2 quick thoughts:

1. I spoke to a quant investing club at Cal this past week. Lots of seniors in the room so the one bit of advice I wanted to make sure I left them:

   Optimize for learning when choosing your first job. 2 components to this:

   a) Mind your inputs

   Specifically, surround yourself with the best people you can both in terms of character/courage and ability). Your environment will shape you (tyrannically so — its incentives, values, and culture will be absorbed) so make sure you are deliberate in choosing one.

   b) Get to having real responsibility as fast as possible

   Responsibility = risk and risk accelerates learning. A little more responsibility than you think is appropriate will stretch you — if you want to rise to that you likely will. If you don’t feel stretched, even if you’re making good money, the human capital part of your ledger is being docked. Rest-and-vest attitudes are deceptively expensive in the long run — don’t ever adopt one in your 20s and 30s (and probably not after that either).

2. Paul Bloom, from his chat with Russ Roberts, on chosen suffering:

   I think there’s a wise point there, which is: one of the — it may be the major theme of my book — is about the importance of chosen suffering. I have a very different opinion about unchosen suffering, we can talk about that. The importance of choosing suffering as part of a good life is, I think, the projects that make life worth living involve suffering. We often know this ahead of time. And, having kids is such an example. For one thing having kids, at least for me–maybe I’m prone towards anxiety–is really an experiment in feeling mild dread for the rest of my life. Loving such fragile creatures–and they remain fragile even into their 20s — it is like there is a hangman’s noose sitting around your neck all the time. And then they will separate from you. If you do it right, if you are lucky, and if you do it right, these creatures that you love and devoted your life to, will leave you. And, actually, if you do it right they will think a lot less about you than you will think about them, because they’re into their own lives. It’s such a perverse project. And I think it’s a very human one.

   Russ Roberts: Yeah. I agree with that, obviously. What you said reminds me of a quote I heard from Elizabeth Stone. It’s the following: ‘Making the decision to have a child–it is momentous. It is to decide forever to have your heart go walking around outside your body.‘ I thought that captured the kind of anxiety you’re talking about there.

   [Kris — choosing responsibility is a form of chosen suffering. But it’s so obviously a privilege. I am tediously dramatic about this — the kids and I were bringing in the garbage bins to the tune of their whining and I banged them over the head with “you should be happy you get to do this…would you rather not have legs and not be able to be helpful?” I wish I uttered a more sensitive example on the spot but that’s what happened.]

Money Angle

I added another post to this Moontowermoney.com series:

Checkpoint: Risk Tolerance (moontowermoney.com)

Full post:

In a Word About Goals and Risk is unavoidable. Let’s get to the good news, we established 2 cornerstone axioms:

Risk is personal

If you need ransom money by Friday betting your savings on a hand of blackjack or borrowing cash from a loan shark become prudent alternatives in light of your singular goal.

On the other hand, a comfortable person who risks what they need for something they merely want is setting themselves up for failure. Even if the gamble pays off, that decision pattern eventually catches up with them.

Doing the inner work to distinguish “need to haves” from “nice to haves” is a personal exercise. Looking over the fence at your neighbor leads to miswanting and disappointment. We cannot fully see what practical and mental constraints others have that lead to their choices. You must ruthlessly “do you”.

A bright side of personal investing is that it is solitaire. You do not need to worry about competitors the way professional investors do. Professionals are compared to benchmarks which introduces tracking error risks (”why are you only up 8% when the SP500 is up 11%?”) and path dependency. Employees are more likely to browse LinkedIn job boards when you don’t keep up, which aggravates your competitive position further.

💡The personal investor is unburdened by the expectations of others

Risk is unavoidable

Examples of this reality:

• If you don’t invest your cash its purchasing power will erode. In the past 100 years, cash has lost >95% of its value. Not investing is surrendering to an inevitable, maybe slow, but quite inevitable loss.

• If you do invest, you open yourself to the possibility of a faster loss. This is true in both nominal and real (ie adjusted for inflation) terms. In the 21st century alone we’ve seen sharp drawdowns from the Dot Com bubble, the 2008 GFC, and the covid pandemic in 2020. Drawdowns of these magnitudes, while rare, are inevitable and part of the investing experience. As Meb Faber shows, this is true even in real terms:

• The trade-off between “failing fast” and “failing slow” shifts as you age. If you lose 40% of your assets at age 24 you have your whole adult life to recover. If you’re in your 60s such a sharp loss could impair your standard of living throughout retirement. This is commonly referred to as sequence of return risk. It’s the basis of “glide paths” that slip your investment mix from higher to lower risk holdings as you age.

Wrapping Up With Helpful Framings

By now we have laid out the nature of markets as well as the investing “problem”. The strategy we employ needs to be well-matched to our risk tolerance. Investment returns are carrots for us to take risk and solve our “problem”. There is no way to fully remove risk from a strategy but we can imagine a frontier of strategies that require lesser units of risk for the same potential reward. For example, if a fair coin flip offered 2-1 odds then this is a great investment. But if you bet all your money on it you turn this great investment into one that is not worth the risk since losing all your money is not an acceptable outcome.

💡We want to avoid strategies that are inferior with respect to our goals

Our tolerance for risk is a personal function of our emotions and our stated goals. Financial advisors try to match their approach to a client’s risk appetite with questionnaires such as the Grable & Lytton Risk Assessment (link). A common though cynical take is such gauges are more about covering their liability than actually zeroing in on risk tolerance. A charitable view is that asking someone to predict how they’d feel if their account lost 25% is a doomed exercise from the start. We are not Vulcans capable of such reasoned foresight.

