Bits From DFW

We’ve been up to a lot of fun stuff in Texas. Some of it will make for good discussion when I’m ready but in the meantime, I’ll just mention a few DFW places that we have enjoyed in the past couple of weeks.

  • FC Dallas MLS games

    We went 2x. For less than $40 you get amazing seats. The overall environment is fun and positive. I have never been to an MLS game before and while I know nothing about soccer, I and everyone we went with found the fan experience to be outstanding.
     
  • Burger’s Lake (Fort Worth area)

    We went here 2x as well (the friends we are staying with have been hosting 2 to 4 families from our NYC/CA crews the entire time we’ve been here, so we repeat activities as the revolving door requires). It’s a lake with high diving boards, water slides, a trapeze swing, and attractions catering to younger kids. Bring your own picnic or use the camping grills to make burgers. You will need to sneak booze in. On weekends they check your cooler, but we got away with it during the week. Your welcome for the tip.
     
  • The Stockyards (Fort Worth area)

    Also did this 2x. Step back into the history of cattle-ranching. There’s plenty of activities for kids and rows of old saloons and restaurants for the grown-ups. And if you want something less rustic, the newish Hotel Drover is a great spot to grab a ranch water (I make this drink all the time, but didn’t realize Texans have a name for it). It also looks like a fun spot for a weekend getaway with a nice pool and access to the stockyards. Time your visit to see the daily longhorn cattle drive up the main drag. 
     
  • Deep Ellum (Dallas)

    This is an area of Dallas that reminded me a bit of Wynwood in Miami. Cool restaurants and shops (Jack White’s baseball brand Warstic is headquartered here). Plus lots of locals flexing their muscle cars (my kids are totally obsessed with cars right now especially Challengers with kits such as Demons, Super Bees, and Hellcats. Hellcats come with 2 keys, a black and a red one. The black one is the regular one. The red ones unleash the beastly Hellcat engine. These cars are built for drag racing. If Fast and Furious movies didn’t have cringey sex scenes, I’d take the boys to see F9). If you visit and dig tequila/mezcal you need to go to the Ruins. I tweeted about it. 
     
  • Bar hopping in Dallas

    Grab a cocktail at the Mitchell, see the decor in the Adolphus Hotel, and end at the Thompson Hotel. There you can see some prettiness and pretty people at Catbird before grabbing dinner at Monarch or sushi at Kessaku. The sushi was outstanding by any coastal city standard but pricey. Sake choices were underwhelming, but the view is a consolation prize. Finally, end the night, at a ridiculously good mezcal bar hidden in a bridal store. In a strip mall. The empanadas and cocktails are lit at this tiny spot started by two bros from Mexico City. It’s called La Viuda Negra. It was better than the movie we saw of the same name last night in IMAX. 

Dan McMurtrie with Howard Lindzon

Link: https://howardlindzon.com/dan-mcmurtrie-founder-of-tyro-partners-llc-joins-me-on-panic-with-friends-to-discuss-information-overload-and-behavioral-investing-ep-151/

About Dan: Dan McMurtrie is a 28-year-old founder, portfolio manager, and Twitter phenom more commonly known to his nearly 60,000 followers as @SuperMugatu. He’s an insanely funny, original and inspiring person who knows a lot about social media, maintaining an audience and the behavioral side of investing. Dan’s New York-based hedge fund, Tyro Partners LLC, focuses on trends and supply chains driving technology, healthcare, industrial, and consumer markets.


An insight common to making money and making people laugh

Something everybody knows it to be true but no one’s speaking up about it being true

On people struggling to make sense of the world

It’s a paradigm shift to a networked world…going from one-to-many media to many-to-many media, and having cycle times for communications go down to sub-second, meaning the number of cycles, the number of communications is going to infinity really fast. That’s leading to all these weird neurological effects because your brain is not used to having hundreds or thousands of opinions scattered at it. Your brain is used to thinking that an opinion from somebody means something, which is super wrong. And so I think this knee-jerk reaction to dismiss things that well-trained investors in the past three years have developed is actually the biggest weakness you can have, because everything now is like this kind of meta game of “it looks absurd but it’s actually not. Actually you shouting that it’s absurd, is what’s going to give it the audience that makes it real!”

The output of our quickly networked world is disrupting seasoned investors’ heuristics

It’s scaring the shit out of people. They’re looking at this and they’ve been around the block a few times, and their experience is betraying them because they’re seeing things that are so behaviourally horrifying to them that they don’t realize that they’re then becoming just instinctive and knee jerk, And they’re not running basic numbers [and asking themselves] “Is this a material amount of money?”.

[consider the lazy argument against Dogecoin that it has unlimited supply]

Is it actually unlimited supply? I’m like, “Yes, but is it unlimited supply forever. No. There’s a more nuanced point  that it’s not unlimited supply at any individual point in time, there’s a rate limiter on time with those points, which is why this pump thing is working. 

An example of how brains get hacked in this networked world, orchestrated by the guy that oversaw such hacking at Facebook

There’s a technique that I think Chamath does that I call “the 90% rule”. What you do is you say something that’s technically accurate, but like maybe 10% off of how a professional would say it, or maybe it’s 10% not correct, but it’s in the spirit of correct. For example, Chamath said something on Twitter — that he was up 120 basis points this year, and the market’s up 30 basis points, so he said he’s outperforming by like 300% or 400% or something. [Everyone jumped on Chamath for this], but do you actually think that Chamath doesn’t understand basic math. Do you think the guy who led monetization of mobile advertising for Facebook doesn’t understand the way things are reported. The guy who’s leading several SPACs, who’s talking to bankers every day, who has a sophisticated family office. You could dislike the guy for a million things, but basic numeracy is not one of them. And yet the knee jerk reaction [by people on Twitter] is that he’s wrong. I think the reality is, and here’s the brutal thing about Twitter, most people on Twitter are strivers. The people that are working really hard, they’re trying to make it, and candidly for most people it’s not working out. Especially the finance guys. The guys who went to finance, they’re not getting the money. It’s not working out. They’ve got the CFA, they’ve got the MBA, they worked at Goldman, they went to Wharton and they’re still not making a fraction what they thought they were. They’re not moving up. It’s not working out because of top-down industry dynamics which you’ve talked about ad nauseum, but that makes them really bitter. They’re really bitter because they feel like they’re getting screwed. And so when they see this guy, who’s making billions of dollars, making a beginner mistake, that would have gotten them fired, the amount of unrighteousness or injustice feels so massive. It overrides all logic and reasoning.

Nobody is immune from the brain-hacking that the networked world is doing, but the first step to understanding it is being aware of it.

My big thesis right now is technology is being used to program people, not the other way around. In the frickin documentary on Netflix [referring to “Social Dilemma”] is half of the stuff and [Chamath] is doing it. It’s crazy how effective this stuff is. A great example of this was when I tweeted a stupid joke that “no one actually knows what’s in chalk, they just teach you to accept the premise when you’re so young, and they just go with it.” And you have people, like real people with PhDs responding like I’m a fucking idiot. Everybody knows what chalk is. Don’t you see this as tweeted from my iPhone?! I tweeted this from a supercomputer in my pocket. Even if I didn’t know what chalk is, I could obviously put faith in it. [This is obvious if you think about this] for more than a split second but you have people who have multiple PhDs from places like MIT, who are completely hacked. Their brains are being hacked. And they look like fools, and they think they think that they’re smart because they’re speaking. Not to validate what they’re saying. They’re speaking to validate themselves, and that’s the weakness that all people have. This is the dark arts that you have to study now.

Change is occurring at an accelerating rate

There’s a concept called the Overton window, which, not to be like a dropper of concepts but Overton Window refers to what like types of political policies are acceptable to talk about in public. [A few years ago universal basic income was considered a quack idea], last year Donald Trump initiates universal basic income. Admittedly because of a virus so I’m not saying it was a wrong move, but you need to understand how insane that shift is society that that went from unthinkable to expecting it, and actually the people almost revolted. I mean I was in Richmond, Virginia when the protests were happening there. We were watching the breakdown of society happened, because there was some uncertainty around it that changed in a year.

