the iron butterfly

I think about what Matthew Clifford said about technology when he was on Infinite Loops back in 2022 and before ChatGPT was a household name. Carved from my notes:

Matt Clifford: …modernity, however you want to define that…is about constant or apparently constant, apparently unstoppable motion towards the reduction of variance in our lives…for most of, let’s say, the second half of the 20th century post Second World War, anyone who lived in, for one of a better term, the west, had a life of far less variance than say 3, 4, 5, 10 generations before that. You could call that the triumph of modernity.

…if you look at what the 20th century was about from the perspective of work and ambition, it was really about having these more or less formalized tracks for ambitious people to climb.

And then something happened in the midst of these fantastic variance dampening institutions, we somewhat accidentally unleashed the mother of all variance amplifying institutions, and it’s called the Internet. And what the Internet does, is it selects the weird and amplifies it.

One slightly provocative framing would be that the rise of modernity, the rise of variance dampening institutions was really bad for ambitious people. It was really good for the average person…if you’re a super ambitious person today, you actually look back historically, I think, and look, well, actually it was possible to do more as an ambitious person. It was possible to find more leverage, to have fewer constrains in the past. It was then a period of about 50 years, like the great moderation, if you’d like, where a lot of that was constrained.

He lays out bull and bear cases for humanity, yet this is just a snippet:

We can imagine and creating world, whole worlds in which people can fulfill their ambitions and like the fullness of who they want to be in a way that is less damaging to others potentially. I mean, again, like you could say, that’s a very bullish case. There’s lots to critique in that, but there is something about the idea of virtualization as a way to enable many more people to achieve what they want to achieve, because we move from scarcity to abundance or potentially to abundance. Again, lots of footnotes on that, whether actually the metaverse as it is to actually emerging will permit that. I think the bear cases well, actually what the internet does is exposes us to, as you’ve already said, like a global competition where previously there was a local one, it sort of amplifies inequalities rather than dampening them.

The internet obviously accelerated learning for the motivated. I think it was on Smartless that Steph Curry admitted that Wemby can do that tennis ball dribbling drill as well as he can.

There’s this idea that the reason the 4-minute mile threshold was breached quickly and by many people once Roger Bannister finally broke the long elusive mark was psychology. The fact that someone proved it possible boosted other elite runners’ hope and motivation.

[It’s not something I’ve studied, but perhaps that’s one of those “just-so” causation stories that sounds plausible. In Ed Thorp’s autobiography, he says the reason he worked so hard to crunch the numbers in card-counting by hand was that he knew the pace of computing progress in the mid-60s meant many researchers would publish the calculations within a year or so of his frantic effort, and he wanted to be first. Maybe the 4-minute mile was already being seen less as an asymptote and more of an inevitability, and Bannister was the first of an already-oncoming pack.]

The internet feels like a variance pump because it turbo boosts Mendelian experimentation. The YouTube subculture of speedrunning looks like a Game Genie to someone raised on Metroid.

Reinforcement learning on all human knowledge and activity is the next turn of the crank. Recursion will mean later turns of the crank will not only come faster but possibly without our hand on it. We don’t really know where it goes in the long run (I don’t know if long-run means the next Haley’s comet, the next World Cup, or the Super Bowl), but in the meantime we can see that the range of ability is widening.

Now if leverage, a word embodying technology in the Archimedean sense, is accruing much faster to the top of the range, then Clifford will have spoken about variance when he should have been speaking about skew and kurtosis. To the initiated, it’s the strangle that’s interesting, not the straddle.

In options trading, there’s a structure called an Iron Butterfly. Like the band. It’s a long strangle (own the wings) and short straddle (the meat or body of the fly). It’s characterized as a short vol trade that has capped downside because you clip the losses in the tails. But if you ratio the legs of the trade to be long extra strangles, you could have a vega-neutral iron butterfly. This trade is long “vol gamma” (“volga”) or as some prefer to say, long vol of vol. It’s a second-order bet.

I’m not quite sure what the real-life activities are that would map to this idea. In investing, the mapping is probably more straightforward. You can literally own strangles and then continue to invest in all the forms of carry that have been documented to work. If you think the US stock market is TBTF, then you can just stick with the mother of all carry, equity risk premia, so instead of moaning about boomers’ influence, profit from it.

In a mature society, there’s an inertia, a calcification of the state’s administrative bones, protectionism, regulation and Nimbyism that spans across the right and left. The horseshoe is not a curious accident but unison decrepit impulses that reside in people who otherwise claim to only like chocolate or only like vanilla. The collision of variance suppression and variance amplification is a predictable human-paced response to technology’s scaling laws.

When it comes to real-life, we say things like “going out and meeting people is long vol”, but it’s harder to categorize activities as vol-neutral yet long vol-of-vol. Second-order Greeks are weird. Clifford’s a very smart guy, he may have been thinking in wings, but colloquially speaking in terms of variance. A commitment to TBTF, even if artificial, stabilizes variance. The artificial part has a lot of institutional cement holding it together and while the crack is a when, not if, the timing is uselessly Poisson.

You don’t want to be naked long or short vol. You want the vol of vol. We just gotta figure out what that means.

investing orbits

Here’s a summer reading book rec for investors:

My wife and I are both reading this. It’s laugh-out-loud funny. Gary is an excellent writer. The novel is written from the point of view of an elite school’s endowment CIO. It presents as a series of meetings with prospective managers, deals with politics within the endowment but also with the external culture of the investing world. If you are in finance, Gary’s sharp eye will delight you til no end.

I’m less than halfway through it and already I can’t recommend it enough. It was recommended to me by an allocator (thanks Tom!) and I saw in a recent Byrne Hobart letter that one of Byrne’s friends physically accosted him for not having read this book yet.

You can see Matt Levine’s endorsement in the screenshot. I wouldn’t have articulated what Matt wrote, but once he said it, I noticed that’s the exact feeling I get reading it.

The CIO’s banter, verbal chess, and inner monologue reveal a fox-like savvy honed by years of battle with both the market and the managers who make convincing cases for how they’ve mastered them. It gave me a tremendous appreciation for the difficulty of the job. If you are not a professional investor and have confused the most generous market run in anyone’s living memory for your own brilliance, then considering the CIO’s constraints will update your context for the pro version.

I found this recently reinforced by Jeremy Giffon in this terrific interview on ILTB.

Patrick: You have this funny view that the whole myth of how difficult it is to beat the market, however you want to define the market, is wrong. I’m curious for you to expound on that. That seems to have become, post-Jack Bogle, one of the deeply held truths of the market is that it’s extraordinarily difficult to beat the market, so you shouldn’t even try. You should just opt out of the battle. I think you have a very different view on this.

Jeremy: Buffett and Munger were my main teachers on investing. Buffett says that he wants his estate outside of Berkshire to be put in the S&P. That’s his advice to the general public. People take that to say that Buffett’s saying you can’t beat the market. I don’t think that’s what he’s saying. I think he’s saying for the average person, you shouldn’t try and beat the market. Implicit in that statement is leaving out any sort of active investor. Maybe the anecdotal side would be Buffett saying you should put all your money into the S&P. That’s the most rational thing you should do. On the other side is the sort of empirical argument, which is, look, most professionals don’t even beat the market after fees. This is this one-two punch of — the godfather of investing says, don’t try. Seemingly the smartest people with the best incentives in the world can’t do it.

And then the other thing is, for a professional manager — and this is sort of the paradox with the Buffett thing — it is really hard to beat the market because you have all these other factors that the average person doesn’t have. And this is the Peter Lynch argument — and increasingly I think Peter Lynch was a genius about this — which is that, yeah, when you’re a professional manager, by and large, you have all these mandates, you’re running a business, you have customers that you need to keep happy. It’s more difficult for the professional money manager to beat the market than the average amateur.