When it comes to goals, the problem is more tractable, especially for near-term objectives. If you are saving for a down payment on a house in the next few years, you can compare your savings rate to the fluctuations of your account to decide how much risk is reasonable. If you have $450k saved for a $500k down payment and you are able to save $25k per year, then if you took no risk you are about 2 years from affording a home. If you invest the $450k in BTC you could lose many years worth of savings in a single swoop. You should match your the riskiness of your investments to what you consider a “need to have” vs a “nice to have”. A common sense approach is a robust balance between being simple enough and effective enough.

When it comes to personal finance, optimization suffers from garbage-in, garbage-out problems. The idea is not to make perfect the enemy of the good. It’s to find an approach that mostly works that you can stick to. It is easy to get bogged down in FIRE-esque micro-budgeting or dazzled by promises of easy money in rental properties or option selling. But before you even consider an investing strategy, it’s critical to establish your goals for both your wealth and your time. If eeking out an extra 1% on a $500k portfolio takes 100 hours, you are working for $50/hr with no guarantee that you are focused on the right levers.

2 qualitative frameworks that can help define your investment mission:

• Jeff Bezos’ regret minimization framework Imagine you are old or at your funeral looking back in time. What did you want to give the world or your family? What would you regret not having done? The idea is simple — don’t take risks that close those doors. Structure your life so you can take the risks that open those doors. The key to this is defending your aspirations with a mix of personal courage plus resistance to distraction and comparison.

• Venkatesh Rao’s fixed point futurism This is the antidote to the inherent spreadsheet nihilism of efficiency, optimization, and “paper-clip maximization”. It is deeply personal.
  • Fixed-point futurism is related to the idea of inventing the future rather than predicting it…It’s simple: don’t make plans, choose fixed points. Choose one thing to make true, force to be true, about the future. Something that is likely to be within your control, no matter how the future plays out. Something that isn’t rationally derived from something else more basic, but is sort of arbitrary and self-defining. It sounds silly, but it’s really amazing how such small assertions of personal agency, far short of putting a “ dent in the universe ” can magically make life feel more meaningful. You’re arbitrarily using your life to declare that futures, where you wear blue shirts, are better than ones in which you don’t. Many people intuitively do fixed-point futurism. In fact, in the U.S ., the so-called American Dream has historically been based on the standard fixed point of homeownership. As in, “no matter what happens in the future, I’ll be a homeowner. ” A way to understand fixed-point futurism is to think of it as a priceless commitment. No matter what happens, and no matter what else goes wrong or off-the-rails in weird ways, you’ll make sure one thing goes really, really right, even if you have to go crazy making sure it does. The nice thing about fixed-point futurism is that you don’t have to worry about tradeoffs. You don’t have to constantly revisit cost-benefit analyses. You don’t have to worry about competing priorities. The fixed point is priceless, so you can commit to it without knowing lots of important things about the future.
  • This type of thinking says “I’m going to play in a band even if there’s no reward. I just want to do it”. It could mean taking an insurance policy knowing that no matter what your kids will have X even if it’s not as “smart” as self-insuring the future via a separately managed investment account. A reckless person can use fixed-point thinking to rationalize poor decisions, but overly analytical people can benefit from pulling their noses out of Excel to think more approximately. The whole “it’s better to be roughly right, than precisely wrong” thing.

🔗Learn More

• Newfound Research’s Failing Slow, Failing Fast, and Failing Very Fast (Link)

• Nick Maggiulli’s A Change in Perspective (Link)

• Alpha Architect’s Even God Would Get Fired As An Active Manager (Link)

• Venkatesh Rao on Fixed Point Futurism (Link)

Money Angle For Masochists

I knocked out Euan Sinclair’s Positional Option Trading in a few hours which is to say much of it overlapped with my own knowledge. It takes the approach professionals start with but adapts it to the constraints of retail (you probably aren’t delta-hedging for example).

You can see my notes:

Positional Option Trading by Sinclair (Moontower)

I want to direct your attention, especially to these 10 points (emphasis mine):

1. “Option pricing models don’t really price options. The market prices options through the normal market forces of supply and demand. Pricing models convert the market’s prices into parameters.”
2. If we pay the wrong implied volatility level for an option, we might still make money, but we would have been better off replicating the option in the underlying.
3. Risk premiums versus inefficiencies discussion from chapter 2

   [Kris: I appreciate how Sinclair attempts to categorize each source of edge as either a risk premium or inefficiency. He’s also candid about the difficulty in categorizing some of them, but the thought process is useful to observe for understanding what kind of evidence he needs to sort the edge.]

