E189: Inside the Goldman Sachs Prop Desk: Lessons from a Top Trader w/Nancy Davis

Nancy Davis spent nearly a decade on Goldman Sachs’ legendary prop desk before founding Quadratic Capital, the firm behind the popular iVol ETF. In this episode, we dive deep into her options-based approach to investing, why she believes most investors manage risk backward, and how her firm is positioning for a potential return of stagflation. We also talk about her early days at Goldman, the psychological traps investors fall into, and why she thinks humility and coachability are underrated superpowers in finance. If you’ve ever wanted to understand volatility, inflation protection, or how to think like a derivatives trader—this episode is for you.

Episode Transcript

(00:00):
You started at the Goldman Sachs prop desk,which had a much sexier, less politically

(00:07):
correct, title at the day at the time.
I think it was called risk arbitrage.
What was it like working on the Risk Arbitragedesk in Goldman Sachs in the 1990s?
It was amazing.
I loved every second of my time there, and Ifelt so privileged to be part of that team.

(00:28):
We did not touch anything to do with clients.
So all we did was invest Goldman's capital.
We were actually not allowed to trade withGoldman for the majority of my time there.
So we traded outside like a hedge fundessentially with other outside firms.
But it was an amazing experience.

(00:49):
I had some of the best mentors and high qualitypeople around me, and it was a joy, and I feel
very privileged to have been there.
One of the most interesting things about whatyou did is you traded internal partners' money
versus end client money.
How did that change the nature of yourinvestment strategies or risks you could take?

(01:10):
How we invested was essentially using debitcards.
So we used nonlinear derivatives, specificallyoptions, and we sized based on the most we
could lose.
When I started at Goldman, was prior to the IPOof the firm, the firm IPO ed in 'ninety nine.

(01:33):
And it was just a really interesting way tothink about managing risk, which is essentially
sizing your risk the day that you invest andthen profit taking when that investment makes
money versus kind of the rest of the world usesstop losses, which is sort of the opposite
where you take risk and then you risk managewhen the position doesn't go your way.

(01:56):
Intuitively, it feels like it makes sense toput in stop losses to manage the risk in your
portfolio.
Why are you anti stop losses, and why do youbelieve in managing your portfolio the way that
you do?
You put in your stop loss the day that youimplement your investment because when you buy
an option, very simply, you pay the premiumupfront.

(02:17):
So that's my metaphor analogy to being a debitcard.
You fully pay for it and you can never losemore than that amount of stop loss at the
beginning.
And then your risk management is more aboutprofit taking, whereas traditional stop losses,
you set your risk with linear instruments,whether they're stocks, bonds, using

(02:42):
derivatives, whatever it is, and then you riskmanage after you lose money.
Essentially, our risk management style, we'realways buying low and selling high because
we're profit taking.
If you think about a traditional, I don't know,let's just say a traditional CTA, right?
They try to replicate an option payoff byexecuting very quickly when that stop loss is

(03:06):
breached, but that demands liquidity in themarket and also the ability to trade.
So if like March 2020, when oil went negative,that was the moment I was like, Oh my goodness,
this is going to really break a lot of peoplebecause there's no way to execute, necessarily
when when you have these shocks.

(03:26):
To use a simple analogy, it's instead of buyingsomething at a 100 and then having a stop loss
at 90, you're paying the $10 upfront.
And then if it doesn't execute, it goes down tozero, but it's essentially the same loss.
The difference there, when there's a stop loss,you're actually selling at the exact wrong
time.

(03:46):
You said that very well, David.
And I think the other thing that's sointeresting is we we don't use leverage in the
sense that we're not borrowing money, but wehave the asymmetry from the option payoff.
So when you size something, if you're buying anasset at 100, when it goes up to 110, instead
of making $10 we make an asymmetric amount onour premium at risk.

(04:10):
So having that nonlinear payout, a positivenonlinear payout is very attractive, I think,
because when you're right, you have multipletimes of what you had at risk.
And when you're wrong, you know what your riskis.
There's this psychological aspect and, youknow, people get into these, I guess, death

(04:31):
spirals where they might lose 20% of stock andthey can't sell it because they can't take the
loss.
And yet sometimes options are seen as much morerisky.
And of course, they're a very sophisticatedinstrument.
But it seems that the lack of self awarenesscould actually be much more risky than
actually, like you said, using a debit cardpaying and knowing that that's what you're

(04:51):
likely to lose something about thatpsychologically seems more predictable.
Our philosophy is very unusual.
Right?
You we're probably the only firm that you'vetalked to that the options are the portfolio,
right?
Is that true, David?
That is true.
That's true.
If you think about it, if you just close youreyes, most people have their core portfolio and

(05:16):
then the options around the periphery, right?
They're either selling options as a way of kindof overriding, generating income, or they're
buying options for hedges.
But either way, those two type of strategies,both of them are trying to lose money in the
options, right?
That's their goal is to have the options expireworthless because it's not their core

(05:42):
portfolio.
For us, we just turn that around and theoptions are our core investment.
I think it's a really good source of alphabecause most people are not trying to make
money in the options themselves, whereas weare.
So it's just a variant, perception.
Reason I have this psychology framework isactually my own my own previous experiences.