This is from Mandy Xu at the CBOE this week:

The outperformance of small-caps is a sign that the equity rally – which has long been dominated by the mega-cap Tech names – is starting to broaden out. In fact, over the past month, Tech has been the worst performing sector (-10%) while YTD laggards such as Healthcare and Financials have been the best performing (+12% and +8%, respectively). The calm at the index level (SPX Index -1.7% over the past month) belies these large rotations underneath the surface. This is why single stock volatility has been so elevated, even as the VIX® Index has fallen. The spread between the two, as measured by the VIXEQSM-VIX Index spread, widened to an all-time high of 31% last week.

If the single stock volatility is high relative to the index volatility, that’s another way to say the realized correlation between the stocks is very low. The index is dampening volatility because it’s acting well-diversified. A so-called stock-pickers market.

There’s so much violence under the surface. A momentum rotor whirring to give different categories an unpredictable spotlight before abruptly re-targeting.

I’m going to think aloud here a bit.

On the one hand, the momentum rotor feels like a market technicals concept. It’s the signature of flows and liquidity reaction functions. The intent of the orders that generate these flows might have a fundamental thesis behind them. In an investing mind. The trading world is indifferent to the ultimate intent but seeks to collect a service fee by spreading the acute dollar pressure in one part of the investing crust to another part of the surface.

From this perspective, the marginal price is set by an active investor. Perhaps the cumulative orders of levered pods.

At the same time, we hear of the “passive” bid. The Trump accounts and their monogamy to the SP500 (for the moment anyway) being yet one more increment to the bid.

If passive is the marginal price setter, I’d actually expect correlations to be structurally increasing. Not only do they seem to be structurally falling, they are conspicuously dormant at today’s historical lows.

I’m not sure the best way to reconcile these arguments. Is it an artifact of observation at a short time scale (rotor flows) vs a longer time scale (a slice of S in the GDP identity is pro-rata routed to the SP500 as long as the economy grows)? It’s reminiscent of the Earth’s dual rotation, where the planet spins on its own axis while orbiting the sun. The momentum rotor is called a “day” and the steady levitation of valuation comes from the passage of the “years”.

Regardless of the reconciliation of orbits or lack thereof, I am fractured by an ongoing dissonance:

I don’t discuss any of this in the Investment Beginnings Course!

It’s easy to anticipate a commoner’s consolation. “Kris, you are right to be teaching the textbook basics; we want the kids to learn investing, not gambling.” But it does feel quaint and too convenient to not address the marginal price setter. Buffett does so in a particularly striking way based on Graham’s allegory:

He said that you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his.

Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market’s quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terrified that you will unload your interest on him…

Mr. Market has another endearing characteristic: He doesn’t mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you.

Mr. Market is there to serve you, not to guide you.

Yet, I have my humble reservations about Buffet’s view. It’s not that I think it’s wrong, it’s that it leaves you in a quandary about a critical aspect of decision-making. How do you weigh information when forming an opinion?! A strict reading of Buffet is that Mr. Market is emotional and irrational. But traders are taught to respect bids and offers. They are made with real money in proportion to conviction. It’s exactly why we say betting is a tax on bullshit. The essence of trading decisions is how you form priors and then Bayesian update. You can’t ignore bids and offers if you think they contain information (and you certainly would care about if the bids and offers are forced or “uneconomic”).

[The maximalist Buffet view is that “short-term”, an admittedly poorly defined descriptor, price behavior contains no information. I’m not actually opposed to this possibility under some conditions but it’s obviously not universally true. The price signals from shortages and surpluses in the physical world matter. It’s the entire basis of capitalism. Insofar as share prices are an inference on the supply and demand of the physical world, we should not ignore their deltas. But the amplification embedded in the math of capitalizing those inferences into a multiple leaves a lot of room for accepting and refuting its justifications.]

Circling back to what I teach the kids in the future or possible course edits might be to discuss macro simply in terms of Kalecki-Levy type accounting identities. They aren’t predictive but they are explanatory. Every liability is someone else’s asset. So if the G deficit spends, the private sector savings mechanically increase (I need to review the framework, to be accurate in teaching it, but you get the gist). Some of that S will be siphoned into stocks, creating structural demand to be weighed against the arrival of issuance (ie supply).

From that foundation, one can see the movement of the index of all corporate shares as one orbit, and the micro discernment of relative value underneath being the subject of traditional valuation canon, while the trading/gambling science informing the physical “equations” that govern the sector rotor.

I stuck with physics in adherence to the orbital analogy but we all know investing is biology.

But I’ll wrap with a quote from my article about why it feels like astrology (this remains the most widely read post in moontower history):

In a recent interview on Corey Hoffstein’s Flirting With Models, volatility manager Cem Karsan explains:

In the very long term, all that matters is cash flows. At some point you’re gonna have a liquidity crisis and when the liquidity is not available, companies have to create their own liquidity and that’s where fundamentals matter…they matter, to the extent that they are necessary for purchasing their own stock or buying other companies.

I’ve used this analogy before, it’s kind of hokey, but I can’t think of a better one. If you’re on an airplane, 30,000 feet off the ground, that 30,000 feet off the ground is the valuation gap. Valuations are really high, but those engines are firing. Are you worried up in that plane about the valuations or are you worried about the speed and trajectory of where you’re going, based on the engines, based on the flows? The flows are what matter for where you’re going.

But when all of a sudden those engines go off, how far off the ground you are is all that matters. And so, [valuation] is more of a risk management tool, and ultimately it really matters when you have a liquidity crisis. It also matters if rates were to go back to 8, 9, 10%. Something crazy again, where nobody can borrow money, and there is no liquidity. Cash flows are all that matters again and we have a world where fundamentals are all that matters. So I want to be clear. It’s not that fundamentals don’t matter at all, it’s that they don’t matter in a world of massive liquidity.

I’m not naive enough to envision a unifying theory of investing, but teaching the class does motivate an impulse to do better than the textbook in tying things together in a way that is not just correct-ish but useful and relevant. And respectful to preteens and teens’ intellects, for whom education is increasingly patronizing.

present tense

I turn 48 today. Once again grateful that another year of life insurance premium went to waste. It’s a reflective one, not because of me but because my eldest turns 13 tomorrow. I didn’t ask for it to be reflective, but my wife was watching old videos of him from ages 2 to 5 before bed and I got drawn in.

I never seek out the old videos. I figure one day I will when I need to make a slideshow or something. It’s a strange feeling. Because I forget what their little voices and mannerisms were like, so it feels like I’m watching a film that wasn’t actually my own life. And in that period, their constant need for you absorbed all your free time and energy. It’s a moment where all the young parents reading are in right now feels like forever. When you’re on the playground with your toddler and think how a 1st grader seems so old. Be careful ruffian, can’t you see my boy is only two and a half.

But it’s a flash. And all of it that absorbs you right now will cease to be remembered in detail. Only in shape. I can’t tell you about any one Saturday, but I can tell you about all of them together. The Tilden train every Saturday. Your day’s 2 halves. Before and after a nap. Each part starts with another coffee.

I’m not here to say enjoy it because it’s fleeting. I mean it is, but another phase will start. And it’s great. They’re all great. But if my memory of only 10 years ago is already foggy, I’ll predict that will be true for all that’s happening now when I’m 58.

I think I used to carry some anxiety about “will I remember this?”, “how will I remember this?” And you don’t really think about how the kid’ll remember this because you know they won’t. But as they get to elementary school age and older you know they’ll remember. And everyone wants to do core-memory-maxxxing for their kids. Us too. It would be nice if when they’re grown they look at their childhoods fondly. Or even better, if they think it helped them become whoever they’ve become, especially if they’re proud of that person.