   1. A risk premium is earned as compensation for taking a risk. If the premium is mispriced, it will be profitable even after accepting the risk. A risk premium can be expected to persist, as the counterparty is paying for insurance against the risk.
   2. In contrast, inefficiency is a trading opportunity caused by the market not noticing something. An inefficiency will last only until other people notice it.
   3. Differentiating a risk premium from an inefficiency can be challenging.
4. Behavioral explanations can be used as part of a checklist for why an inefficiency might exist. For example, together with historical data and a theory of underreaction, one can have enough confidence that post-earnings drift is a real edge. The data suggests the trade, but the psychological reason gives a theoretical justification.
5. In the long term, values are related to macro variables such as inflation, monetary policy, commodity prices, interest rates, and earnings. These change on the order of months and years. Worse still, they are all codependent. A better way to think of market data might be that we are seeing a small number of data points that occur a lot of times. This makes quantitative analysis of historical data much less useful than is commonly thought. [Kris: This is the old “Thinking in N not T” where we recognize that samples drawn from the same regime reduce N. This is also why I think the concept of attractor landscapes is important.]
6. Calendar spreads have a similar payoff diagram to a butterfly at the expiration of the front-month option. [Kris: This intuition can guide one’s thinking about how the skew in the front month relates to the slope of the term structure]
7. A method for choosing the strike to sell [Kris: paraphrasing Sinclair in my own lingo: choose the strike that has the greatest dollar premium to a flat vol surface (as opposed to the highest vol, which will correspond to a low premium option)
8. Despite views to the contrary, skew trades are not particularly useful for speculating on the movement of the implied skew itself. The fluctuations in implied skew are dwarfed by the effects of stock movement and the level of implied volatility. [Kris: I’ve said this before and strongly agree. Sinclair offers a math justification based on the order of magnitude comparing Greeks]
   1. Skew trades might make more sense with longer-dated options that have more vega and less gamma, but the skews are also more stable. It’s possible to make money with this trade, but the edge is likely overwhelmed by noise.
   2. Ratio trades have all the same problems mentioned with skew trades and are an even worse vehicle for trading. An idea that isn’t very good to start with. [Kris: In my opinion, risk reversals and ratio spreads are “path trades” and should be framed as bets on spot/vol correlation. In fact, a great demonstration of this point is the challenge of calibrating your delta in the presence of strong spot/vol correlation. Actually, buying the ratio to sell the single skewed option, which will have a higher skew premium in dollar, not vol, terms could be a better expression of the skew trade!]
9. Stops don’t just stop losses. They drastically change the shape of the return distribution and can lower the average return. Adding stops won’t transform a losing strategy into a winning strategy. The only reason that we would add a stop is that we prefer the shape of the stopped distribution.
10. A position should be exited when we are wrong. Sometimes this will coincide with losing money. In this case, a stop is harmless. But sometimes losing money corresponds to situations for which we have more edge. Here, a stop is actively damaging and contrary to the idea behind the strategy. [Kris: Fully agree and why I believe in risk rules that are independent of P/L for option trading. Instead, focus on ex-ante risk shocks].

From My Actual Life

I’m introducing the boys to the first 2 Terminator movies and they are into it (we are about halfway through the first movie. We put them to bed last night right after Arnold removes his eye and dons the Gargoyle shades for the first time).

I was curious about what the internet thought of how age-appropriate these movies are (they’re not) and got a nice chuckle about one reviewer reminding readers that Terminator was an “Eighties R” — which means a “hard R”.

In the olden days, getting a VHS from the rental shop (pre-Blockbuster) is one of those memories that I can trace the footsteps of. When I was in first grade a friend slept over and my mom rented Terminator for us to watch. My youngest is in 2nd grade. He hasn’t looked away once from the screen. Which reminded me that I’ve gotten more squeamish as I’ve gotten older.

To bring things around from today’s open, nobody has ever had more responsibility resting on his shoulders than this annoying kid:

Stay groovy ☮️

Friends,

For the past 3 years, the Berkeley Chess School has done a weekly lesson in our backyard. About 15 kids attend. They are mostly 2nd and 5th graders because we know the families through our kids.

I walk home from school with all the kids on chess day. I usually throw out a math question or riddle and by now the kids just ask for them on our strolls. Lately, the questions deal with rates, percentages/fractions, exponents/roots, or some basic number play stuff (“How do you know if a number is divisible by 9?”)

Some examples:

• Start with $100. If you earn 10% then lose 10%, how much money do you have?
• What’s larger 3⁴ or 4³ and similar questions?
• If you travel 5 miles in 12 minutes, how fast are you going?[I haven’t dropped this one on them: “If I drive around a one-mile track and average 30 mph for the first lap, how fast do I have to drive the second lap to average 60 mph for both laps combined?” (Solution)]
• If you have 5 kids on your team and only 4 kids start how many possible starting lineups are there?
• If you lose 25%, how much do you have to make to get back to even?[I like that one because it’s a useful elasticity idea. If X is the loss percentage, you need to earn back X/(1-X).

  If you are selling lemonade and you cut your price by 20%, you need to sell 25% more cups to be revenue-neutral.]

I started giving these questions because, well it’s just play. Riddles are inherently satisfying. But I’m also conscious of imparting some durable concepts. It’s not quite as deliberate as hiding the dog’s pill in the peanut butter but there’s some overlap. Honestly, the main motivation is keeping the kids who aren’t into sports engaged. There’s about 40 minutes between the kids getting to my house and the start of chess. The 2nd graders usually play soccer and the 5th graders hoop it up. A few kids aren’t into either but they gravitate to the riddles (my boys just wanna play sports and my 5th grader, Zak, with sass tells his friends “This is the stuff I deal with all the time”).

Lately, I’ve been doing more exponent stuff because I know they aren’t doing that yet in 5th grade but it’s reachable for them. Zak is taking the online Pre-Algebra I course on Art of Problem Solving which is comprised of 7 chapters. He just wrapped chapter 2 which is all about exponents so that’s been top-of-mind for coming up with the questions.