You can’t put your head in the sand about the role of social media. The genie is out of the bottle. Dan sees evidence that some managers do not understand that reality.

The thing about Twitter within hedge funds or institutional endowments that nobody really wants to admit is, even if the CIO isn’t on Twitter, (and if he isn’t, it’s only because he’s too old) all of their analysts are! So, like there’s this huge issue right now of mass group gaslighting of mimetics and ideas spreading like viruses and if you’re a CIO right now, you probably don’t actually know what your firm’s sourcing mechanism is (unless you’re pushing all your ideas down). The number of times I meet with the senior guy who runs a fund, and he starts rattling off ideas I’m like “Yo, you know your analysts ripped all of that from Twitter right. And they’re like ‘What are you talking about?’ and I’m like, Look, there are these cliques of people on Twitter, I’m not even I’m not saying they’re bad ideas, but they aren’t original ideas. I’m just telling you. I’m not going to doxx your boy, I’m not going to get anybody in trouble, but I’m just telling you that you don’t know how your own investment process works. You don’t realize you’ve already been fully infiltrated by social media.”

Instead of fighting this new reality, adapt to it.

[You’ve been infilitrated by social media] but you actually kind of want that because if you are the only guy who’s not participating in these things [you are missing important context]. For example in January, and the end of December [during the stock squeezes]. I’m not particularly smart, especially relative to other hedge fund guys, but I was seeing where the liquidity was in the market and I was seeing the type of stuff happening on StockTwits and Reddit and all these other places I mean there was just gonna be just some crazy stuff happening. I went to my clients and said “Look, I’m not gonna play this game. I’m gonna take exposure way down. Yes, I believe I should be short half these companies, but I’m short the stock not the company. I’m not messing with this.” I had several people say I lack conviction, long-term investing blah, blah. Then the next three months it was just a hedge fund after hedge fund blow up. This is not going away, it’s not going back because it’s not 2000. This is not instant messaging. Last year was the first year that most waking hours for humans were online, and everybody was on one to five websites. Nobody really understands how significant that is. Everybody’s now networked, all the time 24/7.

The bar for what is considered table stakes is rising. Psychology and the repercussions of being highly networked should receive more of your attention to gain an edge.

People don’t realize how fast these big changes happen and so when I just look at some people who think we’re gonna, we’re gonna be good investors because we do more conservative discounted cash flow analysis than the other guys I’m like, “You’re like a dude with a horse and a saber walking into WWII. You’re about to have a really bad time. Like I can’t even explain to you the ways in which you’re going to get beaten down, and you’re not psychologically prepared to deal with any of this stuff because it’s gonna seem random. It’s just gonna be chaos. There’s gonna be bombs dropping and machine guns and you’re not gonna know what either of those things are. It’s just a really weird time to be an investor and I think you have to move the psychology stuff up in how you’re relating to the world into a really forefront position. Or these systems are just going to eat you.

How Dan’s fund is adapting

We’ve continued to zoom in on this behavioral stuff. Everything else is table stakes. Of course, you need to know how to value something, you need financial analysis, you need to be able to read transcripts, and do value research. But that became commoditized sometime between 1995 and 2010. Look at the number of people who have CFAs or how many people went through banking here or internationally. Companies like thedeal.com. You can go online, hire somebody anywhere in the world in like 10 minutes with a contract and a 1099.

Right now, I think the markets become a pure metagame of the game. Where does it go from there? The thing is humans are still very human, and actually, the rise of passive means the humans are a smaller percentage of the market. When they move at once they have a bigger price impact, because it’s just everybody running out the fire door of a theater. It’s as old as the hills. It’s all the same stuff again but remixed and much faster. It’s still music but it’s going from jazz to dubstep, way more aggressive, way faster, with all these different games being played. So we spent a lot of time trying to understand the fundamentals and what’s going on in these businesses and what’s going on in the supply chain, but also what is the psychological game going on in the market.

You must find a lineup where you’ve got great fundamentals, good business improvement, a really long-term runway, and you have some really distracting psychological thing that’s distorting the price. Or more importantly, maybe in this era, mandate arbitrage. As more and more capital is just driven by somebody’s investment policy statement, or an endowment investment policy statement or the S&P index rebalances. Those legal mandates are really powerful and just getting bigger. So we want to see a clustering of understanding why the opportunity exists. Because of legal mandate, because of agency costs and behavioral things like [where investors] can’t go to LPs and own it because they are going to get upset. If we see that plus it’s a good business [that becomes a potential opportunity].

This bit reminds me of the style of trading I’m more accustomed to where we don’t predict so much as try to “see the present clearly”. I’m more accustomed to measuring what is happening now than predicting tomorrow. (An example from my world would be owning optically expensive volatility because it’s carrying well)

We don’t try to predict. We try to observe. We might have a starter position on but when we see thesis confirmation, we’re going to add. What we do not really like to do, is make a big bet because we think x is going to happen. I don’t think it’s necessary because I don’t think the market adjusts to new information as well.

Dan loves Warren Buffet but scoffs at his cargo-cult imitators

I’m a huge Warren Buffett fanboy. My favorite people in investing are Warren and Charlie and then my least favorite people in investing, generally speaking, are people who tell you that they’re fans of Warren and Berkshire.

A great filter is to ask them “what’s your favorite Berkshire business?” If they say See’s Candy, you know that they know nothing. Nothing about Warren Buffett or Berkshire Hathaway. The reason is Warren Buffett is probably one of the greatest marketers to ever live. He’s built this brand. He’s built this brand that’s hyper-consistent. That allows him to not answer any critical questions, because he doesn’t actually have to defend objectively right or wrong. He just has to defend consistency with his brand.

There are several value investors that really market themselves as like Warren Buffett or Charlie Munger brands. Baby Buffetts. They all have kind of good records of not losing huge amounts of money but none of their records would stand on their own in a vacuum. They live off this same narrative. Recently I’ve had some interesting interactions with a couple these people. You ask them “How do you think about your business?” They’re very candid. “Look, I am looking for somebody, where that’s what they want. They want to feel that they’re investing in a long-term, conservative thing. They’re not going to lose their money. They will compound well and they get to feel like they’re part of the church of Buffett.”

At the end of the day, what are they selling is a psychological safety blanket. They’re not selling an investment product at all…they will only take inbound clients because they don’t want to go out and convert anybody. Look at how these [investors] behave. If you’ve ever studied cults, you see the exact same behavior. I don’t necessarily think it’s malevolent or bad, but I think that in the modern era, with everything that Warren Buffett did now being sped up 100,000 times, and on Twitter everyday with people doing these explainer threads and Substacks. These are all the same psychological manipulation techniques. It doesn’t mean they’re malevolent. If you really understand how Warren built his public persona, why he built it the way he did, and how he changed his business at every scale level of capital [out of necessity] you’d understand that the idea that Warren Buffett The Empire Builder, bears any resemblance to Warren Buffett The Ruler is naivete.

Why 2020 made Dan optimistic

Looking forward, I think the takeaway from last year, has to be a profound optimism for humanity. We just took a global pandemic on the jaw. As pissed off as everybody is we’re calling it the Five Aces Problem. It’s like you being dealt a poker hand with four aces and people are like “It would be good if we had a fifth ace”. There’s no fifth ace in the deck! You can tap something on your phone and have a pizza in 20 minutes! You can have a date in 5 minutes. You can have anything you want delivered to your house within 2 days. Like woe is you that you couldn’t get the specific dumbbells you wanted that week. During quarantine, we were living a better life than people in the 1960s were able to live. People in the 25th income percentile now live better than Rockefeller did. We’re going up a curve that is getting exponential so people are not understanding how insanely awesome the performance last year was of humanity. And sure we have some supply chain chokeholds leftover from last year. Yes, there are obvious knock-on effects. We’ve got some issues around the government explicitly putting all risk onto the dollar and making some big bets on modern monetary policy. Those are generally concerning things, but they are super obvious. I just don’t see how you can’t be optimistic about our ability to solve these problems.