Enjoy it, but not because it’s fleeting and not because you’re playing memory inception.

Enjoy it because it’s all there is.

You have no control over how matter might organize itself to bombard all that you love, all that you remember, and how you remember it. Your mind mediates reality, which itself we can only glimpse from the limited frames of our attention. The whole you-don’t-notice-your-breathing-until-I-say-pay-attention-to-your-breathing thing. The memories are sensitive to not only what you happened to notice but on the revisions that life’s future path dependence cast backwards.

The personal past (as opposed to big H History) to me is a social thing. A laughback with friends. A reminiscence you bond over. It’s not something I care to meditate alone on. Meanwhile, the future is a paradox. You want to watch your kids’ story unfold. You want to see the world with your partner and loved ones. There’s so much to look forward to. Yet you want time to slow down. You’ve got an awesome trip coming up in 6 months, but you don’t want to say “hurry up and get here” because the last thing you want to say is “hurry and let my kids/parents/pets be 6 months older”.

My 13-year-old is building a gym in the garage. It’s that time of life for him. He notices who has a 6-pack when they play shirts and skins. He wants to be stronger in the paint. I’ve been selling stuff on FB marketplace to make space for this iron temple. This week I sold a piano stool to the most energetic 82-year-old woman. She was apparently telling her karate instructor she never learned music and he offered to teach her piano. So here she is, stoked to be learning something new. You’d like to see that every day.

Knowledge and preparation demand we think of the past and the future. But you don’t want to live there.

I leave you with one of my favorite songs.

Moontower #320

In this issue:

  • investing orbits
  • present tense

Friends,

I save my editorializing for the section at the end today. Let’s go straight to Money Angle.

Money Angle

This week, I take the 12+ year-olds into the lab during market hours to buy their first portfolios for real. You can see the course recap and guide for prepping for the lab.

💾Download the course recap

What’s inside:

  • What we covered: businesses → compounding → picking stocks → risk → markets
  • Where investment returns come from
  • Why a long time horizon changes how you invest
  • What to own besides stocks, and why not bonds
  • The effect of valuations and fees on returns
  • Three starter portfolios, plus rules for picking individual stocks
  • A checklist for lab day

[The language in the recap is AI-talk which I hate too, but the material is certainly what I want to convey. Unlike writing this letter, I need to be efficient and not mastermind every word to actually make this stuff happen.]

For all the course materials see:

🧠The Investment Beginnings Course Page

Money Angle For Masochists

Here’s a summer reading book rec for investors:

My wife and I are both reading this. It’s laugh-out-loud funny. Gary is an excellent writer. The novel is written from the point of view of an elite school’s endowment CIO. It presents as a series of meetings with prospective managers, deals with politics within the endowment but also with the external culture of the investing world. If you are in finance, Gary’s sharp eye will delight you til no end.

I’m less than halfway through it and already I can’t recommend it enough. It was recommended to me by an allocator (thanks Tom!) and I saw in a recent Byrne Hobart letter that one of Byrne’s friends physically accosted him for not having read this book yet.

You can see Matt Levine’s endorsement in the screenshot. I wouldn’t have articulated what Matt wrote, but once he said it, I noticed that’s the exact feeling I get reading it.

The CIO’s banter, verbal chess, and inner monologue reveal a fox-like savvy honed by years of battle with both the market and the managers who make convincing cases for how they’ve mastered them. It gave me a tremendous appreciation for the difficulty of the job. If you are not a professional investor and have confused the most generous market run in anyone’s living memory for your own brilliance, then considering the CIO’s constraints will update your context for the pro version.

I found this recently reinforced by Jeremy Giffon in this terrific interview on ILTB.

Patrick: You have this funny view that the whole myth of how difficult it is to beat the market, however you want to define the market, is wrong. I’m curious for you to expound on that. That seems to have become, post-Jack Bogle, one of the deeply held truths of the market is that it’s extraordinarily difficult to beat the market, so you shouldn’t even try. You should just opt out of the battle. I think you have a very different view on this.

Jeremy: Buffett and Munger were my main teachers on investing. Buffett says that he wants his estate outside of Berkshire to be put in the S&P. That’s his advice to the general public. People take that to say that Buffett’s saying you can’t beat the market. I don’t think that’s what he’s saying. I think he’s saying for the average person, you shouldn’t try and beat the market. Implicit in that statement is leaving out any sort of active investor. Maybe the anecdotal side would be Buffett saying you should put all your money into the S&P. That’s the most rational thing you should do. On the other side is the sort of empirical argument, which is, look, most professionals don’t even beat the market after fees. This is this one-two punch of — the godfather of investing says, don’t try. Seemingly the smartest people with the best incentives in the world can’t do it.

And then the other thing is, for a professional manager — and this is sort of the paradox with the Buffett thing — it is really hard to beat the market because you have all these other factors that the average person doesn’t have. And this is the Peter Lynch argument — and increasingly I think Peter Lynch was a genius about this — which is that, yeah, when you’re a professional manager, by and large, you have all these mandates, you’re running a business, you have customers that you need to keep happy. It’s more difficult for the professional money manager to beat the market than the average amateur.

This is from Mandy Xu at the CBOE this week:

The outperformance of small-caps is a sign that the equity rally – which has long been dominated by the mega-cap Tech names – is starting to broaden out. In fact, over the past month, Tech has been the worst performing sector (-10%) while YTD laggards such as Healthcare and Financials have been the best performing (+12% and +8%, respectively). The calm at the index level (SPX Index -1.7% over the past month) belies these large rotations underneath the surface. This is why single stock volatility has been so elevated, even as the VIX® Index has fallen. The spread between the two, as measured by the VIXEQSM-VIX Index spread, widened to an all-time high of 31% last week.

If the single stock volatility is high relative to the index volatility, that’s another way to say the realized correlation between the stocks is very low. The index is dampening volatility because it’s acting well-diversified. A so-called stock-pickers market.

There’s so much violence under the surface. A momentum rotor whirring to give different categories an unpredictable spotlight before abruptly re-targeting.

I’m going to think aloud here a bit.

On the one hand, the momentum rotor feels like a market technicals concept. It’s the signature of flows and liquidity reaction functions. The intent of the orders that generate these flows might have a fundamental thesis behind them. In an investing mind. The trading world is indifferent to the ultimate intent but seeks to collect a service fee by spreading the acute dollar pressure in one part of the investing crust to another part of the surface.

From this perspective, the marginal price is set by an active investor. Perhaps the cumulative orders of levered pods.

At the same time, we hear of the “passive” bid. The Trump accounts and their monogamy to the SP500 (for the moment anyway) being yet one more increment to the bid.

If passive is the marginal price setter, I’d actually expect correlations to be structurally increasing. Not only do they seem to be structurally falling, they are conspicuously dormant at today’s historical lows.

I’m not sure the best way to reconcile these arguments. Is it an artifact of observation at a short time scale (rotor flows) vs a longer time scale (a slice of S in the GDP identity is pro-rata routed to the SP500 as long as the economy grows)? It’s reminiscent of the Earth’s dual rotation, where the planet spins on its own axis while orbiting the sun. The momentum rotor is called a “day” and the steady levitation of valuation comes from the passage of the “years”.

Regardless of the reconciliation of orbits or lack thereof, I am fractured by an ongoing dissonance:

I don’t discuss any of this in the Investment Beginnings Course!