The challenge question to end the chapter was to solve for the 2 possible values of X (see below). But keep in mind, they haven’t learned how to compute square roots or any other kind of roots. You can do this without any involved computations and without roots. You can find the solution at the end of the post.

Find the 2 possible values of x:

Anyway, I didn’t give the kids that question but by this past week, they understood the basics of computing a simple exponent or taking a square root. So I took a stab at base 10 logarithms. I just explained it as the power you need to raise 10 to get to the target number.

“So if our target is 100, what do you have to raise 10 to? How about a target of 1,000?”

They had no trouble with this. So I explained how both the Richter and decibel scales were log scales that compressed a wide range into a smaller ruler. A 6 on the Richter is not twice the energy of a 3 but 1000x more energy. Every integer increase in the scale is just a higher order of magnitude.

The most pleasant thing happened. The kids that gravitated to this stuff were stoked. As it it settled in their brains they were all Keanu Reeves “Whoa, that’s so cool”.

I texted one of the parents:

Putting aside the pure joy of watching a kid unlock, exponents and logs are fundamentally important operations like adding and subtracting. Our first formal introduction to them outside a math class is usually science (exponential growth/decay) but more prosaic to this audience is the topic of investing, specifically the idea of compound growth. It’s an idea you’d love to see people internalize as young as possible.

Typically when someone (and I’ve done this too) writes about compounding they reference Einstein’s 8th Wonder of the World quote or talk about how our minds think linearly and find exponential growth unintuitive. [This was a common conversation at the start of the COVID pandemic with VCs patting themselves on the back for lateral thinking about how coefficients of virality applied to…the domain where exponential growth is usually people’s first contact with the topic. Like twisting a eulogy into a chance to talk about yourself. I’m not even mad, it’s the whole wheel of cheese].

With that in mind, I’ll leave you with an excerpt from Grant Sanderson, the mathematician behind the 3Blue1Brown YouTube channel. This is from his appearance on

excellent Lunar Society Podcast:

Have you come across those studies where anthropologists interview tribes of people that are removed enough from normal society that they don’t have the level of numeracy that you or I do? But there’s some notion of counting. You have one coconut or nine coconuts like you have a sense of that. But if you ask what number is halfway between one and nine, those groups will answer three whereas you or I or people in our world would probably answer five and because we think on this very linear scale.

It’s interesting that evidently the natural way to think about things is logarithmically, which kind of makes sense. The social dynamics of as you go from solitude to a group of 10 people to a group of 100 people have roughly equal steps in increasing complexity more so than if you go from 1 to 51 to 102 and I wonder if it’s it’s the case that by adding numeracy in some senses we’ve also like lost some numeracy or lost some intuition in others, where now if you ask middle school teachers what’s a difficult topic to teacher for students to understand they’re like logarithms. But that should be deep in our bones right so somehow it got unlearned

What a cheeky observation. Gives a second entendre to the expression “natural log”.

Money Angle

I’m using this space to invite you to play PitBulls (formerly StockSlam) online this coming Friday evening. It’s totally free but space is limited.

Reserve your spot (choose Friday November 3rd if you want to play with me)

• Click here to run through a tutorial. <— the app improves daily; you can now practice on your own against bots!
• Host your own game for free

This is my testimonial for the game:

One of the most fortuitous decisions I made in my career was accepting a job from SIG out of college. Back in 2000 going to Silicon Valley or I-Banking was all the rage. While trading was a coveted job, the idea of going to an exchange floor to sling options was not a mainstream career choice. And SIG was not a well-known company outside this narrow world.

The job offer I got from them was the lowest paying, but the interview process stood apart from the banks and other firms I talked to. It was clear that working for SIG meant a serious education in decision-making commensurate with the objective — to take responsibility for risking the partners’ own money after as little as 9 months of training.

I was placed at the American Stock Exchange where I would learn from senior traders including their head of education in NY, Mike Steiner, simply known as Steiner.

Steiner was a natural teacher, able to communicate complex ideas with simplicity and frankly, joy. It was no surprise when I discovered 20 years later he retired to become a physics teacher in public school.

In 2022, we reconnected and he showed me the prototype for what would become Pitbulls. Pitbulls is a game distilling the essence and mechanics of the mock trading program we used in training. Pitbulls is a fast-paced game requiring players to think quantitatively while building intuition and understanding investor psychology. Steiner focused on making it fun — it’s a game first. But when I saw it I was immediately struck by its potential to bring investing principles to life!

Skills that will immediately develop from the very first game:

• market making in an open outcry market
• tracking multiple quotes from competitors
• managing a rudimentary portfolio
• reacting to new information

Deeper concepts embedded in Pitbulls:

• arbitrage pricing, inter-dependent pricing
• expected value and probability
• the concept of edge as the foundation of a business
• how you can be profitable without relying on prediction
• making trading decisions under uncertainty
• risk and diversification
• the role, wisdom, and conditions of a healthy market
• an introduction to derivatives
• a bridge from trading to investing principles

Steiner has been hosting in-person playshops for years and I helped organize larger events in NYC, SF, and Chicago to overwhelmingly positive feedback. Unsurprisingly, the most universal suggestion was “give us an online version”. People wanted to play on their own and host their own sessions.

Starting now, you can play online!

I’ve been writing about financial education topics for years. These posts go into how Pitbulls and its underpinnings can improve your thinking in powerful ways.