I think one of the things people struggle with, I just wrote about this, is as the world gets better, as you go from being a caveman to being an office worker, your job is moving further and further away from the kind of base Maslow needs. You’re not hunting a saber-toothed tiger, you’re typing in data entry or doing social media posts. That’s why every generation looks at the next generation and thinks they’re soft as hell. You know “they had to walk both ways to school uphill in the snow.”

It always happens like that. That’s what progress is.

Disneyworld Tips

Earlier this week we went to Disneyworld in Florida. A few observations and tips:
  • We stayed at the Yacht Club. It’s considered one of the mid-tier Disney properties but we thought it was plenty nice. We chose it because it has the best pool. It didn’t disappoint. There’s a great water slide that starts in the crow’s nest of a pirate ship and takes you down to a 4′ deep pool. It’s fun for adults and kids probably as young as 3 or 4 (if they can’t swim you can catch them at the bottom). The staff coordinates activities for kids in the pool, there’s water volleyball, a lazy river, a whirpool with a strong current that’s fun to try to swim against, and many pools with sandy bottoms! Toddlers and younger children will especially love the kiddie pool/beach section.
  • The Magic Kingdom is still not doing fireworks or outdoor shows which is strange (Yinh was up late one night though and did see a practice fireworks show after midnight). The park is crowded and nobody is masking so I presume operations will go back to normal soon. Except the new idea of mobile ordering. More than half the concession and food options have no lines because mobile ordering is mandatory at those spots. I suspect that trend is staying. Between using the app in the park, mobile ordering, and taking pictures make sure you have enough phone battery. Oh yea, I discovered a frozen dessert called a Dole Whip. For $5 it’s the best deal in the park (although I recommend the vanilla soft-serve that you can find at the same stands. Perfection.).
  • The best rides in the Animal Kingdom are the Expedition Everest rollercoaster (the Yeti theme and surprises are awesome) and the Avatar: Flight of Passage ride. I thought that ride was exceptional and in the running for best ride overall. If the line wasn’t so long, I’d have gone again.
  • My favorite park of the 3 we visited was Hollywood Studios. The Star Wars section is called Galaxy’s Edge and is an unbelievable re-creation of places from the movies. The attention to detail hurt my brain. Total devotion to quality. The kids especially loved the Millenium Falcon ride called Smuggler’s Run. It’s interactive as everyone plays the role of either pilot, gunner, or engineer. But the show-stealer is the 18-minute experience called Rise of The Resistance. You must reserve one of the limited spots and the ride is very popular. I’ll pass along the tips we learned to ensure we’d get in. Call customer service on the Disney app to link the app accounts for all the adults in your party. This process took about 2 hours the night before (mostly just sitting on hold). Then have everyone in your party ready to snipe the “virtual queue” on the app when they start accepting people (just like trying to snipe concert tickets when they go on sale). 5 of us sniped at the same time, anticipating as the clock turned from 6:59 to 7:00 am.

    Finally, if you want a chance to grab a drink in the Cantina bar make a reservation. They book 2 to 3 months out. We didn’t know about this. Next time.

  • I learned that when my kids are scared on rides they keep repeating with utter calm and monotone “I hate everything about this”. Then when it’s over they claim it was their favorite. Psychopaths.

Today, we are in the Dallas area for the next few weeks crashing with close friends. We lived near each other in NYC and amazingly in the Bay Area as well. Now they are making a full-court press to have us move to TX. I don’t know, it’s pretty hot here. They are targeting my vanity and weakness for frivolous beverages. Never a bad strategy to be honest.

Getting Less Screwed On Compensation

I’ve talked about compensation deals in the past.

For example, one of the tweets in this thread:

Anyone that has ever worked in derivs or at a mm knows what a beast comp negotiation can be. There’s a trader on both sides of the table. Both sides are pricing calls and puts, netting risks, and trying to find structures that work for both sides’ risk preferences.

In On #Voltwit Melees I wrote:

If you really want to examine incentives, think about the PMs at the fund. The non-equity owners want maximum vol since their downside is just losing their job, but their upside is a percent of their performance. Their equity-owning counterparts want the assets to stick. Notice how the non-equity-owning PM has the same incentive as the LP, not the GP.

Comp structures, just like fee structures, are about shifting incentives to create alignment. But there’s a lot of haggling under the hood that looks an awful lot like options trading. When you negotiate comp, do you ever wonder who the patsy is? Or do you think you are in the ballpark of fair value AFTER considering all the levers/scenarios?

Recently, a friend reached out for advice about a specific type of situation. I see a concern that is worth sharing more widely. A bit of background first:

The friend is a senior employee. They are not too concerned about the downside of the new opportunity they are looking at (meaning if they just earned their salary and no bonus they could tolerate that outcome…salaries tend to be a small percentage of total comp for senior employees). The friend is really interested in the opportunity for the upside so, in trader parlance, the friend wants maximum call exposure and doesn’t value the put (ie a minimum guaranteed bonus) much. I have found that employers can be flexible on these structures. If you are risk-averse they are willing to give higher minimum bonuses but take your upside. Of course, on the trading or fund management side, employees are usually in it for the big payoff so do not choose this option, especially if they have savings and can survive on their salary alone if needed.

The major points to be aware of:

  • This friend wants max upside and is not concerned about the downside of the opportunity they are considering. In fact, the friend would be taking a substantial paycut for the shot to have large exposure to the new gig’s success.
  • The nature of the gig is the friend would be launching a fund that had an AUM fee but no performance fee (it’s not a hedge fund) and the fund would be closer to systematic than discretionary.
  • The friend is focused on how to ensure they are aligned with the employer in the case that the venture succeeds.

That’s going to be tricky. Can you anticipate my warning?

Here’s what I told my friend:

You are willing to accept a large carrot on the back end to take risk on the front end. The prospective employer agrees in principle to that arrangement. If possible, the gold standard of alignment will be tying your stock awards to a trail of your efforts in the building of the new product.

The correct appearance of the trail is that it should look overly generous to you in the event that it “hits”. Remember, you took a paycut and a risk upfront. The real-time value of that trail cannot simply be weighed against your real-time efforts since the trail is a lagging indicator of your work.

You are being very clear that your situation allows you to take a risk but it’s critical that you get paid off if things work out. There is always a form of “credit risk” when structuring a deal like this in the sense that at many winning positive scenarios, on a forward-looking basis, it will always look like the right play for the employer to cut you. You are addressing this ahead of time, and want the employer to assure against the incentives it will have AFTER you have borne the bulk of the risk.

What safeguards are in place to “remember how this deal was supposed to work”?

At every review, owners can exercise the option to screw you. Insuring against that is pretty difficult. A big difference between startups and fund management is that early startup employees own true equity. This reality is harshest when things go well. I suspect some market-making firms (they are not funds but the analogy holds) could have paid every employee millions of dollars last year and still had record profits. But they didn’t. People were paid well but found out they had zero delta to the upside at some threshold.

I’m sympathetic to their employer as well. If you paid everyone what they “deserved” many would have quit having hit their FU number. And if you don’t, sure some might rage-quit, but there’s not some other employer willing to pay them more based on some outlier year. Most likely, the owners will admit to themselves, that ownership has its privileges and they are the risk-takers. An unhappy employee is free to start their own business. In fact, that’s who entrepreneurs often are…people with chips on their shoulders.

Ownership is the only true call option. Not shadow equity, where you are promised a percentage of the p/l. That’s not a stake that you can cash out to partners.

If you are in the game for upside, be careful about who writes your checks.

(Option traders know the warning well. Bonus season, despite its moniker, rarely feels like bonus-y fun. Reviews are mostly endurance tests in which you restrain yourself from flipping a desk as you read a disappointing number off a page, several times until it finally registers that it’s what was indeed intended, all the while a superior gaslights you about how good a job you did. The canyon between words and actions so wide, you might even look around to see if there’s someone else in the room. But no. They are actually talking to you.