It’s easy to anticipate a commoner’s consolation. “Kris, you are right to be teaching the textbook basics; we want the kids to learn investing, not gambling.” But it does feel quaint and too convenient to not address the marginal price setter. Buffett does so in a particularly striking way based on Graham’s allegory:

He said that you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his.

Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market’s quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terrified that you will unload your interest on him…

Mr. Market has another endearing characteristic: He doesn’t mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you.

Mr. Market is there to serve you, not to guide you.

Yet, I have my humble reservations about Buffet’s view. It’s not that I think it’s wrong, it’s that it leaves you in a quandary about a critical aspect of decision-making. How do you weigh information when forming an opinion?! A strict reading of Buffet is that Mr. Market is emotional and irrational. But traders are taught to respect bids and offers. They are made with real money in proportion to conviction. It’s exactly why we say betting is a tax on bullshit. The essence of trading decisions is how you form priors and then Bayesian update. You can’t ignore bids and offers if you think they contain information (and you certainly would care about if the bids and offers are forced or “uneconomic”).

[The maximalist Buffet view is that “short-term”, an admittedly poorly defined descriptor, price behavior contains no information. I’m not actually opposed to this possibility under some conditions but it’s obviously not universally true. The price signals from shortages and surpluses in the physical world matter. It’s the entire basis of capitalism. Insofar as share prices are an inference on the supply and demand of the physical world, we should not ignore their deltas. But the amplification embedded in the math of capitalizing those inferences into a multiple leaves a lot of room for accepting and refuting its justifications.]

Circling back to what I teach the kids in the future or possible course edits might be to discuss macro simply in terms of Kalecki-Levy type accounting identities. They aren’t predictive but they are explanatory. Every liability is someone else’s asset. So if the G deficit spends, the private sector savings mechanically increase (I need to review the framework, to be accurate in teaching it, but you get the gist). Some of that S wll be siphoned into stocks creating structural demand to be weighed against the arrival of issuance (ie supply).

From that foundation, one can see the movement of the index of all corporate shares as one orbit, and the micro discernment of relative value underneath being the subject of traditional valuation canon, while the trading/gambling science informing the physical “equations” that govern the sector rotor.

I stuck with physics in adherence to the orbital analogy but we all know investing is biology.

But I’ll wrap with a quote from my article about why it feels like astrology (this remains the most widely read post in moontower history):

In a recent interview on Corey Hoffstein’s Flirting With Models, volatility manager Cem Karsan explains:

In the very long term, all that matters is cash flows. At some point you’re gonna have a liquidity crisis and when the liquidity is not available, companies have to create their own liquidity and that’s where fundamentals matter…they matter, to the extent that they are necessary for purchasing their own stock or buying other companies.

I’ve used this analogy before, it’s kind of hokey, but I can’t think of a better one. If you’re on an airplane, 30,000 feet off the ground, that 30,000 feet off the ground is the valuation gap. Valuations are really high, but those engines are firing. Are you worried up in that plane about the valuations or are you worried about the speed and trajectory of where you’re going, based on the engines, based on the flows? The flows are what matter for where you’re going.

But when all of a sudden those engines go off, how far off the ground you are is all that matters. And so, [valuation] is more of a risk management tool, and ultimately it really matters when you have a liquidity crisis. It also matters if rates were to go back to 8, 9, 10%. Something crazy again, where nobody can borrow money, and there is no liquidity. Cash flows are all that matters again and we have a world where fundamentals are all that matters. So I want to be clear. It’s not that fundamentals don’t matter at all, it’s that they don’t matter in a world of massive liquidity.

I’m not naive enough to envision a unifying theory of investing, but teaching the class does motivate an impulse to do better than the textbook in tying things together in a way that is not just correct-ish but useful and relevant. And respectful to preteens and teens’ intellects, for whom education is increasingly patronizing.

From My Actual Life

I turn 48 today. Once again grateful that another year of life insurance premium went to waste. It’s a reflective one, not because of me but because my eldest turns 13 tomorrow. I didn’t ask for it to be reflective, but my wife was watching old videos of him from ages 2 to 5 before bed and I got drawn in.

I never seek out the old videos. I figure one day I will when I need to make a slideshow or something. It’s a strange feeling. Because I forget what their little voices and mannerisms were like, so it feels like I’m watching a film that wasn’t actually my own life. And in that period, their constant need for you absorbed all your free time and energy. It’s a moment where all the young parents reading are in right now feels like forever. When you’re on the playground with your toddler and think how a 1st grader seems so old. Be careful ruffian, can’t you see my boy is only two and a half.

But it’s a flash. And all of it that absorbs you right now will cease to be remembered in detail. Only in shape. I can’t tell you about any one Saturday, but I can tell you about all of them together. The Tilden train every Saturday. Your day’s 2 halves. Before and after a nap. Each part starts with another coffee.

I’m not here to say enjoy it because it’s fleeting. I mean it is, but another phase will start. And it’s great. They’re all great. But if my memory of only 10 years ago is already foggy, I’ll predict that will be true for all that’s happening now when I’m 58.

I think I used to carry some anxiety about “will I remember this?”, “how will I remember this?” And you don’t really think about how the kid’ll remember this because you know they won’t. But as they get to elementary school age and older you know they’ll remember. And everyone wants to do core-memory-maxxxing for their kids. Us too. It would be nice if when they’re grown they look at their childhoods fondly. Or even better, if they think it helped them become whoever they’ve become, especially if they’re proud of that person.

Enjoy it, but not because it’s fleeting and not because you’re playing memory inception.

Enjoy it because it’s all there is.

You have no control over how matter might organize itself to bombard all that you love, all that you remember, and how you remember it. Your mind mediates reality, which itself we can only glimpse from the limited frames of our attention. The whole you-don’t-notice-your-breathing-until-I-say-pay-attention-to-your-breathing thing. The memories are sensitive to not only what you happened to notice but on the revisions that life’s future path dependence cast backwards.

The personal past (as opposed to big H History) to me is a social thing. A laughback with friends. A reminiscence you bond over. It’s not something I care to meditate alone on. Meanwhile, the future is a paradox. You want to watch your kids’ story unfold. You want to see the world with your partner and loved ones. There’s so much to look forward to. Yet you want time to slow down. You’ve got an awesome trip coming up in 6 months, but you don’t want to say “hurry up and get here” because the last thing you want to say is “hurry and let my kids/parents/pets be 6 months older”.

My 13-year-old is building a gym in the garage. It’s that time of life for him. He notices who has a 6-pack when they play shirts and skins. He wants to be stronger in the paint. I’ve been selling stuff on FB marketplace to make space for this iron temple. This week I sold a piano stool to the most energetic 82-year-old woman. She was apparently telling her karate instructor she never learned music and he offered to teach her piano. So here she is, stoked to be learning something new. You’d like to see that every day.

Knowledge and preparation demand we think of the past and the future. But you don’t want to live there.

I leave you with one of my favorite songs.

[The musical build from the delicate flanger-tinged mixolydian walkdown to the drop-d dirt of the chorus and its desperate message…straight into the vein.]

 

This week in The Options Trench

📺Erik and I decode the inputs to Black-Scholes-Merton

 

Stay groovy

☮️

Moontower Weekly Recap

“betting as a tax on bullshit”

🎙️Wrong numbers and why they survive | Complex System Podcast

Patrick McKenzie interviews famous Wall Street quant and author Aaron Brown(Poker Face of Wall Street, Red-Blooded Risk) about his new book Wrong Number, which tackles a stubborn, nagging mule of a question:

“Why do institutions that produce bad statistics face so few consequences?”

I really enjoyed the interview and if Aaron’s other writing is any indication, the book will be outstanding. But I just want to excerpt a section from below that I appreciated.