• Finance As A Laboratory For Decision-Making [StockSlam Preview]
• If You Wait For All The Info You’ll Be Too Late
• Mock Trading
• The Benefits Of Betting Culture
• Lessons From Susquehanna
• Thinking Like A Trader
• Calibrated Confidence

Money Angle For Masochists

Quant legend Peter Muller wrote a candid, somewhat irreverent post 20 years ago that holds timeless wisdom.

🔗Proprietary trading: truth and fiction (Link)

Excerpts:

1. But the most important risk is the possibility of our models not working correctly. To minimize that risk, we set loss targets for strategies — if we lose more money than the pre-specified target then the strategy is re-evaluated and shut down for a while (perhaps forever). This is not that different from the old school of proprietary trader management: ‘Go ahead and trade, don’t do anything too risky, and if you lose more than $x we’re going to shut you down. ’Our strategies are evaluated by looking at reward/risk measures. For symmetric, market-neutral strategies without significant tail events, the Sharpe Ratio (SR) is probably the best ex-ante measure. SR is defined as the portfolio annual excess return divided by the annualized standard deviation of that return. Our benchmark is cash, hence measuring excess returns is appropriate for our portfolio. For long-only managers, the Information Ratio—which measures excess returns relative to a benchmark—is more appropriate. When we evaluate past performance, we also look at peak-to-trough drawdowns (a measure of the maximum drop between consecutive maximum and minimum values of return over the life of the strategy) as an additional risk variable. This can help pick up serial correlation in portfolio returns that the Sharpe Ratio doesn’t capture. Also of interest is the fraction of expected gross profits consumed by expected transaction costs. The higher this number, the more money we expect to lose if our model stops working. At least some of our edge comes from opportunities that are created in the market by institutional managers who trade too much. Their trading is usually based on either an exaggerated view of how well they can predict investment returns or a misunderstanding of how trading costs increase with size. The strategies of institutional managers can still be perfectly rational despite providing us with opportunities through over-trading, simply because of the huge agency issues in portfolio management.
   
2. In Grinold and Kahn’s book on Active Portfolio Management, the authors describe the ‘FundamentalLaw of Active Management’: a strategy’s Sharpe Ratio is proportional to the number of independent bets taken by the strategy multiplied by the correlation of those bets with their outcome. To get a higher SR, you need to increase the number of your bets or increase the strength of your forecasts. In my opinion, it is far better to refine an individual strategy by increasing both the number of bets within the strategy and the strength of the forecasts made in the strategy, than to attempt to put together lots of weaker strategies. Depth is more important than breadth for investment strategies…I would much rather have a single strategy with an expected Sharpe Ratio of 2 than a strategy that has an expected Sharpe Ratio of 2.5 formed by putting together five supposedly uncorrelated strategies each with an expected Sharpe Ratio of 1. In the latter case, you’re faced with the risk that the strategies are more correlated than you realize (think Long Term Capital). There is also the increased effort of ascertaining whether each individual strategy really has a Sharpe Ratio of 1.
   
3. An important choice for many proprietary traders is whether to focus on shorter or longer-horizon strategies. Typically, shorter horizon strategies get their edge from providing temporal liquidity to a marketplace or predicting short-term trends that arise from efficient trading. Longer-term models focus on asset pricing inefficiencies. How does the implementation of these strategies compare? Shorter-horizon investment strategies are desirable because they tend to create higher Sharpe ratios. If your average holding period is a day or a month, you have the opportunity to place many more bets than if you hold positions for three months to a year or longer. On the flip side, shorter horizon strategies tend to have capacity issues (it’s easy to make a small amount of money with them, but harder to make a lot of money). Shorter horizon strategies also require serious investments in trading infrastructure, since quick and inexpensive execution is much more important than for longer horizon strategies. Risk management for shorter-horizon strategies tends to occur through position trading rather than portfolio construction. Assets are not held for long periods of time and portfolio characteristics change quickly. The biggest risk for shorter horizon strategies model risk, or the risk that the trading strategy deployed has stopped working. Since even the best trading strategies experience periodic drawdowns, the hardest challenge for the short-term model-based trader is to figure out whether his model is going through a regular drawdown or has stopped working altogether. Longer-horizon model-driven investment strategies have different issues. Since assets are held for longer periods of time, execution costs (although still important) are not the primary focus. Statistical inference becomes more difficult and the danger of overfitting or mining data becomes larger. Risk management for longer-term strategies happens in portfolio construction: since rebalancing occurs less frequently, more care needs to be taken to ensure the portfolio is not exposed to unintended sources of risk. Because they tend to have lower Sharpe ratios, longer horizon strategies have a different kind of capacity issue—the capacity for pain. However, there is one advantage: because trading occurs less frequently it’s possible to lead a much better lifestyle than if you’re running shorter horizon strategies!

2 ways I came up with to solve the AoPS question

Method 1:

x could also be -243 since it’s being raised to an even power.

Method 2:

The undisputed heavy-weight champ of finance writing is Matt Levine. I’m 4 bid on how many chuckles you’ll get per letter. I wouldn’t sneak-read his stuff during a meeting — there’s always literal LOL risk.

But it’s not just the humor. Matt Reustle and Dom Cooke, hosts of Making Media, put their finger directly on Levine’s appeal in their recent interview with Levine.

Matt. R: [00:53:12] He has basically carved out this category where when you see certain things hit the tape, you say to yourself, I can’t wait for Matt Levine’s interpretation of this. And that’s such a symbolic thing that I think many people probably strive to have, and he clearly has achieved them. I love that.

