logic and proportion have fallen sloppy dead
Moontower #304
In this issue:
white rabbit
a downside of trading careers
oil options, Iran, Polymarket
Friends,
I’ll be short up top here today as the Money Angle sections are longer than usual. This is just something fun.
My adult ensemble band played a short set at Norm’s in Danville on Thursday night for “rock band karaoke”. Our set list was High and Dry from Radiohead, You’re Love by The Outfield, and finally White Rabbit via Jefferson Airplane and written by Grace Slick.
White Rabbit is one of my favorite songs because of how it builds, a signature feature of just one of its many eclectic influences, the Spanish bolera. If you’re into song origins this was a great watch.
Apparently, Slick wrote the song after listening to a Miles Davis record for 24 hours during an acid trip. The lyrics reference Alice in Wonderland:
One pill makes you larger
And one pill makes you small
And the ones that mother gives you
Don’t do anything at all
Go ask Alice
When she’s ten feet tall
And if you go chasing rabbits
And you know you’re going to fall
Tell ‘em a hookah-smoking caterpillar
Has given you the call
He called Alice
When she was just small
When the men on the chessboard
Get up and tell you where to go
And you’ve just had some kind of mushroom
And your mind is moving low
Go ask Alice
I think she’ll know
When logic and proportion
Have fallen sloppy dead
And the White Knight is talking backwards
And the Red Queen’s off with her head
Remember what the dormouse said
Feed your head
Feed your head
Money Angle
Ex-SIG quant trader, friend of the Moontower, fellow Substacker Whirligig Bear and prediction market enjooooyer Andrew Courtney went on the Odds On Open with Ethan Kho.
(Ethan’s pod is totally catching fire with his great guests and interviews. He works hard as hell on this project as well as school so I’m stoked he’s getting such traction).
Not surprisingly, it’s a terrific conversation, but I want to zoom in on an idea that resonated deeply for me and easy to overlook for aspiring traders.
Ethan: You left the firm with I think you said only around 40 or so real professional connections. You said that that was one of the other defining things of being a trader — you’re with the same group of people, obviously making lots of money, but it’s not the place for someone who wants to be wants to have this insane network of a lot of different people. Talk to me a bit about the culture.
Andrew: Let’s frame it as who might this fit or not fit. Let’s contrast it with some other high leverage elite type careers. Say you’re a consultant and you’re meeting C-suite people from all different kinds of clients, you know, and you’re only a year out of college. Or you’re an investment banker and you’re doing deals with all these different firms. You’re gathering this wide network of people, a
lot of different information sources. You are working with many people versus my primary relationships were my co-workers. These were fantastic people but that was the most of my network. When you’re a quant trader, you’re not out there at conferences telling people what you’re doing or networking. You’re not talking to anybody about what you’re doing.
So I had a pretty tight network and and good relationships with a lot of these people, but it’s not it’s not like I can the C-suite or get career advice or something like that. It was much more narrow and concentrated and dense network. So it’s a different type of career definitely.
This is very rarely talked about. But the trader career will not leave you with much of a usable business network if you change careers compared to a more sales-oriented job (I say sales because high leverage careers only fall into 2 camps — being on the road selling/deal-making or being a 99.5 percentile solo-player in front of a computer. And the latter is very much under threat right now).
I am always urging early career traders to take the effort to be outward before they need to. You have to overcompensate for the narrow network. After all, you’re going to make a lot of money, right? Well, you want to have people to invest with or raise money from if you decide to become an entrepreneur one day (if you’re trading for a living, there’s a misfit inside you that probably doesn’t want to be an employee forever).
I was fortunate to be on the trading floor which does expose you to lots of people. That network was critical. It led to my next job after SIG, it created most of my broker connections when I left the floor, and it has helped me connect people with firms. But my network didn’t really ramp until I became far more outward. Reaching out on Twitter to learn, starting this letter, and adopting a more sharing posture in general. There is a zero-sumness in trading that leaks into your mindset. It has its purpose to be sure, but don’t let it creep beyond its usefulness.
One last bit that Andrew alludes to…if you want a lunch break or lunch meetings, trading isn’t for you. You never get your full attention. Want to code or do any deep work without one eye scanning screens? Tough luck. Even your basic needs take a backseat.
I forget which comedian made the joke about the weird life of pro athletes. They are rich and influential. But they still have to chase a ball around.
There is no self-aggrandizing story to tell about trading. You serve money. If you’re not there to pick it up when it presents itself why’d you even come in?
Money Angle For Masochists
Oil vols and calls skews were up a lot this week as the expectation of the US striking Iran increases. A few pictures:
Polymarket implies only 38% chance that the U.S. does NOT strike Iran by March 31.
