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Moontower #265
Friends,
Hello from Texas! I’m on Spring Break with my family visiting friends in the DFW area before heading to Austin. I’m having my kids do a shadowing day at Alpha School (which has been in the news lately). My good friend Sonny, who lived up the street from me, moved to Austin to work more closely with the folks behind the school. I’ve known about the school for awhile (some moontower readers also send their kids there) and with Sonny holding the welcome sign it was all the catalyst I needed to make the trip.
That said, I’ll be back to publishing in early April so I’m all-in on the break. Today will also be short.
But important.
I got a distressing text on Tuesday. A close friend I grew up with informed me that her younger brother’s daughter, Rachel, was just diagnosed with AML, a rare aggressive leukemia. Rachel turned 10 this week.
I just sat there. What is there to say? How can I help?
Her little bro Jeff was like my own little bro and now he’s living a nightmare. Not to mention having an 11-year-old daughter who is being passed around the relatives in NJ as the parents will be posted up at Children’s Hospital in Philadelphia for the next 5 months for what is just the preliminary stage of treatment. Daily in-patient chemo.
I went to Twitter and found that the follower community there is amazingly generous and I promised to put this in the letter as well. There’s no pressure. Even an equivalent gesture to a cup of coffee multiplied by the number of readers is an enormous help:
My friend Jamie is a nurse and the best equipped in the family to coordinate care. She’s applied to multiple foundations for help and this is the GoFundMe:
On March 19, just 8 days before her 10th birthday, Rachel was admitted to Children's Hospital of Philadelphia and diagnosed with Acute Myeloid Leukemia. She is currently on a ventilator in the ICU at CHOP, and will be admitted for at least the next 5 months for an intensive regimen of daily chemotherapy. Jeff and Sam have been left reeling as their entire lives were upended, and the road ahead is going to be the hardest of their lives, both emotionally and financially. They are struggling to do the impossible: spend every minute by Rachel's bedside while still being present as a support system for Rebecca. The medical bills are already racking up and there is no end in sight. Any help during this heartbreaking ordeal would be incredibly appreciated and certainly utilized, and we would be beyond grateful if this page could be shared as widely as possible. Please send love and prayers for our sweet girl as she fights the hardest battle of her life.
The Simon family and I thank you for help, boosting, and prayers. 🙏🏽
Money Angle
I went on Quant Insider. It’s one of the more thorough interviews I’ve done, getting into option details a little deeper. I asked the host, Tribhuvan, to actually cut up the interview into a bunch of mini-videos to make a playlist, one for each question, because he asks some foundational educational questions that I think have evergreen answers.
In the meantime, this is the full 2-hour chat. You can find some of the key timestamps below.
[03:32] What is volatility trading, why does it matter, and how do different players approach it?
Vol trading is essentially options trading, focused on the volatility input.
Explained moneyness, interest rate, time to expiration—all known inputs.
Volatility is the only subjective input to the price.
Traders can express views on implied volatility (IV) or realized volatility (RV).
Two approaches:
Buy/sell options based on view of future IV
Delta-hedge options to profit if realized vol differs from implied vol (replication)
[07:37] Can you explain relative value in volatility?
Opportunity is driven by investor flows
Establishing what’s normal or “fair” vs what stands out as a candidate for further exploration
Detection via cross-sectional lens at the top of a the funnel
Stressed the importance of context and flow in creating those mispricings.
[09:35] How do you decide if a premium is cheap or expensive? What metrics do you use?
Mentioned implied vol percentile/rank as a starting point, but overly simplistic.
Better method: use liquid markets as references—they embed collective wisdom.
Term structures, event pricing, and skew levels are useful.
Combine quantitative tools with qualitative context (e.g., upcoming events, product launches).
[13:45] What are some common misconceptions retail traders have about vol trading?
Biggest misconception: “High vol = sell, low vol = buy”
Explained mean reversion bias in vol and the fallacy of price = value.
When vol is low, it's usually because realized vol is even lower, so implied vol still trades rich.
Similarly, when vol is high, options often still lose money due to negative carry.
Market doesn't offer easy trades—vol is priced smartly even when it's low or high.
[20:37] Can you give an example of a vol trade based on these principles?
During the 2023 banking stress (e.g., SVB, First Republic), longer-dated implied vols became unusually elevated.
Could use a calendar spread to short forward vol: sell longer-dated options and own shorter-dated ones.
The idea was that if the panic subsided, forward vol would compress, and the trade would pay off.
Key concept: forward vol and stress regimes
When a name is under acute stress, the options market prices in worst-case scenarios. That makes the forward vol particularly rich.
Shorting forward vol in the already-stressed name offers favorable odds because a lot of bad news is already priced in.
If the stress is systemic, lagging names will reprice higher, and there's more room for vol expansion there.
If the stress is idiosyncratic, vol in the stressed name will mean revert faster.
This setup creates a relative value vol trade: short the forward vol in the stressed name, and optionally own vol in the laggards that haven’t yet reacted.
[25:41] What is market-making in simple terms?
Defined market making as a solution to the double coincidence of wants problem.
Options markets are fragmented with strikes and expirations—market makers fill the gap.
Market makers use vol models to price options, not directional views.
Described how both sides (customer and market maker) can win by seeing different edges.
Introduced idea of options being zero-sum globally, but not necessarily at the individual trade level.
[30:28] How is market-making in commodities options different from equities?
No dividends or corporate actions in commodity futures.
Differences in cost-of-carry models.
Huge difference: each option expiration in commodities refers to a different underlying future.