Market-making firms are generally run by ruthless Ayn Rand worshippers. Whether they converge to this mindset as a post-hoc rationalization for their role in doing “god’s work” or start with it likely varies. I suspect it takes a certain type of person to get to the top of that profession. That person will be good at rationalizing and see wealth as evidence of being right. It’s all quite convenient.)

Follow Up To “The R Word”

Last week I shared The “R” Word.

The post was about trying to reframe a career in a sustainable way. In a way that aligns with how our idiosyncratic energies work. Aligned with the types of people we want to be around.

The largest payoff to this isn’t immediately obvious. It relieves the pressure to build a nest egg with an overengineered margin of error. Instead of relying on assumptions of things that are out of your control like returns and inflation you choose to rely on your human capital.

The key is that you will still be excited to employ your ability and the returns that come from being a willing perma-learner. You won’t have a strong desire to stop working since you chose a stroll that forgives you for meandering instead of a sprint. A sprint taxes you not just physically, but mentally, by making you think there’s only one way to win. Racing is insidiously expensive because it directs your gaze to a finish line. A bizarre approach to life, since tomorrow is never guaranteed.

The post led to many responses (it’s the most reactions I’ve gotten from a post, especially as a percentage of total views). Many of you are thinking deeply about the same topic. I’ve had a few young people respond. I am impressed at how deliberate they are about their long-term strategy. I was never that mature. Unsurprisingly, most of the responses came from finance/trading folks of similar age as me. Many extremely financially successful or downright rich. Some of them have been sick of their profession for years but in the absence of a roadmap can’t pry themselves away from stacking more chips.

I keep thinking about this. I keep coming back to a half-baked thought but I’ll blurt it out and you can finish it in your own oven. It could be a wasteful or irresponsible thought. Or it can unlock more thoughts and break inertia. I take zero responsibility, blame, or credit for what you do with it.

You will never walk away from money without a reason. But money is not fungible with risk. Actually it’s a risk-absorber. For many, the feeling of a life well-lived requires risk. If you accumulated more money than you need, you have sterilized a lot of risk. And you’ve sterilized the feeling of being alive. There are many types of risky pursuits. Some are fun but not meaningful. Some are meaningful but not fun. And everything in between.

Before making any changes to your life think about:

  • The size of risk you need to feel engaged
  • The nature of the risk you need (where is it on the fun/meaningful spectrum?)  

With the answers to these questions, you will know whether you just need a new hobby…or if you need “a man to come through the door with a gun”.

Finally, I’ll point you to 2 terrific related posts that have lingered for me.

  • The Path (5 min read)
    Chris Wong

    Excerpt with my emphasis:

    For me, The Path started when I began my career in finance in 2002. Actually, I’ve probably been on The Path even longer, since middle school. Get good grades, get on the honors track, do extracurriculars. Get into a good college. Get a good job. Get promoted. Get a better job. Get promoted. Get a better job. Get promoted.By the time I turned thirty, I had begun to question The Path.

    The real reasons were that the money was good and The Path was a siren’s call to a life of comfort. The money to me was security and optionality. But I wasn’t using the optionality to do anything and because I had already stopped spending money on things I didn’t enjoy, I had a degree of financial security. Why be inauthentic to myself in order to pursue goals that didn’t interest me? In finance, the answer to the interview question “Why do you want this job?” is a dirty open secret. You are not allowed to say money. Even though that is everyone’s real answer. You must make up an answer to prove that you are not a masochistic psychopath. I couldn’t lie anymore. The only reason to stay in this job was money, but to me cash was the applause of Performance Art and I would rather put on my own show in an empty theater.

  • Speculation: A Game You Can’t Win (More To That)
    Lawrence Yeo

    Risk aversion is the idea that a loss of X hurts more than the joy of winning X. That means the profession of investing has an emotional volatility drain that wears us down. This short post will similarly resonate with traders. If you are not a trader and it resonates, I’d suggest you are misallocating your time.

    Excerpt from Lawrence’s post:

    …financial freedom isn’t about money, it’s about attention. The less you have to think about money, the more free you actually are. Speculation is the antithesis of that statement.

    Read the whole post here.

The “R” Word

The fact that it takes a moment to figure out if it’s a financial commercial or a Viagra ad is enough of hint that drugs are being sold in both cases.

When I introduced the Moontower Retirement Model, I mentioned how destructive I think the whole vision of retirement is as portrayed by Charles Schwab commercials.

Retirement Is An Unsustainable Idea

The average American’s savings are inadequate to even cover an emergency. Forget having enough savings and social security to survive with dignity from 65 to 85 or 90. The presumption that investment returns will make up the shortfall even if everyone invested is fragile at best and quite likely nonsense. Despite a scorching decade of investment returns, pensions remain underfunded. It would take astronomical valuations for assets to balance liabilities. And if markets permanently reset higher, it would guarantee that any newly formed promises could not be kept with a straight face. People are living longer. An increasing share of work is done by sitting in front of a screen. The classic idea of retirement has outlived its usefulness. It is a vestige of a bygone era and was targeted at people who did back-breaking work. In fact, our modern conception of retirement is a Frankenstein evolution from 1800s rail workers (I summarized Charley Ellis’ history of the “retirement age” in Origin Of The Pension Crisis).

To see why the traditional concept of retirement is obsolete let’s start with a macro perspective before moving to the problem on an individual level.

Dependency Ratios

Broadly speaking, a dependency ratio is the percentage of people in a population being supported by the productive portion of the population. So if the ratio of youth and elderly is high compared to the working-age population then the dependency ratio will be a larger percentage of society. It is well-known that birth rates have been falling across all developed nations. Asia, Europe, and the US all face demographic headwinds with respect to their economies. The poster nation for an aging population is Japan. Challenged by low birth rates, low immigration and the lost decades that followed its late 80s bubble, the fate of Japan’s elderly has been dire. Hiding grandpa’s body to keep the pension payments is desperate.

In The Mystery Of Japan’s Missing Centenarians, we see a grim future. Japan’s over-65 population is expected to cross 40% by 2050. Less morbid solutions than pension fraud are playing out. Dependency ratios in Japan are starting to decline after more than a generation of increases. But as Joachim Klement explains in Following In The Footsteps Of Japan, the reason is not cheerful — Japan’s elderly are re-entering the workforce. Klement doesn’t believe that demographics are fate and he warns against overfitting Japan to the US (in this interview, Lyn Alden, lays out many reasons why the comparison is limited). But the necessity of elderly people needing to work because their investment returns were inadequate is a visceral risk for anyone set on retiring in their 60s or earlier.

This brings us to how to think of the “retirement” problem on an actionable, personal level.

The Nastiest Hardest Problem in Finance

That’s what Nobel-prize-winning economist William Sharpe calls the retirement problem. Solving for how much you need to save and for how long, solving for how much you can withdraw annually and for how long, all so you don’t outlive your money. If you have walked through the Moontower Retirement Model you learned the levers — savings rates, longevity, and post-tax inflation-adjusted returns. Every one of those terms is impossible to forecast. The problem suffers from intractable amounts of garbage inputs. The value of the exercise is not the outputs, it’s for articulating the problem in the first place and gaining a low-res appreciation for the sensitivities.

Khe Hy has tortured his own retirement models and instead of Excel confessing the answers, Khe confessed the same unnerving conclusion that Sharpe did — it’s too hard to calculate. In There’s No Such Thing As “The Number”, Khe points out several issues:

  • Let’s work backward and assume you’re a 77-year-old (male) RadReader. The average life expectancy is 78 (81 for women) so, on average you have 1 year of life remaining. Forecasting your expenses and investment returns should be pretty straightforward, right? Well, any good statistics geek will know that averages don’t paint the full picture. In fact, the standard deviation of life expectancies is 15 years. This means that our 77-year-old homie has a 34% chance of living until he’s 92.