Timestamps

(01:12) The agricultural demand curve discrepancy
(04:06) Why experts prioritize teaching over learning
(05:17) Institutional indifference to error
(06:26) The brand halo of high-status institutions
(08:34) Lessons from COVID-era decision-making
(10:19) Financial statements versus scientific rigor
(18:19) The difficulty of auditing and replicating research
(22:12) The CDC eviction moratorium and its justification
(23:34) The NTSB curbside carrier safety study
(26:41) Conspiracy versus incompetence in data manipulation
(30:05) Error correction in financial markets
(32:52) The culture of the advantage gambler versus the academic
(35:28) Betting as a tax on bullshit
(38:44) Using market pricing to evaluate risks
(41:04) The track record of scary predictions
(43:34) Environmental success stories and technological optimism
(48:21) Energy efficiency and the path to global wealth

Betting as a tax on bullshit (emphasis mine)

Patrick: I think Nate Silver calls this the “River” versus the “Village.”

Aaron, agreeing: As somebody said about Nate Silver, betting is a tax on bullshit. [Patrick notes: I associate that line with Marginal Revolution. The post coining it was, fittingly, about Nate Silver.]

Patrick continuing: In some fields, it seems viscerally distasteful that someone could be keeping a record of someone being wrong. That person is a threat to social harmony. When folks from the advantage gambler camp say, “You’ve expressed 99% credence that X is true; would you bet $50,000 at even odds?” it functions as a tax on bullshit. Some people find it extremely negative to be seen publicly responding to that in a repeated fashion.

Aaron: My friend Philip Tetlock did a book, Expert Political Judgment, which showed that experts in a field have less than random—or worse than random—predictions. The more prominent the expert, the worse the performance.

Here’s a good trader question. When somebody says, “Gold is overpriced, it’s going to fall to a thousand dollars,” you ask them: “How much would the price of gold have to go up before you admitted you were wrong?” For most people, it’s a blank look. They haven’t thought about it. A trader will tell you, “I think it’s going to a thousand, but my stop is six thousand. If it hits six, I’m getting out; I was wrong.” If you haven’t thought about that, you haven’t taken the first step toward forming a bet. If no evidence will convince you, then it’s an article of faith.

While humans use git to version defenseless letters and numbers into knowledge with traceable lineages, they themselves resist self-audit. To torture the analogy, betting is like a merge you can’t roll back for free.

I really just love the way Patrick put this:

In some fields, it seems viscerally distasteful that someone could be keeping a record of someone being wrong. That person is a threat to social harmony. When folks from the advantage gambler camp say, “You’ve expressed 99% credence that X is true; would you bet $50,000 at even odds?” it functions as a tax on bullshit. Some people find it extremely negative to be seen publicly responding to that in a repeated fashion.

These talkers want an infinite Sharpe. Return for zero risk. The bettor/trader/investor finds THAT “viscerally distasteful”. How dare you lay claim to the Holy Grail without so much as a dent in your armor?

It’s quite predictable that I’d enjoy such a podcast. I’m partial to idea of “taxing” lies and laziness, but the episode is also a welcome reminder that metrics are tabulated, presented, and interpreted by humans. There’s an irreducible amount of subjective cradling the objective.

Brown is the most recent messenger in a parade of writers I’ve been sharing here. Zvi Mowshowitz, Ben Recht, C .Thi Nguyen, Dan Davies, James C. Scott. Each one is touching a different part of the corruption-of-metrics elephant, whether it’s malice or incompetence or coordination failure.

Scott’s critique of modernism and its high-minded faith in optimization bridges the hubris of retro-futuristism to these voices warning us today. But the interview with Brown was alarming not because the examples he presents were defined, not by hubris, but by feckless apathy.

Retro-futurism was at least optimistic. But today’s failures are like forfeits because nobody felt like waking up for the morning game. Meh, there’ll be another one next week, and nobody will care who wins that one either.

“Hey, we’re going to Mars!”

“What’s the difference if I have to go with you?”

Despite our ascendant progress in science and mechanics, the human psyche starts at zero with every birth. An interminable game of Trouble with the pop-o-matic® bubble bonking every generation back to the home base.

The tension you feel “in the room” is that we have come so far and yet remain in the same place. The battle for hearts and minds on both sides of the argument will be fought with McNamara-esque precision. Countable, listable, sortable.

You’ll be a little more awake for it if you consider what Brown saw when he stopped to get a better look.

Delta-hedged risk reversals

We recently added multi-leg support to our Attribution Visualizer, our tool for allowing you to track an option contract’s p/l assuming you hedged the delta daily. The tool breaks out the p/l according to gamma + theta (which sum to realized p/l) and to implied vol (vega p/l).

With multi-leg support, you can now entertain yourself with countless questions. Like “how would a masochistic skew trade work out if I trade a risk reversal and hedge daily?”

I ran a few risk reversals through the attribution tool.

USO: Buy call/sell put after the Iran war started

Date: March 13

Expiry: June 18, 2026 (~ 3 months)

Spot: $119.92

Risk reversal: 140c / 100p (equidistant strikes ~ each 17% OTM)

Initial hedge: Short 73 shares per risk reversal (the RR had .73 delta)

The war had already flipped the skew hard toward upside strikes. The $140 call traded 94% vol against the $100 put’s 83% IV. It cost $5.83 in option premium.

At expiration, the stock expired at $114.87

So how did it work out to buy the premium IV?

moontower.ai
moontower.ai

Not good. The cumulative delta-hedged p/l was a loss of over $4.50 as you lost to both realized vol and vega. At the initiation of the trade, paying the premium vol meant you were flattish gamma but paying theta.

You were also long vega because, despite the options being equidistant, at a generally elevated vol level the lognormality of the underlying distribution and its associated positive skew pumps up the delta of calls. In fact, the 140 call was ~.47 while the 100 put, which is closer in dollar space, was only .27d. The higher call delta says the 140 strike is much “closer in vol space”. That’s why the equidistant risk reversal cost so much premium to buy the call. You are buying at OTM that has a delta that we usually associate with near ATM options!

Let’s adjust the strikes so that our call and put are both ~.25d

To equalize deltas against the $100 put you have to buy…drum roll please…

The $190 call! 58% OTM for 101% IV. Now you collect a $2.17 credit to own the call and short the 100 put. Your initial Greeks mostly vanish.

The trade still loses, but it fares much better as the loss is only $1.29.

It’s tempting to conclude paying a premium vol doesn’t work. But if you bought the much cheaper call and shorted the put on a hedged riskie in SPY before the war started, then you got smoked if you chose April 30th expiry (SPY bottomed the last day of Q1), recovered once the market started rallying, only to lose again as the market…continued rallying! SPY riskie:

moonotwer.ai

I’ve said it repeatedly over the years in different ways, but riskies are the whips and leather of the option world. If you bought the call on the SPY Feb 720/650 risk reversal on the first trading day of the year and hedged daily until expiration, you actually would have lost $.25 despite the following:

  • the trade collected about $2.75 in premium at the outset
  • the stock’s closing prices stayed inside the range of $675-$700
  • the call you bought was 10.2% IV and the put you sold was 16.8% IV
moontower.ai

In Financial Hacking, Philip Maymin invents an optimistic junior trading assistant who sits down his bosses at the bank to explain that he has found an infinite money machine. Selling the high IVs in SPY puts and buying the cheap IV in SPY calls. Maymin asks the reader to figure out why this logic doesn’t work.

Our tool provides the day-by-day audit which feeds the charts. Armed with that, Claude does an admirable job of not only answering Maymin’s prompt to the reader but also pinpointing exactly which days carry the biggest weight in the answer.

