and — when trading momentum squeezes (citing Wall Street Bets–style gamma events in names like silver/gold ETFs) — prefers selling call spreads over naked options to harvest the post-spike vol collapse.