(06:05):
I got caught in this death trap, and it's it'svery vicious in that, you know, and the
opposite is actually true as well, which iswhen once you have a gain, there's this kind of
knee jerk reaction to sell.
This this is the most common example of this isin Bitcoin.
A lot of people bought at a 100 and sold at a135 and thought they were geniuses.

(06:28):
Sometimes you're also selling too soon, andsometimes you're not selling soon enough.
So there's a lot of psychology around that.
When I was preparing about this interview and Iasked about you, somebody at JPMorgan said that
you had some of the biggest trades on WallStreet at the time, in the world, in the entire
market.

(06:49):
And then when I clarified, it wasn't actuallyGoldman Sachs.
It was you, Nancy Davis.
So what are some of those trades?
On behalf of Goldman Sachs.
On behalf of Goldman Sachs.
Yes.
Disclaimer.
But what were some of those markets and how didyou end up being the largest player in some of
these markets?
It was definitely an amazing time and, youknow, sizing physicians with options.

(07:13):
It was, We were doing things that people werenot doing in the market.
And what I found very early on is that if youhave also the delta exposure, so you're not
trying to just capture that implied volatilitydifference.
You're actually expressing your directionalview with options.
It's a really great way to make money becauseyou can have the exposure to the underlying

(07:38):
asset class directionally, but also have allthe Greek risks with new as that position
works, we tend to roll our strikes.
So, say in your example, if you, whatever, wedon't trade Bitcoin, but just just for example,
you buy something for a 100 and it goes to$1.35 instead of just saying, we're gonna sell
it and be done like a Delta one portfolio woulddo.

(08:02):
We would just roll our option strikes and resetthe convexity.
And it's a way of actually locking in ourprofits, which we did with Silicon Valley Bank.
We definitely had a huge move very quickly, inthe rates market.
And in hindsight, I wish I had sold more androlled more aggressively.

(08:23):
We didn't do enough because with the BTSP, themarket kind of normalized very quickly.
But I think having that you know, rigor and andand rules based way of investing where you're
just constantly profit taking as the strategyworks.
When we last chatted, you mentioned that themarket is no longer concerned with inflation,

(08:47):
which really shocked me, maybe naively.
How do you know that the market is no longerconcerned about inflation?
You can see where it's pricing.
When I started my career in Goldman in the latenineties was right when the treasury started
the inflation protected bond market.
So TIPS are pretty new product.

(09:08):
They only started in the late '90s.
So a lot of people, when they want to addinflation to their portfolio, they're looking
at things that were around in the '70s or '80s.
And I like to grab people and say, look, theinflation markets are new.
They you know, a lot of people don't look atinflation because it didn't exist back then.
And then the interest rate derivative markets,that's even newer than tips.

(09:32):
Let's just take TIPS for a second.
TIPS reset with one index, which is theconsumer price index.
For the next ten years, the market is pricingCPI inflation to be around 2.3%, 2.4%.
So I think there's not a lot of inflationpremium priced into that market.

(09:55):
For instance, like just in the COVID shock, thetwelve month realized CPI hit 9.1.
Right?
So it's really kind of hugging that long termtarget of 2% where the Fed's expecting it.
So to me, that's pretty asymmetric.
The ten year right now is 2.4.
The five year is 2.45.

(10:17):
So the inflation curve is downward sloping,meaning the market is pricing in that CPI is
going to fall in the future.
The Fed sets a policy rate, but the market setsa term premium interest rates.
And it's a really crazy, crazy time because theyield curve inverted in 2022, and it stayed

(10:39):
inverted for three years.
It's never happened before that the yield curvewent as negative as it did and for as long as
it did in the history of financial markets.
So now in 'twenty five, the two ten spot curve,for instance, and I'm looking at the swaps
market just went positive in '25.

(11:00):
And so it's a really, really exciting time tocapture that.
So backing up to your time at Goldman, youspent a decade at Goldman Sachs working on the
risk ARB deck, which is the proprietary fund,York was some of the smartest people on the
face of the planet at that time, at least.

(11:21):
What were some lessons that you learned whileat your time at Goldman?
As we talked about in the opening of yourpodcast, having that different way of managing
risk and getting exposure, that was probablynumber one.
But I think it was also just an incredibleplace to work because I had so much

(11:42):
intellectual firepower and culture around me,especially as a young trader.
I worked at Goldman in my 20s, right?
It was a really wild time.
I was very young, but the prop test was a very,very flat environment.
And being in a real meritocracy, especiallybeing, I would say somewhat bubbly, Long blonde

(12:08):
hair, I've always had that.
I've always been I smile and giggle when I getnervous.
I don't know if I would have made it if I wason the sell side because I wasn't a very kind
of normal trader.
But being on the prop desk was just anincredible place to be.
And I spent not my entire ten years at Goldman,I was there for almost ten years.