  • The people who love this analysis the most face some of the greatest uncertainty. The post-MBA. The post-MBA will have the most uncertainty to codify into their model. Will they get married? Have kids? How many? Will they both work? Where will they live? Will they ever change jobs? These are the personal variables; what about the global ones like inflation, tax rates (and not just individual rates, i.e. the SALT effect), market performance, and entitlements (will Social Security even exist?). Plus, they’ll still need to forecast the 68% chance they’ll die somewhere in between 62 and 92.

  • And if you’re still unconvinced about the difficulty of this calculation, it doesn’t get any easier for retirees. In fact, retirement spending isn’t linear, it looks more like a smile: It starts high, gradually declines, and then increases toward the end of a retiree’s life.

  • There is one way to try to make The Number work: by assuming the most conservative approach to every variable. Khe calls this the Max() Approach. If you are impossibly risk-averse or suffer from a “scarcity” mindset, he and I have bad news for you. Especially if you are a salaried employee (which is more likely if you are extremely risk-averse). You will never hit that Max(number) that will let you sleep at night. Sorry. And the more expensive markets get, the less help you get from returns. Sorry yet again.

Khe shares my conclusion. The answer isn’t in the spreadsheet. The answer is in your approach to life.

The Key To Sustainability: Your Human Capital

The policy level debate should focus on delaying retirement ages. This will not feel fair to anyone nearing retirement and will especially disturb droves of Americans who see their working years as something to just get-over-with. But you cannot manifest higher investment returns just because you need them. You might live a long time. Your kids will almost certainly need to work longer than prior generations. You must expand the time horizon of your earning life. It’s one less year of drawing down on your savings plus one more year of savings. That’s a double-whammy of benefits for every extra year you can work.

If you have thus far thought of your career as a race to a finish line you are having an allergic reaction to this. That’s all good. Some of you are close enough to the ribbon that you can ignore me, especially if this last decade of returns has been kind to you. . But for many of you who are young, you should not be using your parents’ template for your own. And if you are middle-aged like myself and fortunate enough to have built a cushion, do you hang on for 5, 10, or 15 more years? Any 40-year-old who mostly works for money grapples with this. You have either imagined alternate paths and decided it wasn’t worth it, you’ve made a leap, or you are still deliberating. But you have definitely visited this problem in your head.

I hinted at it in WFH: Deux Ex Machina. Covid shutdowns offered an opportunity for reflection. Reflection about where to live and how to work. It halted the treadmill so you could think about aligning your working life to your living life. I wrote:

An emerging efficient frontier trade-off between salary and location offers a promise of better-centered lives. We should agree that matching ourselves to our environments is a public good. A sustainable balance means we can work more years. A double bonus. We save for more years and withdraw for fewer years. It is the only viable solution to the pension crisis. If remote work means more sustainable working lives then WFH will be the pension crisis’ deus ex machina. And that’s a bigger cause for hope than the short-run sprint of getting paid SF wages while Zooming from a lakeside cabin.

The key to the pension crisis is the same as the key to our professional crises’ — sustainability. Unlike the “number” in the spreadsheet, sustainability doesn’t rely on interest rates or 529s. Sustainability rests entirely on your human capital. Khe nails this:

Tending to one’s craft, learning new skills, and creative problem solving are key components to leading a rich and fulfilling life. So why on earth would 30 or 40-somethings want to stop pursuing these activities?.

There is always work to be done that utilizes your talents and appeals, at least abstractly, to how you think and what you enjoy. It doesn’t mean it’s easy to identify. But finding it is a technical problem. A technical problem can be broken down into smaller steps and attacked. Doing that is beyond the scope of this post, but you should be comforted that this problem can be solved. And the best part — the payoff is a sustainable life! That’s a successful outcome no matter what other variables you pass to Excel.

The Payoff Of A Sustainable Approach

Internalizing a truly long view will change your relationship with risk. It will lift the pressure you place on:

  • your next performance review
  • your portfolio returns this year
  • the fact that you haven’t read a book in 2 years

The idea that you can work until you are 75 or 80 is freeing IF you can do it on your terms. If you can take a break for a year sometimes. If you can work 4 days a week, or from wherever you want. If you actually enjoy bringing your uniqueness to the job to be done. The definition of a sustainable life is one you actually want to sustain. Nobody wants to sprint forever, and sprinting for a short while doesn’t make the scarcity mindset go away even if you “win”. This is partly why rich people fear inflation. They thought they were “done”. What is “done” anyway?

My disdain for retirement, the “R” word, comes from its insidious focus on a future that doesn’t exist. A future where you are a different person who suddenly gardens or plays piano. The reality is your retired future is spent worrying about new things. Your health. Your fixed income. The dream of retirement is sold in an opiate-of-the-masses manner. Like heaven and its pearly gates. But everyone knows the anticipation of a vacation is better than the destination. Why do you think it would be any different with “retirement”?

I’ll turn to Khe’s post one last time:

I love asking people in pursuit of The Number a simple question: If you won the lottery today, how would you spend the next five years of your life? Most people cannot answer this question. Five years is a long time, too long to pick one activity (family, travel, exercise, sleep) and do it for an extended period.

Harvard Business School professor Theresa Ambile interviewed 120 newly retired professionals and found that the things that made them happiest in retirement were quite simple: not using an alarm clock, the ability to pursue a hobby, not needing to commute and the flexibility to spend time with family.

This is where the your secret arbitrage comes in. The pursuit of The Number is a complete distraction. In fact, it’s worse. It’s sending you on a wild goose hunt in the wrong direction – taking precious mind space away from you finding the intersection of 67 weekly hours pursuing interesting work, with cool AF people, while retaining basic life flexibility.

Permission To Speak Freely

I’m going to be 43 next month. I left the race 3 months ago. I’ll just splatter my thoughts.

I’m still trying to understand it. Sometimes I think about just how random life is. Any career you fall into to will feel like a historical accident. If you thrive in that career, you will probably come to like it more and stay with it.

And voila…21 years flies by.

I used to love trading. Somewhere along the line, it lost its luster. I didn’t have what I wanted to give it. I grew bored of the video game. I used to get up in the middle of the night to trade. I don’t even want to follow prices on a daily basis anymore. I watch many of the active trader accounts on Twitter and think how exhausting that looks. I don’t think what I’m feeling is burnout. It’s worse. It’s apathy. I struggle to draw a line between making myself (and others) richer and my own happiness. Motivation became blood-from-a-stone.

For some, the thrill of winning is reward in itself. Sure. It’s a great feeling to win, but I also think Michael Jordan is a sociopath. I can marvel without admiring. I’m never going to look up to win-at-all-costs types. Many believe the “ends justify the means”. More often than not, I think that is a self-serving rationalization. I’d concede that there are cases where it makes sense. But they sure as hell aren’t in the hedge fund world.

My career choice was highly optimized for money (actually money per hour, otherwise I might have considered banking). I never understood my sister who wanted to become a veterinarian since she was a child. And did.  Now I marvel at how mature my sister was to not aggressively seek money. The lack of cash created so much tension at home when we were growing up. Our parents worked so much. They didn’t get to enjoy us the way we enjoy our kids today. And the grind eventually wore their marriage down.

So I went money-hunting thinking it would save me from my parents’ fate. When I was 21 I told my mother I’d retire by the time I was 40. But once I satisfied some sense of financial security, money was not especially motivating. It helps to not care about fancy cars. The only financial goal I had remaining was optionality. Now you understand where that essay came from.

I was faced with the yuppie conundrum…last a few more years and hit “the number” or…what? What do you do if you hit “the number”?

Uh oh.

It’s not going to get any easier to answer that question later. In fact, I’ll probably feel the same way then as I do now. Financially pretty good, but a bit lost. If anything, I’ll be more likely to be in “protect” mode. Protect from inflation. Protect from “socialists”. Protect from whatever bogeyman people who have lost faith in their human capital fear.

