how many coin flips until your goal?

Moontower #239

Friends,

A few weeks ago I plugged an exceptional podcast:

The Risk of Ruin podcast is exceptional. It’s a gambling podcast hosted by John Reeder aka @halfkelly….This podcast series is special. @halfkelly adds many recorded notes to frame the questions — they are an amazing education in their own right. It’s an outstanding format.

There's a ton of subtle wisdom that comes through that probably doesn't land to a novice but rewards experienced listeners. Pixar-ish. He overtly side-steps complexity but somehow conveys novel frames on evergreen topics that have been picked to death. I think I’m jealous of his skill even — which is a strong signal of how much work goes into these. Reward him and listen to it.

Well…John just published:

An Interim Update on the Progress of this Podcast Series (5 min read)

It’s not just a punchy, vulnerable post…it’s packed with insight both in what’s said and in how John reasons through his choices, opportunities and constraints in what is both a creative and commercial project.

A few hooks in the post:

• When I started this podcast I had some general ideas for what the show would be, and the value it could offer to listeners. Those ideas were roughly…

• Over the fours years since the show has launched I’ve made some progress in proving up those ideas. Here are some of the positive signals that I see…

• That all sounds positive, but perhaps you can see the problem?

• A Now What? section filled with tactical questions. Many portable to other types of projects.

• A serious bout of soul-searching aloud

This show is top quality and yet John is undoubtedly at a crossroads. It’s a lot to think about for anyone considering what it takes to make passion projects sustainable. Very early in my writing, Khe encouraged me to simply focus on showing up. Something like if you publish a letter for 20 consecutive weeks you are already in the top 1% (this only sounds like a low bar to people who have the uncharitable reflex of saying things like “I could do that” to everything but actually don’t do anything. It’s a child’s posture and a great filter for spotting immature adults).

Khe’s advice is spot on because it focuses you perfectly on what matters most.

At the start.

But what about once you are past showing up? Once you have traction. Once you are validated by the marketplace. Proven a lot to yourself. When you find yourself 7 tosses of heads…into a chain that requires 15 heads in a row?

That’s an expression I picked up from my dear friend and longtime biz partner Fonz. After 20+ years trading I was probably about 10 heads deep. Put in the work. Had my share of luck and built the trust of good smart people (this is the largest dose of luck — the professionals in my sphere took risks on me. You can be great but nobody is an island. If your bosses and colleagues don’t care or have an interest in your growth, you are in a rotten place and that can easily happen for no fault of your own).

But I was probably another 8 flips from where I wanted to be but I no longer had the will for that path. (So of course the only thing to do was blow up my life and go back to flip #1…I’m kidding but only a little. Heck, when people come to me looking for a sympathetic ear to their desires to bail, I push back hard. Not because I regret it but because I think you need to be incredibly tactical in how you think about it. By pushing back I can stress-test the decision. The last thing you need are enablers. In fact, if you need them you definitely shouldn’t bail).

@halfkelly’s post is a glimpse into the gut check when you find success but have seen, felt, and internalized just how long that chain of heads needs to be.

John, there’s no shame in whatever you choose. I’d support you either way. Everything starts with doing great work and only you can understand the conditions you need to sustain it.

Money Angle

• Home Insurance is a Really Big Problem (13 min read)
  Kyla Scanlon
  
  I mentioned last week in why home prices could fall with mortgage rates that home insurance where I live in CA is not only very expensive but you’re lucky if you can even get a policy. Florida is at the epicenter of its own home insurance crisis. Kyla gives a handy overview of the forces at play — I think the post’s subtitle says it all: A repricing of the American risk model
  

• Matchmaking
  

  I haven’t really done this before but given the readership of this letter it makes sense: my friend (and former colleague from my team at the fund) is looking for a new position…so asked if I could post about him in moontower. I’d say he’s doing me a favor so I appreciate him indulging me.
  

  A little blurb about him:
  

  Quantitative Research Engineer focused on equity derivatives. Experience in building greenfield projects for conducting research, trading and market making as well at industry leading hedge funds and prop trading firms.
  

  I’ll add my own 2 cents — he was a key contributor in building a system that traded a fuck-ton of equity options. A f-ton. That’s a technical term. If you are at a serious investing or trading firm and interested in connecting reply to this email.

Money Angle For Masochists

Last Sunday, I sent out a paywalled flash post explaining why I thought GLD November volatility looked like a sale based on Friday, 8/16 marks. The trade was still available on Monday morning.

It was a good trade.