(12:30):
It was like not quite a decade, but about tenyears, a little shy of it.
And the majority of my time was with this, whatused to be called, when I joined, it was risk
arbitrage, but we had a couple of differentname changes over the years.
But it was a super cool place to be, and I'mvery grateful for those people that I worked
with and the knowledge and kind ofdifferentiated way of managing risks that I

(12:55):
took away after I left.
Several institutional investors that know youhave said that you're very good at being
mentored.
What exactly does that mean?
And break down that skill set for me.
I think I'm coachable.
And, I think kind of keeping humility and notthinking, when people giving you feedback, A,

(13:20):
being grateful for that feedback and B, tryingto change.
I consider myself a lifelong learner.
And for instance, I've been running my own firmas an entrepreneur for twelve and a half years.
It's longer than my time working at Goldman.
And there are not a lot of women out there whogo and create their own asset management firm

(13:43):
and run a company.
And there are lot of things that I've had tolearn that I never had any experience with.
And I'm always grateful for feedback fromeveryone about how to continue to improve.
And I think having that mindset that whensomeone gives you critical feedback, it's to

(14:05):
help you.
And I think that's always how I took it.
And that's probably how it helped me kind ofrise up quickly during my time at Goldman is I
am coachable.
Like I'm not perfect.
I make mistakes all the time.
My goal though is to know when I make a mistakeand not do it again, right?
And always be learning.

(14:26):
I'd never been a CEO before.
I'd never run a business before.
There are a lot of new things that I had tolearn and a lot of mistakes that I made, but I
tried to correct as I made them and figured outI was doing things wrong to fix those issues.
If you asked a 100 people on whether they likefeedback or they like to be coached, I'd say

(14:52):
probably 95 to 99 would say yes.
But the reality would speak differently.
And the way that I think about it is thatpeople like to get feedback in the abstract,
but not always in the specific case.
And that is because there's almost this fight,this spiritual fight in everybody in terms of

(15:14):
getting better and preserving their ego.
And at the time when that feedback isdelivered, most people as a default, unless you
train your mind, your default is to go into egopreservation mode, which is kind of an
evolutionary predisposition, which leads to twothings.
One obvious thing, one is you don't get thefeedback, so you don't learn.

(15:36):
But two is also something to keep in mind isthat if somebody comes to you, delivers
feedback, and you do anything but smile and saythank you and constantly positively condition
that person for giving that feedback, they'reunlikely to do it again.
So you also have to think about it from theperspective of the feedback giver, which is
they have a strong incentive not to givefeedback for that same very reason that most

(16:00):
people go into this ego preservation mode.
You almost can't overthink somebody forfeedback because there's such a reluctance to
provide feedback.
We'll get right back to interview.
But first, we're looking for the next greatguest.
If you or someone you know is a capitalallocator and would make for a great guest,
please reach out to me directly [e-mail].

(16:22):
What's your most contrarian take for the marketfor the rest of 2025?
My most contrarian.
I mean, people are pretty euphoric right nowon, you know, equities are near all time highs.
I'd say the most contrarian take that I wouldhave would probably be, the stagflation word,
which I know is a really dirty, awful word, butI think there's really no guarantee that things

(16:51):
are going to continue as they are.
And I do think stagflation is one of the risksthat eyeball can help potentially mitigate.
But I do think it's kind of the disaster nodefor most people, right?
That's where specifically a sixtyfortyportfolio really has problems.
So I think I don't know that that's going tohappen, but I do know that it's not priced into

(17:15):
markets and implied volatility in particularhas fallen tremendously from where it was
around Silicon Valley Bank.
So to me, having that long optionality payoffis a really contrarian view because most people
are not worried about about volatility or kindof anything anything surprising the market.

(17:38):
And that that to me is a buying opportunity.
And stagflation being high inflation, sloweconomic growth, and high unemployment, kind of
a triple death spiral.
Yeah.
And that's especially bad for credit.
I think that's the worst performing asset classhistorically is things with credit risk.

(17:58):
And so I know some of our really smart clientsuse eyeball as a spread product, but without
adding credit spread, it adds rate spread andas a potential diversifier just you know, in
case that does happen.
Nancy, this has been a master class on options,on derivatives.

(18:21):
What would you like our listeners to know aboutyou, about Quadratic, or anything else you'd to
share?
Oh, that's so open ended, David.
You know, we're we're an open book.
I'm happy to talk to people.
I'm very accessible.
Our products are ETFs, so they're fullytransparent.
It's kinda like a managed account where you cansee all the holdings, all the positions.

(18:44):
So, we have our, our ETF websites if you wannacontact us, learn more about it.
Do you want me to give the website?
Sure.
So, the eyeball website is just eyeball, noteyeball, it's ivoletf.com.
And on that you can see all the prospectus, theSAI, all of our materials, even our white paper

(19:11):
is there for financial professionals to read upabout, you know, these macro environments like
risk off, risk on, and stagflation and and howeyeball could potentially help.
Well, I'm due for a trip to Greenwich,Connecticut.
I look forward to continuing this conversationlive.
That would be awesome.
I look forward to meeting you in person.

(19:31):
Thank you, Nancy.
Thank you.
Thanks for listening to my conversation.
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