I’m not interested in complacent protect mode. I am hypochondriac enough to know whatever I can offer to the world will fade one day.  I’m not sure what I want to do but I know that I always want to think, create and solve. If I’m going to do that later anyway, then what difference will a few extra bucks in the flat part of the utility curve make? Sure the pressure to monetize might be a bit higher but that feels like a technical problem. And the faster I get to a journey that I know I’m going to take anyway, the better off I’ll be. The whole “we underestimate what we can do in 10 years” thing.


There’s an apocryphal bit of advice to writers from novelist Raymond Chandler:

When stumped, have a man come through a door with a gun.

I basically did that with my life. I left without a plan. I am not recommending this. I disappointed people. People I care deeply about. They understood. They care about me and want me to do what’s best for me, but if it’s bittersweet to me, it’s more bitter for them. I get that.

My wife is thrilled for me. For us. She knows. Our kids are young. She took a year off several years ago. It was amazing. One parent at home means a lot more slack in the domestic system. It’s a luxury if you can afford it. My mother was a single parent for a good chunk of our childhood. The contrast is totally unfair. Exercising the option to be underemployed is expensive but I like the payoff better than a Lambo.

When I was a kid, I had a specific marker for class. The parents who picked their kids up vs those of us who took the bus. I was always jealous of the kids who got picked up (or got pulled out of class to go on vacation for that matter). Today, I drop my kids off at school in flip-flops. This feels like an enormous privilege just as I imagined it. The fact that my 14-year old beater is sandwiched between the neighbors’ literal Lambos and G-Wagons (gag me) makes no difference to me. This is what I wanted.

As far as risk, if there was a pressing need for income I’m confident I could get a job where I wouldn’t starve. Unless I launch a successful business, my peak earnings are probably passed. I’m not naive. My professional track record is something I’m very proud of. I hang out on Twitter a bunch. There’s always a question of whether people are full of shit. I’m confident that if snoopers inquired at my track record with employers or investors it would only boost my rep. That’s definitely a flex. Maybe one I need for myself. Because that’s the end of a very specific life.

Whatever comes next, I’m a beginner.


I Wasn’t Alone. You Aren’t Either

I’m not sure what’s next. And I’m fine with that. I know many of you might feel like I do. I’m always happy to discuss it. Any aspect of it. It wasn’t always my mindset to be that open but I give a lot of credit to my friend Khe. His openness not just in his writing but via conversations really helped me think through my own issues. Without realizing it, he gave me a model of openness for others. He wrote a lot on these topics when he made his own leap and while he doesn’t write about these topics today as he has evolved well into the next phase of his life his writing on career transition and everything it touches including relationships is absolute GOAT. I recommend looking it up if you are contemplating a change.

I also recommend the writing of Paul Millerd. His recent post The Case For Sabbaticals is A+. Paul is deeply thoughtful on these topics and like Khe has the experience of so many others to draw on as his work has become a beacon to many readers trying to make sense of how their talents can be amplified, shared, rewarded, and sustained in the long-run.

If you have been following along, and reading between the lines, several of my recent posts have apparently been building to this one. If you want to read them in the order I published them, here you go:

  1. How I Misapplied MYyTrader Mindset To Investing (Link)
  2. Talking To The Diamond Hands (Link)
  3. The Option Cage (Link)

Investing Books For A Teenager

A friend asked for some recommendations.

My nephew is 16 and wants to “get rich in the stock market”. He knows nothing. Is decent at school/math. I want to send him five books. He probably won’t have the patience for stuff that is too dry or dense.

My response:

I think it’s helpful to get a glossary understanding of concepts in the first place. Khan Academy is great for that. Of course that it just to explain terms but my book recs would have more to do with think of the markets as competitive games with prices as point spreads.

To that end my recs for core reading:

  • The Most Important Thing by Howard Marks
  • Fooled By Randomness by Nassim Taleb
  • The Psychology of Money by Morgan Housel
  • 4 Pillars of Investing by William Bernstein
  • We both agreed Moneyball by Michael Lewis fits beautifully in this context so that would round out the list.

For a bit more advanced I’d recommend:

  • The Little Book That Beats The Market by Joel GreenblattThe reason this book is great besides being short is that it a hands-on demonstration of how to have a process and marries understanding core business math with an investing process (sorting, filtering, measuring and normalizing). There’s many implementations of the strategy floating around the web with modifications so if he wants to dig there’s plenty of fertile soil. While the vanilla strategy is mined into oblivion at this point, the real objective is to understand the process because that’s universal and applies to trading as well as investing. It’s a mental template.
  • The Accounting Game: Basic Accounting Fresh from the Lemonade Stand by Darrell Mullis and Judith OrloffI read this a few years ago and it’s a hand-on, easy way to learn the basics of accounting. It explains how balance sheets, income statements, and cash flow statements interconnect. It describes how you book items and the tradeoffs involved. It helped me appreciate how much judgement is actually included in accounting as well as how you can tell different stories with the way you choose to do accounting. Accounting feels like a subject I’d enjoy which is a sentence I never thought I’d say. I took my own notes here.

For my other collections see:

The Options Cage

Collecting options is freedom. Freedom is the most revered American ideal. In an orgasm of deductive logic, flowing straight from that idea is most Americans’ prized ambition — “financial freedom”. Sparkling with alliteration, the phrase has led countless dreamers to spend weekends at conferences learning the latest fashion for deriving “passive income”. I’m not judging this goal. To some extent, we all have it in some form. But be honest. When someone uses this phrase earnestly, you kind of want to die of boredom.

I’ll tell you why. Because it’s code for “I’m waiting to live”. As if your life needed rehearsals or prerequisites. This is the person who asks a genie for “a thousand more wishes”. Just delaying the bull and its horns.

Anne-Laure Le Cunff writes:

We are obsessed with optionality. Not sure what to do with your life? Most people will tell you to get a degree. Not quite sure what to do with this degree? Go to grad school. Still not quite sure? Get a consulting role at a big firm so you can decide what kind of job you enjoy. And so on and so forth. We fall prey to the optionality fallacy. As Erik Torenberg puts it, it can be “like spending your whole life filling up the gas tank without ever driving.”

She continues:

The problem is not with optionality itself. The problem is that we tend to assume optionality is built by keeping as many doors open for as long as possible; by staying on the main road for as far as can go instead of taking the risk of making a wrong turn.

This is familiar to anyone who knows a stingy rich person. When options become an end in themselves, it becomes harder to exercise or spend them.

When Options Are Self-Defeating

Having too few options is desperate. Too many options is crippling. Think of your wardrobe. You probably lie somewhere in between a 1-outfit-per-weekday minimalist and a  hoarder. Having a few suits or dresses to choose from based on the season is reasonable. But if having clothes you’ll never wear forces you to rent a larger apartment, it’s a high price to pay to hedge the “what if I get invited to the Oscars and need a ball gown” scenario. The hint to the option obsession is in the previous sentence — hedge. In fact, the logic of option-seeking is inherited from finance brain disease. But unlike financial options which carry an explicit “theta” or time decay, life options have opaque costs.  We can use finance logic to just as easily argue against option hoarding.

“Innumerate Cowards”

I’ll turn the heavy lifting to Byrne Hobart who describes option obsession as not only a “bad deal financially” but “utterly cowardly”. In one of his all-time lines, Byrne spits:

One might cynically describe the MBA’s dream as not so much “Have lots of optionality” as “Own a call option on the proceeds of the continued sale of put options.”

Byrne is actually underselling how cynical this is. What he calls cynical, many fund folk would describe as “great work if you can get it”. The dream is often literally the business of the MBA. Byrne describes mundane examples of option-collecting as well. Holding excessive cash, the “open calendar”, avoiding intimate relationships. These are all ways to preserve optionality. But if taken too far are cowardly:

Many otherwise smart and well-adjusted people have talked themselves into being the Ebenezer Scrooge of optionality, always hoarding the ability to do something later, never actually doing anything when “later” arrives, and giving up a lot in the process.