[Unfortunately I didn’t do it myself and of course I'm cherry-picking by publishing this thread. As karmic penance, this week, I'll write up a recent trade I did do that didn't go so well]

Let’s see what happened.

First, I've now unlocked the full post so unpaid subs can also see the thought process Flash Post on GLD Vol but the tl;dr was the 90d or November expiry stood at as being expensive.

Post-mortem after 1 week

The November 232 GLD ATM call price

⇒ On Friday 8/16 (stock reference: $231.89): $9.37

⇒ On Friday 8/23 (stock reference: $232.05): $8.45

The profit is about $.92 or about 10% of the option premium. But this is a naive way to look at the p/l.

Decomposing the p/l

By selling this option you won to 2 different forces. The trade thesis was that the VRP and vol were both high so it’s not shocking to win on both but it’s never a given.

You would have collected:

1. $.58 in vega p/l due to IV falling

The IV on the 232 call fell from 17.2% to 15.9%. The option vega is $.45.

1.3 vol points x $.45 ~ $.58 cents in vega p/l

That’s an 8% change in strike vol over a week on a 90d option. I haven’t crunched the numbers, but based on writing weekly post mortems on my book for about a decade, I’d estimate that’s about a 1 standard deviation change in the IV for gold.

2. Another $.34 due to realized vol underperforming the IV

Theta won this week’s bout with gamma.

What about delta?

I am being a bit loose with the p/l decomp.

a) If you didn't delta hedge, the stock went down and then rallied again this week. The calls finished the week down $0.92, despite the stock closing basically unchanged (up $0.16 for the week). It’s probably more accurate to say you made a bit more on the theta/gamma battle since you likely lost close to $.08 on delta p/l

b) If you did delta hedge daily, your P&L would have been +$0.84.

This output is from a daily delta hedge simulation assuming you were filled at market mid-prices. Note, it's from the perspective of a long option holder, so the cumulative P&L is -$0.84 but I just flipped the sign since shorted the option.

moontower.ai backend

It's pretty random that the hedged and delta-hedged results were similar. The delta-hedged version is in general the best place to locate the P&L drivers because the trade thesis was grounded in vol not direction.

[Note: Selling an ATM call delta neutral is effectively selling a straddle. To be more accurate, if you sell 100 calls and hedge on a .50 delta you must buy 5,000 shares. You can algebraically re-factor you position as “I’m short 50 calls and 50 synthetic puts” which is 50 straddles. This trade is not quite because you hedged on a model delta of .57 instead of a .50 delta but it’s similar enough that the distinction only warrants being in this bracketed text.]

A thought on exit

If you look at the moontower.ai tools that led to the flash post in the first place they haven’t changed much despite the fall in IV. The short still looks like one of the better legs out there but it did make what I’d estimate is a 1 standard dev profit over a week and it’s not quite as obvious as it was a week ago.

As a retail trader, I wouldn’t add. I’d have a bias towards maintaining the short since it’s still looks relatively high although I’d probably care to take a closer look at how much election vol is embedded. (I’m not a registered advisor so I can speak relatively freely but to be clear I’m not suggesting anything other than how I would think about this. It should be very obvious that what is suitable for me or anyone else doesn’t mean it’s suitable for you. I write a newsletter that should be construed as entertainment and that is how you should view all newsletters. That the entertainment overlaps with useful doesn’t change what it is. If I put this under the guise of advice, I’d have to change a lot of stuff but it would also, like, cost money. I personally like that we have different channels for info to exist rather than trying to stuff all expression into regulated grooves. Don’t poison the commons by being a moron.)

If I was in my fund seat, I wouldn’t add to it (this is the market maker inside me who always argues with the position trader Jekyll who lives on the other side of the corpus collosum) but I certainly wouldn’t cover. If I were short 100k vega and my bid was hit for 20k vega and be content with the “screen edge” to mid-market.

[The nature of being in a noisy, unsystematic, repeat business with brokers is messy art….although my thinking risks becoming “quaint” every year that passes en route to 1 giant supercluster replacing the entire trading world which itself will be a pastoral phase to ruminate upon while we await being refined into robot fuel.

Sorry just a joke. Well, unless I’m right. Then I want the credit inscribed on the steel-ribbed drum containing my innards.]

Commentary

If you look at the "funnel" thinking from the flash post showing how I found this expensive option, you'll see that I thought IV and VRP tailwinds were aligned. That doesn’t happen often. The charts you find in moontower.ai make the "no easy trades principle" really visible. Volatility risk premiums (VRPs) are high when vols are low and vice versa.

Another way of understanding the principle is what I call “distributional edge vs. carry”— aka the problem with buying low and selling high. You can read more about it here: Distributional Edge vs. Carry.