VIX and buy signals

Here’s Victor Haghani:

A high VIX1 is widely considered to be one of the cleaner buy signals out there. A recent piece in The Financial Times made the case directly: when the VIX climbs above 30, forward returns have been well above average, positive most of the time, with double-digit six-month gains.

The Financial Times case is “buy the f’n dip” logic with a VIX gate. It’s exactly the type of thing that a layreader numbly nods at when the SPX is sitting near an all-time high. The Financial Times’ case is lazy from the perspective of both investors and active traders. For the investor, it’s just survivorship bias. Knowing what we know now every pullback has just presented a bargain. The market literally “going on sale” like it’s Prime day. VIX spikes over 30 just coincide with the sales.

The question you care about is one that an active trader hearing that statement would think to hypothesis test. Given that buying any time before an all-time-high has been worked out well, how do I distinguish between relatively better or worse buys?

Back to Victor:

What that leaves out is risk. Buying the spike means taking on a lot more of it, and the strategies that did the opposite, trimming exposure when fear ran high, held up better. So the popular signal may have it backwards.

Raw returns aren’t the right thing to optimize. You care about compounded returns since investing is a repeated game. Compounded returns are risk-adjusted returns because a geometric growth process penalizes volatility.

Elm Wealth tests FT’s claim not on raw return but Sharpe Ratio, or how much return you’re getting per unit of risk taken, as the variable to maximize if we care about risk-adjusted returns.

When Fear Spikes, Should You Buy? Elm Wealth | 5 min read

What they found when they ran the numbers on S&P 500 and VIX data from 1990–2026, they found:

  • A plain static stock/T-bill portfolio: Sharpe ratio of 0.50
  • A strategy that buys more when VIX > 30% (the popular advice): 0.47 which is slightly worse than the null case
  • A strategy that reduces exposure when VIX is high (inverse sizing): 0.54
  • A simple momentum strategy (cut exposure when the market is falling, which is typically when VIX is elevated): 0.59 — the best performer

It’s always bears repeating how risk scales:

When volatility doubles, the risk of holding stocks is actually four times as large (because variance, not standard deviation, is what matters to risk).

To merely hold your position when VIX doubles, expected returns would need to quadruple. To justify doubling down, they’d need to increase eightfold, which the authors deem practically implausible.

This post led to some smart quants chiming in on X.

Here’s @ptuomov:

VIX AND EQUITY WEIGHT

The correct time to take more equity risk is when VIX has been high for six months but has been trending down. The correct time to take less equity risk is when VIX has been low for six months but has been trending up.

The target equity weight is then proportional to the target equity risk divided by VIX. Therefore, at most times, low VIX corresponds to high equity weight and high VIX to low equity weight.

This is a very low-resolution statement because each word represents many variable choices when you get into research:

Define “high”, define “trending”, “six months” was probably just a placeholder term

The degrees of freedom on the choice notwithstanding, the idea makes sense:

You are using the signals from the derivatives market, a place where leverage attracts early movers and smart money, to give a leading indicator on “the market environment is changing from the status quo” and collective anchoring biases make the wider market underreact. The way to profit from the seeds of this new information is to follow the trend.

There’s that line what the wise man does in the beginning, the fool does in the end.

The quant view is trying to find the signal of moving from the end of one cycle to the beginning of another. Trend following in a sense has a long option flavor. The premium is all the false starts and the payoff is when you finally catch a trend.

Meanwhile, buying the dip is a short option strategy in that it is betting on mean reversion as opposed to further divergence. Buying stock when VIX spikes is a mean reversion trade. But when you examine that as a strategy from the vantage point of all-time highs, it takes for granted that the mean is a good thing.

When you read a claim about a course of action, it’s good mental hygiene to first triage it as: is this directionally long or short vol?

Moontower #319

In this issue:

  • free lunches and non-tradeoffs
  • VIX and buy signals
  • delta-hedged risk reversals

Friends,

As one of my favorite HS teachers used to say, every silver lining has a cloud. (That this is one of my favorite teachers, you could probably predict my teenage affection level for rainbows and pop music). It seems I was destined to take to the idea of no free lunch easily.

Costs and Benefits

Trader and author Brent Donnelly, like most of us, struggles with the drawbacks of the otherwise transformative tech packed into our smartphones.

I Want It, But I Don’t Like It | 8 min read

The shocking and amazing thing about the unprecedented economic success of surveillance capitalism is how easily many of us (including me) surrendered to the extraction layer without much of a thought or a fight.

It’s a great example of what DFW called our default groove or “water”. That he’d spend the commencement speech warning us about lapsing into zombie mode BEFORE the smartphone was even invented indicates just how hard it really would be to overcome infinite scroll.

The short book I most commonly recommend to people is Neil Postman’s lengthy essay Amusing Ourselves To Death (my notes). It was published in 1985. My edition as a prophetic foreword:

We were keeping our eye on 1984. When the year came and the prophecy didn’t, thoughtful Americans sang softly in praise of themselves. The roots of liberal democracy had held. Wherever else the terror had happened, we, at least, had not been visited by Orwellian nightmares.

But we had forgotten that alongside Orwell’s dark vision, there was another – slightly older, slightly less well-known, equally chilling: Aldous Huxley’s Brave New World. Contrary to common belief even among the educated, Huxley and Orwell did not prophesy the same thing. Orwell warned that we would be overcome by an externally imposed oppression. But in Huxley’s vision, no Big Brother is required to deprive people of their autonomy, maturity, and history. As he saw it, people will come to love their oppression, to adore the technologies that undo their capacities to think.

What Orwell feared were those who would ban books. What Huxley feared was that there would be no reason to ban a book, for there would be no one who wanted to read one. Orwell feared those who would deprive us of information. Huxley feared those who would give us so much that we would be reduced to passivity and egoism. Orwell feared that the truth would be concealed from us. Huxley feared the truth would be drowned in a sea of irrelevance. Orwell feared we would become a captive culture. Huxley feared we would become a trivial culture, preoccupied with some equivalent of the feelies, the orgy porgy, and the centrifugal bumblepuppy. As Huxley remarked in Brave New World Revisited, the civil libertarians and rationalists who are ever on the alert to oppose tyranny “failed to take into account man’s almost infinite appetite for distractions.” In 1984, Huxley added, people are controlled by inflicting pain. In Brave New World, they are controlled by inflicting pleasure. In short, Orwell feared that what we hate will ruin us. Huxley feared that what we love will ruin us. This book is about the possibility that Huxley, not Orwell, was right.

Brent offers his Easy, Medium, Hard interventions to combat his phone. I share the struggles and have had with various levels of success tried many of these myself.

While the article is ultimately practical, I appreciated Brent’s abstract observation that the phone has both an extraction layer designed to monetize your attention as well as an agnostic technological utility layer (phone, camera, processing). His strategy is to minimize the former while maintaining the benefits of the latter. In other words, this is not the realm of a tradeoff.

In The Sydney Opera House Exam Question Dan Davies writes:

I find that the language of tradeoffs is often used in a rather bullying way. If you listen to people who are objecting to something, it’s rare that they don’t understand that there are tradeoffs in policy. They just don’t think it’s worth it. Or they think that the costs are falling disproportionately on them for benefits that go somewhere else. People think that they are sounding wise when they say that “the public want nice things but don’t want to pay for them”. But that’s just what the words “nice things” and “paying” mean. Everyone wants nice things, and nobody wants to pay, they used to teach you this when you did an economics degree.

You are almost certainly not at the efficient frontier of managing your phone’s costs and benefits.

So there must be a free lunch after all. Check out Brent’s interventions.