And when it comes to options, there’s always that nagging question of price:

Ultimately, there’s a finite net amount of optionality in the world, and it’s zero: every time you pay for the option to buy or sell something in the future, you need a counterparty. If there’s a bias towards being systematically long something with a total net supply of zero, the buyers will tend to overpay.

The Accidental Complacent

If the financial argument doesn’t suit you consider a behavioral one. Professor Mihir Desai eloquently describes how the safety of having many choices gradually neuters us. His tone is less aggressive than Byrne’s. Mihir is impartial as to the net effect of risk-averse paths on our happiness, but his words are a warning to those who find self-castration impermissible.

The emphasis are mine:

This individual has merely acquired stamps of approval and has acquired safety net upon safety net. These safety nets don’t end up enabling big risk-taking—individuals just become habitual acquirers of safety nets. The comfort of a high-paying job at a prestigious firm surrounded by smart people is simply too much to give up. When that happens, the dreams that those options were meant to enable slowly recede into the background. For a few, those destinations are in fact their dreams come true—but for every one of those, there are ten entrepreneurs, artists, and restaurateurs that get trapped in those institutions.

Of course, this is not a pitiable outcome. And in fact, maybe those serial options acquirers are simply masking a deep risk aversion that underlay their affinity for optionality. Even if not explicitly stated, optionality was always the end rather than a means to an end.

In fairness, these optionality-obsessed professionals often wind up happier than the other type I’ve become accustomed to seeing in my office: the lottery ticket buyers. These individuals are just one payday away from securing the resources they need to begin their work toward their true ambition, be it political, civic, or familial. They believe that one Silicon Valley startup or one stint at a hedge fund will allow them to begin their true journey.

While the serial option and lottery ticket buyers seem like different creatures, they are, in fact, close cousins. Both types postpone their dreams and undertake choices that they think will enable their dreams. But they fail to understand that all of these intervening choices will change them fundamentally—and they are, in fact, the sum total of those choices.

Stagnation

While this post is more concerned with our individual choices, it’s worth mentioning that there intellectual circles in which the collective obsession with options reflects a deeper malaise about our futures. Our society is curling itself in a shell of optionality as a reaction to a more uncertain world. You may recognize this as one of Peter Thiel’s primary laments — indefinite optimism. Thiel’s criticism of our incremental approach to progress is cast in relief to the US in the wake of its triumph in WWII.

Scott Alexander, in his review of Thiel’s Zero To One, explains:

But Thiel says the most successful visionaries of the past did the opposite of this. They knew what they wanted, planned a strategy, and achieved it. The Apollo Program wasn’t run by vague optimism and “keeping your options open”. It was run by some people who wanted to land on the moon, planned out how to make that happen, and followed the plan.

The discourse around stagnation or lack thereof falls under the topic of “progress studies” if you want to follow the breadcrumbs. I wanted to point out that speculating on the link between option lust and human advancement is a thing (of course it is).

Let’s return to the use of options in your individual life.

Exercising Options

Options are like an extra room in your house. The cost of the extra space is not marginally excessive and can pay off in unforeseen circumstances. Like if your friend needs a place to stay or if the stork forgot to take you off its mailing list.  But you don’t want to go full McMansion. Instead, let’s think about how to use the space we have better. Let’s explore strategies for exercising options, not collecting them.

Understanding The Stop-Loss Method

Financial options are contractual. They have “hard” optionality. We can replicate financial options by employing a stop-loss strategy. To do this, we need to pre-commit to cutting our losses once our self-defined threshold (the “strike price”) is breached. This is “soft” optionality because it relies on our discipline as opposed to a contract. In the context of investing, soft optionality is inferior because our discipline is uneven and we are exposed to gap risks. But when it comes to life, the stop-loss can be preferred. Byrne argues that while the payoff diagram is the same, the stop-loss method forces you to actually do stuff. The key to this is fortitude. Byrne argues that fortitude is a muscle you can train by re-framing your failures as learning experiences. If you are able to treat sunk costs as, well, sunk then you can just think of them as tuition. This is both philosophically and practically different from the cowardly option collector.

Here’s an example.

  • Cowardly option-collector strategy

    You’ve been saving for years, imagining that you will one day leave the rat race and start a business. Notice, that I didn’t say a bakery or a bar. No, you aren’t even that specific. You are saving for the most open-ended option. A “business”.

  • Stop-loss strategy

    You start a side-hustle in your spare time. You allow yourself a fixed amount of hours and expenses to reach a milestone. If you don’t make it, you pre-commit to cutting bait. No regrets.

The cowardly method saves you time and energy. Instead of doing work on the side you save more money and have no risk. But you also don’t learn how to build, sell, hire, manage in ways you are not used to. These new skills are options in themselves. They can enhance any resume. You will likely discover a pivot as you begin to dig. By exercising options in relatively low-stakes settings along the way, you improve your ability to exercise options more effectively when the stakes are higher.

Enabling Fortitude

I believe that collecting options and actively exercising them along the way is a more full way to live than passively collecting options that you may not even know how to exercise in the future. The stop-loss method resonates. But since it rests on fortitude is not easy. Marching headfirst into winds of fear and potential embarrassment is hard. I will share 2 mental hacks for lowering the stakes. The winds are not as strong as they seem.

2-Way Doors

Reversible decisions are 2-way doors.  Sure, it can hurt to go back to an old job. You might not get the same pay. Your ego will be bruised. It’s a risk for sure. But a survivable one. What is the point of your surviving anyway if you can’t take survivable risks? Don’t underestimate how many decisions are reversible.

Y(D)OLO

Recently I have gravitated to the idea of multiple lives. I’ve seen the idea expressed in overlapping contexts which makes it even more compelling. I first noticed it in how Josh Waitzkin, the chess prodigy, who later turned his attention to martial arts, surfing, and coaching embodied a serial approach to life. Every 5 to 10 years, he would undertake a new life. George Mack’s thread described Waitzkin’s emphasis on focus as a tool to live accomplish this. I’ve seen Marc Andreesen espouse going deep as a higher-yielding use of time. For example, if you choose to do open source work recognize it’s better to make major contributions to one project (as opposed to minor contributions to multiple projects). When you combine Andreesen and Waitzkin’s wisdom you find a philosophy that is more akin to “going all-in” rather than collecting options.

What does this have to do with enabling fortitude? It offers a contrast to safety. It reminds you that mastery and depth are rewards in themselves. And that you can exercise options serially, especially if you are willing to cut out distractions. It’s permission to focus on the quality of experience, not quantity. There’s almost a samurai honor to it that increases the consolation prize if you fail conventionally. Internalizing an appreciation for depth and craft rewards the journey, not the terminal payoff that option-collectors can’t turn their gaze from.

You don’t only live once. You don’t need to keep insuring against FOMO. You can choose strength.

Anne-Laure makes it practical:

One day you will be dead, but it takes about seven years to master something. If you live to be 88, after age 11, you have 11 opportunities to be great at something. Most people never let themselves die and cling onto that one life. But you can spend a life building things, another life writing poems, and another life looking for facts. You have many lives. Each of them is an opportunity to try something new and increase your optionality. Live them.

Avoid Upside Decay

The logic of options love rests on the idea of non-linearity. The payoffs are dominated by extremely low-probability, high magnitude events. It would be a shame to discover that these options you’ve collected have a much smaller upside than you believed. Unlike the random gyrations of a stock, you can influence the value of your options. Since you plan to exercise and not just collect options you should make sure you maximize what is under your control.

The key to this is to never take your reputation for granted. If your character cannot be trusted you will not be able to exercise your options or you will find the upside to be much smaller than you imagined. In Upside Decay: Why Some People Never Get Lucky, Brian Lui lays out a framework based on strong and weak ties. You can think of strong ties as contractual while weak ties are informal.