Dom: [00:53:30] I think it’s stronger than that as well. It’s not even like I want to hear what he’s going to say. It’s, I need to know what I should be thinking about this topic. And he’s the guy that I trust. Tell me what I should be thinking about it. And there are a few people in that account in different topics or verticals, and he’s definitely there in finance for a lot of people.

The interview is a lot of fun and the hosts stand out for asking great questions. Stuff you really want to know.

🎙️Matt Levine – Wall Street’s Art Critic (Making Media)

A couple of my observations:

1) The nerdcall. Matt recognized that weird, complex deals and concepts appeal to technical people broadly — whether they are in finance or not.

Very early on, my sense was that there is an expectation that weird complicated niche topics have only weird niche audiences and that doesn’t seem true. I think my readers, some of them are people who work in fairly technical areas of finance are like finally, I get to read about this fairly technical or like, I get to read about this adjacent technical area of finance that I find interesting because I work in a different technical area and I like technical stuff.

A lot of my readers work in tech and they’re like, “I don’t share anything about finance. I share about finance, I’m not that interested in it, but I like when you talk about complicated things. It’s like the aesthetic appreciation of systems and complexity and the moving parts of the economic drivers of deals.

My impression is that there are a lot of people in the world who want to read about structures and there is not a lot of writing. So they go, great, I get to read about the derivative, fabulous. So I don’t know, that’s sort of the answer to your question. If I were to explain a complicated thing it is going to be fine, like those are going to be good.

This overlaps with my observation of game nerds. I pulled this from an interview with game designer Raph Koster:

Finding real world systems and abstracting them or boiling them down to their essence isn’t actually a very common skill. Games can teach people how to do this. The idea involves setting constraints, modeling real systems, and allowing people to experience them within a game context to understand them deeply. It provides an opportunity for individuals to experiment with these systems, unlike in real life where, for example, you only get one shot at lifetime earnings. Playing a game that emulates this system offers lessons.

I believe that game-playing trains your systems thinking and reading Matt Levine does too. It’s a lot of “how would you expect this to behave at equilibrium and under what assumptions, but we actually observe X so what assumptions are broken or what did the model fail to consider that is true now but wasn’t before”. I give a few game examples in Lessons from Game Designer Raph Koster.

2) Matt explains the benefits and costs of the growing trend of “creators” becoming the farm team for the journalism world. He namedrops a great example —

(fun fact Kyla’s newsletter is the single largest Substack referrer of Moontower subs. Thanks Kyla!)

Levine:

I was just reading Matthew Yglesias this morning, talking about how the journalism career path that used to be, like a small town newspaper to a big city newspaper to The New York Times. And now you started a blog covering national politics and you move to The New York Times.

And I think from my entire time in media, the old model had been replaced by the model of you start at Gawker or Gawker, in particular, became like the feeding ground for media organizations. And now blogs have declined and creator stuff has increased and like Bloomberg works with Kyla Scanlon who’s this great financial content creator. And yes, totally, that’s the future.

I just think it’s easier for people now to just go to a place, you can talk about whatever that has a national or international platform and then they do stuff. And if this stuff gets traction, they’re like, we don’t need to work your way up. Obviously, there is something lost there. We’re like the advantage of being trained at a small town newspaper is you learn to report.

I find it helpful in my career that I started by doing law and banking. So that what I came with when I started writing was not just attitude and style. And there’s a risk, if the training ground for media is starting a YouTube channel when you’re 18 or starting a TikTok when you’re 18, then people will come in with less training, either in reporting or in a substrate that they’re talking about. The upside is that then you come in with the skills that are helping you to building an audience, there’s a trade-off there. I don’t come in with reporting skills, really.

Levine is validating a trend that traditionalists ignore at their own peril — public proof of work is a gate-keeper bypass. [Mark Andreesen discussed the nuance around this in the context of whether one should go to college.]

The trend is not without trade-offs but it’s also not going away. I’d bet on it accelerating. If a resume and references are your only proof of work that’s effective because there are plenty of opportunities that don’t require more. But writing, building, and creating publically are a lot of additional “interview-like” data points that expand the surface area of opportunity. But it’s work. There are no shortcuts anyway, you work one way or the other. (Reminds me of maintenance costs for a home — you can defer them and one day you’ll pay for it with a lower selling price or you can accrue them as they come).

If you’re drowning in info, a trusted source, curator, and really, a second brain, like Levine is saving you time and attention. Media companies understand the value of this. Many brands understand this. The marketing departments of the remaining companies will catch up. And in a world drowning in info, everything is sales. More value will accrue to trust. Feels like one of those big trends that is happening in the background that you can align with to your advantage.

Money Angle

I’m working on some investing education stuff for some friends and family. That led me to resume work on MoontowerMoney.com, a series where I explain how people should approach investing. The target audience I keep in my head is a fictional friend who has accumulated some savings, is not in finance, and has no process. Someone who keeps bouncing from one stock tip to another. Or doesn’t have a cohesive understanding of what the “investing problem” even is.

The goal of the series would be to either help them realize they can manage their own savings in a way that is mentally organized or maybe just realize they should hire a financial advisor.

I’ve shown many people in the past 6 months how to log onto Vanguard to simply buy t-bills. They didn’t know this was a thing. This ignorance is normal and understandable. Many people with savings don’t know how finance and investing work and many others find thinking about it a chore they’d rather ostrich.