Time spreads aren’t hard arbitrages in commodities like they are in equities.
Gave an example of calendar spreads trading for credit in commodities due to price level differences.
[35:43] How does backwardation or contango affect commodity options pricing?
Whether the futures curve is a forecast or just reflects supply/demand matters.
Beliefs about futures rolling down affect put skew and vertical spreads.
Gave examples involving coffee futures and how drift assumptions change skew.
Showed that pricing must be tied to expectations of where futures converge or diverge from spot creating conflict and opportunity
[40:07] Is smart money vs. dumb money a real thing?
Defined dumb money as price-insensitive flow.
Smart money is discerning, optional, and price-aware.
In options, smart money might be:
Insider or informed (directional alpha)
Vol-smart (trading implied edge)
Large size (e.g., SoftBank-style flow)
Explained how market makers classify counterparties (delta-smart vs. vol-smart).
[46:20] Are VIX products flawed? Should retail avoid them?
Not flawed, but misunderstood.
Tools, not investments—mostly for short-term trading.
Roll cost and leverage decay are real, and disclosed.
Retail traders often misuse these products without understanding term structure or decay.
Emphasized investors should avoid them, but traders can use them carefully.
How an old Denis Leary joke relates to the conversation
[50:31] What do you think about the rise of option trading influencers post-COVID?
Compared it to real estate seminar scams.
Most frame options as free income machines without explaining trade-offs.
Framing games: emphasized proper comparison for covered calls is 75% stock position.
Many influencers pitch theta harvest trades without showing risk of underperformance in tails.
Algebraically equivalent to shorting straddles, which no one openly recommends.
[01:10:45] What is gamma scalping and how does it work?
Step-by-step example of buying calls and delta hedging.
Gamma causes delta to shift → you rebalance to remain delta-neutral.
You buy low and sell high as you rebalance.
But gamma scalping is not the source of profits—it's just a hedge.
The true profit comes from realized vol exceeding implied vol.
Gamma scalping reduces P&L variance, it doesn’t increase expected return.
[01:16:43] What does a P&L decomposition look like in gamma scalping?
Gamma P&L = ½ × gamma × (price change)²
Theta is always a loss when long options.
Realized vol P&L = gamma gains - theta losses
Implied vol P&L = vega × change in implied
Delta hedging isolates the vol component.
[01:19:13] How do you incorporate skew or smile into trading decisions?
Black-Scholes assumes constant vol—real markets don’t.
Vol tends to fall as market rises and rise as it drops.
This affects hedge ratios—deltas need to adjust.
Incorporating skew improves hedging accuracy, especially in large books.
Explained sticky strike vs. sticky delta concepts.
[01:26:42] How do you measure volatility risk premium (VRP) and trade on it?
VRP = (implied vol) / (realized vol) - 1
Failure modes:
Future event like earnings → implied is “rich”
Big past move → realized is “inflated”
Must adjust for these with event-extracted vol surfaces
Also used bucketing of realized vol periods to create smarter forecasts.
[01:32:36] How do you analyze changes in vol surfaces to find trade opportunities?
Use heatmaps and scanners to track daily surface moves.
Execute based on flow: Buy what’s down, sell what’s up.
Combine structured lens (your "axes") with tactical execution based on how vol moves.
[01:38:10] Can you generate directional (Delta One) signals from skew?
Didn’t build directional strategies, but others did.
Skew more useful as a defensive filter than an offensive signal.
Described how vol surface can offer alternative expressions of the same idea (e.g., ratio put spread vs. buying puts).
Highlighted that vol markets offer multiple paths to express a view based on payoff preferences.
Volatility surfaces as a menu of path vs. terminal exposures
Options let you choose how you want to get paid — not just if you’re right, but how you’re right.
In contrast to Delta One (which pays off purely on terminal price), vol strategies allow you to customize for:
Path-dependent outcomes (gamma scalping, calendar spreads)
Terminal-dependent outcomes (e.g., vanilla calls/puts, simple spreads)
For example:
A calendar spread is a way to bet on path — you care about vol between now and expiry of the short leg. You're exposed to the journey.
A put spread or outright put is focused on the terminal level — you care where the asset finishes.
Ratio spreads or backspreads blend path and terminal: they monetize certain moves more efficiently but may lose on others depending on the path taken.
Many trades are the result of end users and market-makers simply choosing to focus on path vs terminal value
[01:43:27] How important are second-order Greeks like Vanna and Volga?
Never directly monitored them.
Managed through scenario analysis (spot/vol shocks).
Adjusted positions based on how P&L behaves under various shocks.
Emphasis was on practical, intuitive understanding—not Greek math.
[01:48:32] How do you trade term structure and recognize anomalies?
Term structure reflects different flows (front-month sellers vs. long-term hedgers).
Measured using:
Ratios (e.g., 3M/9M vol)
Forward vols
Spread prices across maturities
Explanation of how forward vols have many-to-one relationships with legs.
Executed trades slowly via working orders, not by crossing spreads.
Emphasized being a position trader with market-making DNA—not purely either.
Videos this week
The basics of option quotes and how stock and option movements relate to implied volatility. Has a market-maker perspective. Enjoy:
Update on the COIN straddle I bought. After recording the video I got filled on a delta hedge of buying 50 shares of COIN for $175.
Stay Groovy
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My family has been affected by cancer as most families unfortunately, and I felt quite moved by the little girls story. Sent a small donation and while it won’t cover much, I hope others also join in. Moontower family show up! Turns out there are some things in life bigger than options math and game theory.