Strong ties are conspicuous. Weak ties are inconspicuous but numerous, and help in unexpected ways. When weak ties are activated, they can be more helpful in aggregate than strong ties. But weak ties will not help an unvirtuous organization! Weak tie assistance is voluntary and altruistic. This means that they only help those they think are virtuous. Without weak ties, organizations resort to strong ties and hard assets. This leads them to adopt a mercantilist approach. Their zero-sum mindset alienates others and makes them even less virtuous, because their positive-sum actions are now viewed suspiciously by others. Left with no choice but to double down on their zero-sum approach, they’ll antagonize all their weak ties and enter upside decay. This also explains why their good luck disappears but they don’t suffer much additional bad luck. Weak ties mostly aren’t motivated enough to hinder an unvirtuous organization, but they’ll gladly refuse to help.

Avoiding upside decay is simple but difficult. The organization needs to build a virtuous culture that leads to a positive feedback loop. At the same time, it needs to punish bad actions that have short-term benefits. This is hard because investments in a virtuous culture have no visible effect at the start, so they will tend to be unrewarded. Punishing unvirtuous actions is also difficult because the bad actor can point to the tangible benefits, while the long-term upside decay is invisible. It must be vigilantly enforced from the very top of the organization.

Go back and re-read the excerpts and insert yourself in place of “organization”. You can destroy your upside with one act of reputational suicide or by an accumulation of minor slights. The perceived gain from each of those tiny overreaches is invisibly offset by a diminished mass of right tail possibility. And that will cost you far more in the long run (possible counterpoint: I wonder if the age of grift we are in is a bet on weak ties becoming less effective as fungible avatars and more distributed end markets disintermediate reputation from actions. That or the price you get to sell your reputation is especially high. Call me old-fashioned for wanting people to come to my funeral).

A nice example of someone thinking about ways to not just avoid upside decay, but actively costing themselves dollars today in an effort to increase it is Ungated’s Rob Hardy. In Transitioning To The Gift Economy, he explains why giving away his work for free will pay off later. This is an active bet on the value of weak ties as opposed to strong ties. This is not surprising. We live in a world where digital (content, information, software) and financial supply is plentiful. Curation and trust become the complement that goes up in value.

Conclusion

Options themselves are not problems. You need them. The problem can arise when you lose sight of why you want them. It’s understandable.  Life is messy. We can drift in the wind for long periods.  Sometimes collecting options is the most legible thing to do. Maybe anything else is too hard right now. If so, keep in mind:

  • Options decay

    If you are in “explore” (as opposed to “exploit”) mode, name that state. You are in an option-collecting holding pattern. Remember to keep this transitory. Don’t let your life pass without acting. Ask yourself, “what is going to change in the future that will compel me to exercise my option?”

  • Opportunity costs are real

    Remember, when you acquire one option (like pursuing a grad degree) you forgo others. In fact, the options with well-marked signs usually lead to well-marked places. If that happens to bother you, don’t pursue the wrong ones.

  • Practice exercising options

    Remember the stop-loss method. The cost of failure is tuition but you will always salvage self-education and self-knowledge.

Option Lenses

If “high” was expensive and “low” was cheap then trading would be easy. I’ve discussed this tension in:

I was recently asked the following question:

Hey Kris, got a beginner question for you if you have some time. Why do people recommend selling ATM spreads instead of slight OTM? If there’s a smile, it seems to make sense to sell the higher IV wing.

Re-stated more generally, the question is:

Why would I ever buy a higher IV or “skewed” option to sell a lower IV option?

You can get into a long discussion about greeks, liquidity, jump probabilities, distributions and their moments, and spot-vol correlations. They will all lead you back to the idea that “high IV” doesn’t mean expensive IV. It’s not an encouraging answer if you are looking for simplicity.

But let me offer a constructive perspective to help you along.

It’s not hard to understand why skew exists in option markets:

  • supply/demand of risk (ie hedging and overwriting flows)
  • correlations increasing when risk premiums expand (here’s my thread on dispersion)
  • fundamentally, a stock is more levered when its equity value falls

In addition to those, I’m sure there are technical (ie lots of math) reasons involving jump models and higher statistical moments. I’m not smart enough for that. Many option traders probably aren’t. But one of the ways to survive/thrive is to take a more intuitive approach.

The logic flows as follows:

  1. Markets are pretty smart. It’s naive to think “high” equals expensive.
  2. Implied vols are a useful ruler for comparing vols but I can’t read too much into them as valuation tools since the underlying distributions are unknowable.
  3. Market prices contain extra intelligence or assumptions about a stock’s distribution but Black-Scholes assumes a singular distribution leading to differential implied vols. (Those differences are a fudge because we are standardizing the underlying distribution, even though we know the market is capable of handicapping a multitude of conditional distributions.)
  4. Focus on relative pricing to make your process less model-dependent. This lets the model errors “cancel out”.

Here’s an example of this relative thinking that I explained to the learner:

Suppose I found 20 reasonably correlated names that all have skews more expensive that at-the-money IV. If you sorted the skewed options as a percent of ATM vol there would be a top half and bottom half of expensiveness. But if you looked at just the cheapest one naively in isolation you would want to sell the skewed option. But zoomed out in a cross sectional view you would have wanted to buy it.

If you are only trading one name you are in the domain of my post Structuring Directional Option Trades. In this case your fundamental analysis is upstream of your option trade expression. So be careful about mixing up vol trading which requires a zoomed out lens and directional options trading which requires a deep  understanding of a single name’s distribution (see Real Talk On Options Trading).

A possible compromise between the approaches is to look at a time series of the skew relative to ATM to see if it’s low end or high end of normal. This will still deceive you in cases when all the skews in the market converge. For example when all skews in the market are “high”, if you look at your name in isolation you still won’t know if it’s relatively “high”. A proper cross-sectional method will benchmark to a liquid name or basket that can be considered “fair”.

So that’s 3 lenses. Cross sectional, fundamental, and time series. It would be nice if your trade idea looked good on a all 3 filters, but option traders usually have limited visibility into fundamentals so it’s too high a bar for pulling a trigger.

How can option traders make up for that incomplete picture? The same way poker players use betting patterns to narrow a hand.

Here’s a clue:

Mindset Boosters

Here are a few things I’ve enjoyed recently that cultivate a mindset that counteracts the trader residue I narrowly described in How I Misapplied My Trader Mindset To Investing:

  • Liminal Warmth 

    I came across this blog via the Twitter account @liminal_warmth. I was deep into several posts that grabbed my attention. There are lots of essays so I reached out to ask for which posts LW recommends. And voila, this thread will get you started.

    LW lives their own divergent script so it’s not surprising that the writing is unique and provocative. In addition to living in a van in a desert and writing tons of fiction, LW is a solopreneur/freelancer with tons of hard and soft skills for hire.

    I’ll single out an excerpt I found resonant from The Weirdness of Becoming Attractive in Your 30s (Link):

    Weirdly enough developing more empathy and more compassion and listening more and being more respectful of other people started working its way into my feelings toward myself… and I started hating who I was a little less. And I realized for the first time that attraction is as much about how you make other people feel as how you look (and arguably much more important). This completed a puzzle piece in my communication style that had always been missing. And it was so weird because I suddenly had this massive wave of empathy for everyone around me and I wanted everyone to feel special and pretty and liked because I knew how much it hurt to not feel that way. So again, I spent more time being actively interested in other people and trying to make them feel good and got more feedback loop results where I got positive attention in response and I felt amazing that I was able to make other people feel good and happy too.

    There’s nothing more addicting than watching people believe in themselves. Just observe a kid that learned to ride a bike or swim. I have a saying that compliments are the cheapest source of capital. Not in a fake or hollow way. But when someone is just doing their thing and you notice it’s awesome, even if it’s not grandly remarkable, just tell them. It unlocks people in a way that everyone wins.

  • The Scarcity Struggle (essay)
    @NeckarValue

    This post is an outstanding reference for battling a zero-sum mindset. It chronicles the author’s own journey but many of you will be able to relate. It’s much better than my own writing on the topic so I will just leave you to read it.

    It reminds me of a hack we use around our house: “You can’t be negative when you are in a state of gratitude”. You are the object of someone else’s envy for one reason or another. Everyone is dust eventually. No point in doing anyone else but you.