This series is a 101 for understanding the nature of markets and risk and ultimately taking the reins in a coherent way that doesn’t require much maintenance.

This week I published the next section:

❓Where do investing returns even come from? (Moontowermoney)

Money Angle for Masochists

Just a few screenshots for your ponderance:

By @EMinflationista:

I’ll never be allowed on a crony committee:

Stay groovy ☮️

I saw this tweet from David:

Everyone understands this feeling.

I heard an interview recently that discussed the psychology behind this behavior.

I’ll cut to the link:

🔗David McRaney on EconTalk

Episode description:

To the Founding Fathers it was free libraries. To the 19th century rationalist philosophers it was a system of public schools. Today it’s access to the internet. Since its beginnings, Americans have believed that if facts and information were available to all, a democratic utopia would prevail. But missing from these well-intentioned efforts, says author and journalist David McRaney, is the awareness that people’s opinions are unrelated to their knowledge and intelligence. In fact, he explains, the better educated we become, the better we are at rationalizing what we already believe. Listen as the author of How Minds Change speaks with EconTalk host Russ Roberts about why it’s so hard to change someone’s mind, the best way to make it happen (if you absolutely must), and why teens are hard-wired not to take good advice from older people even if they are actually wiser.

The best teaser for the interview comes directly from it when McRaney says:

The incepting point of this book was someone in a lecture came up to me and asked about their father who had slipped into a conspiracy theory and they said, ‘What can I do about that?’

And, I told them, ‘Nothing.’ They said, ‘How do I change his mind?’ I said, ‘You can’t.’ And, I really felt, the second I said it, that: I don’t know enough about this to say something like that. I don’t even know if I believe what I just said, but I know one thing I don’t like this attitude I have about this issue. I should at least learn more about it.

And, if I was in that same situation today, I would actually be able to say, ‘Oh, here’s what you should do. Here’s what you should say.’ I no longer believe anyone is unreachable. I no longer believe anyone is unpersuadable.

In conversations that don’t work out the way we think, we blame the other side. We say, ‘They’re dumb. They’re mean. They’re evil. They’re ignorant. They are unreachable, unchangeable, stuck in their ways.’ These are all things that we are using to forgive ourselves for failing.

Listen to the interview. My excerpts are just what I wanted to keepsake. My notes covered:

• motivated reasoning for social acceptance
• the process of radicalization
• reactance (or what I call “reflexive contrarianism”)
• shaming
• specific approaches that work to unblock discussions
• “street epistemology”
• cognitive empathy

If you do nothing else, zoom in on the “reactance “section which I titled this post for — that feeling of “F you I won’t do what you tell me” is ingrained and worth understanding.

If you know the reference, you know RATM. And just in case you’ve never seen it — the video below is a recording of one of their first public concerts. It was filmed in 1991 at Cal State Northridge. It’s a bizarre scene juxtaposing a routine day on a sunny campus quad against the band’s angry energy. An ice cream social with an a cappella group like Chorus against The Chaos would have drawn a crowd faster.

Zach is unfazed. By the end of Bullet In Your Head, the audience starts noticing. If you consider the state of rock just coming out of the 80s (Nevermind was released only 3 months before this performance) and the relative infancy of hip-hop this performance must have been pretty alien.

They would go on to release their debut album a year later and play a side stage at the second Lollapalooza.

They’d play the main stage one year after that.

[Unclassified personal thought: I like watching old concert videos. I’d waste one of my 3 genie wishes to have the power to peer into the present of the audience members I see in these old clips. It’s an escapable thought every time I watch them. Like knowing that skinny, shirtless viper with the long hair slithering to the groove is now bitchin’ about Blackrock makin’ his truck expensive to fill up. Mind you he’s a landlord in Laguna where he bought his first bungalow in 1972. Discovered the town after catching the Dead at the Newport Pop Festival a couple miles down the road a few years before that. A show he hitchhiked to from Indiana while running from the life the ”squares” back home had envisioned for him.

The brightness of youth casts a shadow — the finer rays suggest their own sorrows]

Money Angle

Last Wednesday in Investing With Your Hands On The Wheel, I beat my old drum that trading isn’t really something one does “on the side”. Trading is a business. And I am quite skeptical about the reward per unit of effort for playing Nostradamus in your investing portfolio. I know there are people who disagree with me on this. I’ll happily grant them their track records at face value but wave the plane with zits at them:

The quote:

I’m pretty much in the camp of “get a job where you can do this full-time if you really want to”. If you can’t do this but still want to explore strategies, then fence out some capital to play/learn/experiment…

For the rest of your assets stick with some kind of permanent portfolio implementation depending on your risk tolerance. You can follow folks like Corey Hoffstein, NomadicSamuel, Jason Buck, Lily for that stuff. InvestResolve guys too. All these tweet about it too and it’s all quite solid. I recommend this series by the InvestResolve team.

My gut feel is return-stacking/permanent portfolio for long-term DCA is probably the efficient frontier of work/return/risk triple axis.

If you insist on being active, there is a totally acceptable framing too:

But there’s no doubt that many people want to put their hands on the wheel and that has innate personal value (and that’s true whether it’s misguided or not). So in short I think it’s a tree:

1. DCA permanent portfolio variant if you want autopilot
2. If you want to put your hands on the wheel what does that efficient frontier of effort/return/risk look like where return also includes some illegible component of DIY satisfaction?