Risk reversals, which measure the premium of puts to calls, in USO have shot sharply negative this month.
USO vols are elevated and strongly inverted across the term structure.
Implied vols until late March are ~53%.
You already know to use the free event volatility extractor to compute trading day volatility by removing an expected earnings move from an expiration. Let’s use the calculator in reverse. If we assume a typical trading day volatility of 30%, then if we were certain a strike were to occur, we guess-and-test our way to an 11.3% move size to make the term vol fair at 53%
But this is not earnings. We don’t know if the “event” will occur. We can use the Polymarket probability of 62% that an attack will occur before the end of March. We’ll need to expand the equation we normally use to account for p.
We recall the basic identity:
Term variance = expected event variance + accumulated daily variance.
In math:
where:
DTE = business days til expiry =26
p = probability of strike = 62%*
TermVol = ATM IV from March 27 expiry = 53%
EventVol = annualized vol of strike day = 224%
DailyVol = annualized vol of regular business day = ❓
*Notice in the case where P =1, the equation would be exactly the same as the one behind the calculator.
Solving for DailyVol:
DailyVol = 40.7%
But, wait, we want to fix the DailyVol to be 30%. We need the event vol that generates a DailyVol of 30% assuming that event only happens 62% of the time, not 100%, as our first calcs assumed.
It turns out to be 14.4% or 285% annualized
💡Annualizing a move to a vol
14.4% x 1.25 x √251
Why 1.25? Because a straddle or move size is only 80% of the volatility or standard deviation. See The MAD Straddle
In sum, if we treat an Iran strike that satisfies Polymarket’s definition AND we believe the Polymarket odds AND we think it manifests as one large single-day move, then 53% IV suggests that oil will move as normal at ~30% vol but have a single-day shock of ~14%.
This is a highly skewed way of decomposing 53% vol. To assume there’s a bunch of variance concentrated in just a single day. But that 53% vol is also not the market assuming we move ~ 3.25% per day either. It’s some mix of:
“realized vol is elevated right now because there’s uncertainty”
“at some point in the near-ish future there’s going to be a lump of variance as oil either relaxes lower (which could easily be 10%) or much higher. The current price of oil is a compromise between 2 states of the world but it’s not the right price in either of them and we don’t know which state it’s going to be”
Thoughts on the Polymarket price
Here’s a more up-to-date snapshot (Substack has a Polymarket integration!)
I have zero insight on geopolitics so I’m just going to offer thoughts on prices:
The market thinks a strike is coming soon. March 31 is 64% and June 30 is only 68%. Conditional on a strike happening, the market implies 64/68 ~94% chance it happens before the end of March. You can buy June, sell March and only risk $4.
The dollar volume on these things is small but there are many papers supporting the “marginal trader hypothesis” that it only take a handful of active, well-informed traders to make a market more efficient. This is not suprising. If we played a mock trading game for even zero stakes it wouldn’t take long for you to see how quickly a market converges to a reasonable fair value.
The volatility risk premium across many liquid markets isn’t abnormal. The market either doesn’t care what oil and Polymarket says or a strike on Iran is not expected to have a material effect on the volatility of equity shares. However, defense names have implied vols in high percentiles (while PLTR vols are tanked btw)
Here’s my off-the-cuff impression of the 64% price:
The real odds are probably higher. If this contract were trading for say 10% I’d guess it was overestimating the true probability because of lotto-ticket bias but also because there needs to be a healthy risk premium for seller to enter a highly negative skew trade.
I wouldn’t guess that a bunch of yolo-punting puts a price to 64% for lolz. When someone bids 64%, they are laying odds. Betting nearly $2 to win $1. The price of this contract has doubled in a week…it’s the buyer who likely brings more caution to the order book now.
I could imagine someone buying these as part of a relative value trade against selling oil options but the dollars available means it would need to be retail size and that kind of trade (oil vega vs prediction market?!) doesn’t seem like the kind of thing that would excite the class of trader who expects 20x leverage on crypto perps to get them outta bed in the morning.
If Polymarket depth was big enough to influence stock markets, there’d probably be some interesting scenarios of incinerating a few million bucks, maybe less, to influence the Poly price so you can influence the price of defense stocks where you could make tens of millions. The informational and liquidity linkages between prediction markets and traditional markets will be fascinating (appalling?) to watch as they continue to grow.
Stay groovy
☮️
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This guestimate of +14pct if a strike were to occur was bang on! What is your sense of the market now? I feel like no headlines could be unch to grind lower in oil with vols coming off, a resolution headline resulting in massive move lower in crude, and the tail event higher now shifts to a mining of the strait type of headline/event?