Moontower.ai offers a vol trader's perspective. If you are professional vol trader running a relatively vol-neutral book there’s always things that look cheap vs expensive. By definition if you define fair cross-sectionally, half the universe is expensive relative to the other half. If this is your mandate you are in a low-margin trading business that has very attractive scaling properties.

But you are not that.

Instead you can just look at look at the tools regularly. You’ll typically conclude: “nothing to see here”. There’s nothing wrong with folding cards especially when there’s no ante. Retail’s advantage is not needing to trade. Buffet’s fat pitch and all that.

Buffet, of course, also keeps studied so he can recognize and act quickly when the opportunity comes. I look at moontower.ai every day. Most days I shrug, meh nothingburger, get back to regularly scheduled life and work. Breaking even on the cost of a sub is making (or saving) a dime on 100 contracts in the course of a year. It’s a low bar. The real cost is in glancing at it at least once a week to develop intuition. I talk about this more in this FAQ question. If that cost is too high, there’s no shame in avoiding options altogether or ‘index and chill’. (This is what most people should do. Our tool is for the self-selected ‘compelled’).

The tools really shine when you blend their insights with your own fundamental and directional biases to fine-tune or discover bets. While it doesn't have all the features of full-fledged option software yet, it started with "how I want to see things." It is opinionated. Of course, we care deeply about what users want, but I can't deny the influence of my own taste. In fact if it wasn’t for me wanting to see things my way we wouldn’t even be this far. I certainly didn’t look at the option software space and conclude “oh this looks like a great way to make money”. It starts with having a differentiated way of seeing options and operationalizing it. Making money on the software will be a byproduct of having an experienced approach and philosophy that offers something different as opposed to making shinier versions of features that can feel disjointed when they aren’t pulled together with a trader’s lens.

Wrapping up

As I mentioned earlier, this trade was cherry-picked for the post-mortem. I wouldn’t even have considered the “victory lap” if I hadn’t built the delta-hedged simulator this week. That’s where I pulled the Python screenshot.

So far the only two flash posts I've done are this one and the GME trade—winning two for two is statistical significance, right? Ok, ok. I'll make an offering to the delta gods by writing up a bad trade I did in IWM later this week using a similar volatility decomposition framework.

The main thing I want you to takeaway is that options are always a vol trade (except for reverse-conversion funding stuff). Put-call parity is a very deep insight.

Your understanding of bets, even those without options, will grow significantly if you use even simple option decomposition to think about path dependence and attribution. I'll keep hammering this point—I'm pretty sure even a middle-schooler with an attention span (and interest, of course) could learn this stuff if it's repeated enough.

If the Moontower sphere, the writing and the software, isn't making it easier, then I'm screwing up.

From My Actual Life

A concert-head friend saw Daniel Romano live recently and said it was a top 3 show. Knowing my friend I immediately Spotified the band. Good stuff. The description is apt:

"An insightful, subtly witty, and prolific Canadian singer/songwriter whose music reflects a mix of Nashville's countrypolitan era, 1960s psych-rock, and a host of other diverse influences, Daniel Romano earned widespread acclaim with the release of his 2011 album Sleep Beneath the Willow, which made the long list for the prestigious Polaris Music Prize. A literate storyteller, Romano's lyrics are as strong and compelling as his music, with a style that makes room for the straightforward and the surreal.”

The boogie-style and range remind me of the band Natural Child whose Be M’Guest album slaps.

Stay Groovy

☮️

---

Moontower Weekly Recap

• After-school activities

• Volatility Depends On The Resolution

---

---

Need help analyzing a business, investment or career decision?

Book a call with me.

It's $500 for 60 minutes. Let's work through your problem together. If you're not satisfied, you get a refund.

Let me know what you want to discuss and I’ll give you a straight answer on whether I can be helpful before we chat.

I started doing these in early 2022 by accident via inbound inquiries from readers. So I hung out a shingle through the Substack Meetings beta. You can see how I’ve helped others:

📲Book A Meeting

---

Moontower On The Web

📡All Moontower Meta Blog Posts
👤About Me

Specific Moontower Projects

🧀MoontowerMoney
👽MoontowerQuant
🌟Affirmations and North Stars
🧠Moontower Brain-Plug In

Curations

✒️Moontower’s Favorite Posts By Others
🔖Guides To Reading I Enjoyed
🛋️Investment Blogs I Read
📚Book Ideas for Kids

Fun

🎙️Moontower Music
🍸Moontower Cocktails
🎲Moontower Boardgaming

Upgrades