Accelerated upskilling

Wednesday’s oh well included some links about learning and upskilling. Here’s another one I’ve come across since:

How to ‘git gud’ at Games (Faster Than Everyone Else) | 4 min read

This is from SIG’s gaming blog.

“One of the least efficient ways to improve at a game is simply playing it.”

In our latest gaming blog, Adam, a competitive gamer who has reached Master rank with all races in StarCraft II, cracked the top 50 in North America in Hearthstone Battlegrounds, and is currently ranked #1 in the world in Patchwork on BGA, looks at how you can “git gud” at games (faster than everyone else, of course).

It offers 5 tips to accelerate learning. Actually, “tips” is a flaccid description of Adam’s suggestions. They are the difference between the preparation of amateurs and pros in any skill-based activity. It’s more like an advantage loop. Combining it with talent (which is why matching your activities to your abilities is so important) and persistence is a very simple recipe to achieving rare outcomes.

I didn’t say easy. Just simple.

Maxen-Art

This past weekend I stood up a website for 10-year old to host his art. In the age of AI this is easy even without a website builder.

I bought the domain name on Namecheap, Max found gallery sites he liked that were minimalist, and I told Claude to mimic the format. The HTML is produced is hosted on Github along with a folder where we upload his images. Vercel is the host serving the webpage. There is an automatic webhook from Git to Vercel so that anytime Git updates, Vercel updates the page.

🔗maxen-art.com

 

Money Angle

Here’s Victor Haghani:

A high VIX1 is widely considered to be one of the cleaner buy signals out there. A recent piece in The Financial Times made the case directly: when the VIX climbs above 30, forward returns have been well above average, positive most of the time, with double-digit six-month gains.

The Financial Times case is “buy the f’n dip” logic with a VIX gate. It’s exactly the type of thing that a layreader numbly nods at when the SPX is sitting near an all-time high. The Financial Times’ case is lazy from the perspective of both investors and active traders. For the investor, it’s just survivorship bias. Knowing what we know now every pullback has just presented a bargain. The market literally “going on sale” like it’s Prime day. VIX spikes over 30 just coincide with the sales.

The question you care about is one that an active trader hearing that statement would think to hypothesis test. Given that buying any time before an all-time-high has been worked out well, how do I distinguish between relatively better or worse buys?

Back to Victor:

What that leaves out is risk. Buying the spike means taking on a lot more of it, and the strategies that did the opposite, trimming exposure when fear ran high, held up better. So the popular signal may have it backwards.

Raw returns aren’t the right thing to optimize. You care about compounded returns since investing is a repeated game. Compounded returns are risk-adjusted returns because a geometric growth process penalizes volatility.

Elm Wealth tests FT’s claim not on raw return but Sharpe Ratio, or how much return you’re getting per unit of risk taken, as the variable to maximize if we care about risk-adjusted returns.

When Fear Spikes, Should You Buy? Elm Wealth | 5 min read

What they found when they ran the numbers on S&P 500 and VIX data from 1990–2026, they found:

  • A plain static stock/T-bill portfolio: Sharpe ratio of 0.50
  • A strategy that buys more when VIX > 30% (the popular advice): 0.47 which is slightly worse than the null case
  • A strategy that reduces exposure when VIX is high (inverse sizing): 0.54
  • A simple momentum strategy (cut exposure when the market is falling, which is typically when VIX is elevated): 0.59 — the best performer

It’s always bears repeating how risk scales:

When volatility doubles, the risk of holding stocks is actually four times as large (because variance, not standard deviation, is what matters to risk).

To merely hold your position when VIX doubles, expected returns would need to quadruple. To justify doubling down, they’d need to increase eightfold, which the authors deem practically implausible.

This post led to some smart quants chiming in on X.

Here’s @ptuomov:

VIX AND EQUITY WEIGHT

The correct time to take more equity risk is when VIX has been high for six months but has been trending down. The correct time to take less equity risk is when VIX has been low for six months but has been trending up.

The target equity weight is then proportional to the target equity risk divided by VIX. Therefore, at most times, low VIX corresponds to high equity weight and high VIX to low equity weight.

This is a very low-resolution statement because each word represents many variable choices when you get into research:

Define “high”, define “trending”, “six months” was probably just a placeholder term

The degrees of freedom on the choice notwithstanding, the idea makes sense:

You are using the signals from the derivatives market, a place where leverage attracts early movers and smart money, to give a leading indicator on “the market environment is changing from the status quo” and collective anchoring biases make the wider market underreact. The way to profit from the seeds of this new information is to follow the trend.

There’s that line what the wise man does in the beginning, the fool does in the end.

The quant view is trying to find the signal of moving from the end of one cycle to the beginning of another. Trend following in a sense has a long option flavor. The premium is all the false starts and the payoff is when you finally catch a trend.

Meanwhile, buying the dip is a short option strategy in that it is betting on mean reversion as opposed to further divergence. Buying stock when VIX spikes is a mean reversion trade. But when you examine that as a strategy from the vantage point of all-time highs, it takes for granted that the mean is a good thing.

When you read a claim about a course of action, it’s good mental hygiene to first triage it as: is this directionally long or short vol?

Money Angle For Masochists

We recently added multi-leg support to our Attribution Visualizer, our tool for allowing you to track an option contract’s p/l assuming you hedged the delta daily. The tool breaks out the p/l according to gamma + theta (which sum to realized p/l) and to implied vol (vega p/l).

With multi-leg support, you can now entertain yourself with countless questions. Like “how would a masochistic skew trade work out if I trade a risk reversal and hedge daily?”

I ran a few risk reversals through the attribution tool.

USO: Buy call/sell put after the Iran war started

Date: March 13

Expiry: June 18, 2026 (~ 3 months)

Spot: $119.92

Risk reversal: 140c / 100p (equidistant strikes ~ each 17% OTM)

Initial hedge: Short 73 shares per risk reversal (the RR had .73 delta)

The war had already flipped the skew hard toward upside strikes. The $140 call traded 94% vol against the $100 put’s 83% IV. It cost $5.83 in option premium.

At expiration, the stock expired at $114.87

So how did it work out to buy the premium IV?

moontower.ai
moontower.ai

Not good. The cumulative delta-hedged p/l was a loss of over $4.50 as you lost to both realized vol and vega. At the initiation of the trade, paying the premium vol meant you were flattish gamma but paying theta.

You were also long vega because, despite the options being equidistant, at a generally elevated vol level the lognormality of the underlying distribution and its associated positive skew pumps up the delta of calls. In fact, the 140 call was ~.47 while the 100 put, which is closer in dollar space, was only .27d. The higher call delta says the 140 strike is much “closer in vol space”. That’s why the equidistant risk reversal cost so much premium to buy the call. You are buying at OTM that has a delta that we usually associate with near ATM options!

Let’s adjust the strikes so that our call and put are both ~.25d

To equalize deltas against the $100 put you have to buy…drum roll please…

The $190 call! 58% OTM for 101% IV. Now you collect a $2.17 credit to own the call and short the 100 put. Your initial Greeks mostly vanish.

The trade still loses, but it fares much better as the loss is only $1.29.

It’s tempting to conclude paying a premium vol doesn’t work. But if you bought the much cheaper call and shorted the put on a hedged riskie in SPY before the war started, then you got smoked if you chose April 30th expiry (SPY bottomed the last day of Q1), recovered once the market started rallying, only to lose again as the market…continued rallying! SPY riskie:

moonotwer.ai

I’ve said it repeatedly over the years in different ways, but riskies are the whips and leather of the option world. If you bought the call on the SPY Feb 720/650 risk reversal on the first trading day of the year and hedged daily until expiration, you actually would have lost $.25 despite the following:

  • the trade collected about $2.75 in premium at the outset
  • the stock’s closing prices stayed inside the range of $675-$700
  • the call you bought was 10.2% IV and the put you sold was 16.8% IV
moontower.ai

In Financial Hacking, Philip Maymin invents an optimistic junior trading assistant who sits down his bosses at the bank to explain that he has found an infinite money machine. Selling the high IVs in SPY puts and buying the cheap IV in SPY calls. Maymin asks the reader to figure out why this logic doesn’t work.

Our tool provides the day-by-day audit which feeds the charts. Armed with that, Claude does an admirable job of not only answering Maymin’s prompt to the reader but also pinpointing exactly which days carry the biggest weight in the answer.

I’m excited about the tool even though using it feels like performing surgery on myself. Which weirdly reminds me, I have an option trivia question for readers who made it this far:

POLL

What is a gut strangle?

a strangle without a delta hedge
a strangle with ITM calls and puts
a strangle spanning 2 expiries
a strangle traded before earnings
a strangle spanning 2 underlyings
19 VOTES · 20 HOURS REMAINING · SHOW RESULTS

Moontower.ai note

We will wire up the attribution function to the Moontower API which the MCP can also access so you bulk study multi-leg delta-hedged trades.

We are in the midst of a large round of discussions with traders, brokers, and advisors ahead of our next wave of expansion. Reach out if you want to discuss your workflows to see if we can help you make better or faster decisions.

Stay groovy

☮️

Moontower Weekly Recap

The Scaling Laws of Risk-Reduction

In a misconception about harvesting volatility, you learn that you do NOT need to scalp the gamma to isolate the vol of an option trade.

If you buy options implying a daily vol of 2% per day and it moves 4% per day, your expectancy is positive regardless of whether you hedge or not. That doesn’t mean you will win any more than it means you will win if you flip a fair coin and receive 2-1 odds. You have made Sklansky bucks, not necessarily real bucks.

RIP Sklansky

Hedging reduces the p/l variation around the expectancy.

In Financial Hacking, Philip Maymin explains

The inability to hedge perfectly continuously impacts your trading by introducing random risk. This risk decreases if you hedge more frequently, but only as fast as the square root. Therefore, if you want to halve your risk, you have to hedge four times as often.

He makes this tangible and practical when he says:

Noise from hedging a one-year option on a daily basis instead of continuously is about the same as one volatility point. If you make one volatility point in expected profit and the standard deviation of your profit is one volatility point, then your Sharpe ratio is about one.

His final point echoes my argument that a requirement to hedge to isolate vol is a misconception:

The risk from not hedging continuously can be diversified away.

I built a simulator so you can see this scaling law in action.

An oblique insight can be witnessed if you set up the simulation with negative expectancy, ie pay 24% vol for a stock that realizes 20%. The more you hedge the more certain you lock in negative expectancy.

Doug Costa actually showed that happen in the toy example above. The investor who bought the 110 calls based on the real-world probability but then hedged by shorting the mispriced security actually assured themselves of a loss.

If you have no edge, variance is your friend. Not financial advice.

🎮Moontower Discrete Hedging Simulator

on the corruption of school grades

A few quick hits on the topics of education and learning.

Childhood and Education #18: Do The Math | 15 min read

So this happened at UCSD:

In the fall of 2020, 32 students took Math 2. In the fall of 2025, fully 1,000 students had math placement scores so low they would need it.

Oh. Well, then. That’s 12% of students at UCSD. Who all failed math, then?

Reviewing test results like these, you would expect transcripts full of Cs, Ds, or even failing grades. But alarmingly, these students’ transcripts did not even reflect profound struggles in math. Mostly, they were students whose transcripts said they had taken advanced math courses and performed well.

“Of those who demonstrated math skills not meeting middle school levels,” the report found, 42% reported completing calculus or precalculus.

… The students were broadly receiving good grades, too: More than a quarter of the students needing remedial math had a 4.0 grade point average in math. The average was 3.7.

Year after year, they fall farther behind, and it becomes more and more impossible for any teacher to admit that the students cannot do math and grade accordingly — since that would ruin the kids’ GPAs and college prospects. In this manner, they may make it all the way to college before they find out that they can only do math at a middle-school or sometimes an elementary-school level.

Oh. Well, then. The whole math educational system is a fraud. Once the SAT and ACT were eliminated as requirements for the UC system in 2020, there was no, as Kelsey puts it, ‘reality check’ on any of it, and that was that.

One observer said:

These kids were not doing anything wrong. They were lied to. They were told that they were prepared for classes they were not prepared for. They were told that they were excelling in classes that they were not excelling in. They deserved better.

Zvi isn’t going to let students’ convenient pleas of ignorance go unaccountable. And he’s right. The whole problem, and this sure feels like it goes on beyond math these days, is there is no accountability. It’s almost like the “too big to fail” virus spawned in 2008 infects every giant mass of human coordination effort with a “oh well” shrug of learned helplessness resignation. Home insurance doesn’t work in CA? Oh well. Guess you’ll just have to be rich enough to self-insure or sweat it out. Don’t have the attention span to read a book because short-form video fried the GFI in your brain? Oh well, guess you need parents who have enough discipline and bandwidth to fight you hard enough so you don’t log 12 screen time hours on a Saturday. Can’t do long division? Oh well, what do you need that for when robots are the future.

[I ended up titling this post “oh well” which compelled me to look up the Fleetwood Mac blues rock tune of the same name that’s often covered by guitarists. I forgot it had a distinct call and response structure and apparently I subconsciously had that bleed into how I wrote that section. Oh well I guess.]

Zvi:

I would love to not also blame the kids in all this, but that’s kind of nuts? If you can’t do the most basic math questions, and there’s an AP test at the end that almost no one in class even bothers taking, and you’re somehow opting out of every objective standardized test for math, how can you possibly actually think you’re passing Calculus for real?

Justin Skycak:

This isn’t just a UCSD problem. It’s even playing out at Harvard. Yeah, Harvard. The most prestigious university in the USA and maybe even the world. Last year they had to add remedial support to their entry-level calculus courses.

It should not be so difficult to select a Harvard class that is ready for Calculus. If the school that is the first choice of half of students can’t do it, then that is their choice.

Zvi’s post is about education, not to be confused with, umm, learning.

While the lower 99% get hollowed by accepting the unaccountable default programming, there’s never been more opportunities to avail yourself the ability to learn.

I’d rather share stuff in that vein rather than rolling the same complaints uphill.

Here’s Scott Young, author of Ultralearning, and one of my favorite resources on the topic of learning broadly:

Why I’m Skeptical About Efforts to Revolutionize Schooling | 9 min read

Whenever we have high-quality evidence that rigorously compares two teaching methods, the research invariably favors strong, direct instruction plus practice. Or, in other words, the exact stereotype of schooling that so many of the people asking me about school reform despise.

A “better” school probably looks more like the stereotype of an old-fashioned schoolhouse with kids sitting at desks, drilling facts and concepts that are patiently explained by a teacher. To the extent that school becomes more like free play, project-building or acting like a scientist, it will probably be worse.

Quantity has a quality all its own, and with enough well-integrated knowledge the result is expertise that seems almost magical to those who don’t possess it.

It all rhymes with Justin’s treatise on learning which I condensed and re-factored into:

🎓Principles of Learning Fast

And finally for today, this is a good lesson by PhD Benjamin Keep who researches and writes about learning. He explains a powerful study shwing the value of breaking a complex skill into sub-skills, focusing on them deliberately and in serial, only to watch your general ability improve at the complex super-skill. Learning is a lot of wax-on, wax-off. It was quaint to Ralph Macchio’s ears. Now we have all but forgotten.