I should probably pull together a new Moontower wiki of permanent portfolio content that I like. It might be an insurance policy against me never writing the Implementation portion of moontowermoney.com

[I have all the material that goes into it collected and sorted but it’s a small book-level project that’s on the back burner]

In the meantime, I’ll dribble out some things that really resonated in this column. Today, I’ll point you more closely to the InvestResolve series I referenced in the above quote.

Adam Butler and his team at InvestResolve did a wonderful 12-episode Masterclass on the topic of portfolio construction.

• I took notes on the first 8 episodes. I didn’t take notes for episodes 9-12 as they get into the weeds of quant methods, backtesting, and ensembles. I was more interested in a conceptual primer to risk parity as a portfolio construction method for diversifying across unique edges.
• The notes include a link to the episode as well as a transcript

💡Most important ideas

1. A more diverse portfolio has a higher expected risk-adjusted performance over time.

2. Asset allocation is useful because it maximizes the number of independent bets in the portfolio.

3. Those bets are independent are sustainable because they’re directly linked to fundamental economic properties.

4. A risk parity portfolio is the most efficient portfolio if you believe major asset classes are fairly priced (ie their Sharpe or other measures of risk/reward are the same)

🔗InvestResolve Masterclass On Risk Parity (Link)

If you are short on time focus on the first 3:

• The First Question: Security Selection or Asset Allocation?
• What True Diversification Really Is And How To Maximize It
• The 2 Fundamental Drivers That Determine All Economic Regimes

Money Angle For Masochists

I saw a tweet:

Let’s set aside the obvious “just short bonds” response to a crystal ball that tells you mortgage rates are going to roof. While I’m not sure how volatile the 10-year note/MBS basis is, just shorting bonds would seem like the most direct and reliable trade.

The rest of the crystal ball portfolio underwhelms expectations. Ahh, a recurring parable in the “trading is hard” bible. Like if you knew what a stock’s earnings were going to be would you be able to make money? How do you know what the “whisper” number is or if the market is focused on guidance more than income for this quarter?

It also reminded me of 2 adjacent reads that cut to the heart of “how would you trade if you knew the future but not the path?”

1. In Financial Hacking, a puzzle is presented:Assuming you could not trade options, how much would you pay to know the closing price of SP500 in one month?
   

   🧩Excerpts from the discussion

2. Even God Would Get Fired As An Active Investor (AlphaArchitect)

Alexis reminded me of cringe times from my NYC days. Almost as cringe as referring to probabilities as deltas. As in “I’m 75 delta to meet you for drinks after my work dinner” 🤮

Also, if you were never cringe about anything you have the heart of a dead fish and you should get that checked out.

@yayalexisgay

it’s not “banking” per se but… I mean, it’s all “banking,” really……. right? 🥴 🎥 edited by @Alex Moudgil #finance #comedy #dating

♬ original sound – Alexis Gay

Just one link before we hop into investing topics.

For his 100th essay in his series “We’re Gonna Get Those Bastards”, Jared Dillian tackles the question:

How do you live a happy life?

• Happiness (WGGTB)

It’s short and sweet.

Money Angle

Top of the Food Chain

There are lots of videos online of orca pods feasting on white sharks. What rattles the imagination is how they go straight for the liver. The liver’s bounty is a dense nutrient-rich oil called squalene that can account for up to a third of a shark’s weight.

Hopping over the semantic curiosity that benz and squal just adopt an “ene” to become oil words, I’ll skip straight to ruthless analogy. The pod shops in investing are top of the food chain in asset management. It’s said on the internet, so I know it’s true, that a single shark liver can nourish an orca for a “whole day”. First of all, if that’s supposed to be a jaw-dropping amount of nutrition call me underwhelmed. If a white shark a day keeps the doctor away, I’m left to think Shamu’s cursed appetite has no end — this is an aqua-treadmill of blood without a killswitch.

Which serves the analogy perfectly.

Squalene is alpha. There’s not a ton of it out there and the hunt for it mobilizes the top of the academic food chain. In 2000, I made $50k including signing and year-end bonus my first year out of college. That figure is 8x today for top grads accepting prop shop offers. Talent war.

The trading world’s ruthless focus on squalene — risk-adjusted returns while staying market-neutral to print money in any environment has been adopted by the investing world. And the allocators have noticed. The pods, like the orcas, are eating everyone’s lunch right out of their bellies. And those inflows are arming the war for mature talent too. Giant guarantees to proven managers. The kind of money that can get even the most ambitious manager to re-think starting their own firm.

With that intro, I’ll point you to a podcast:

Patrick O’Shaughnessy interviews Will England (Invest Like The Best)

Will is the CEO/CIO of Walleye’s $5B multi-manager hedge fund. I’m familiar with Walleye because they started in the mid-aughts as an option market maker. Several friends and ex-colleagues have traded for them. But this podcast is about their hedge fund, not the prop biz. It’s the best investing interview I’ve heard this year.

First of all, if you are unfamiliar with the multi-manager or “pod shop” pass-thru hedge fund model then this interview is a great primer. The big 4 managers in the space are Citadel, Balyasny, Millenium and Point 72.

Will’s language, tone, and thinking will be deeply familiar to folks who have done tours of duty at prop trading and option firms. My take on this interview is “damn, that was honest”. Will is in Minnesota but shoots as straight as a Chicago pit trader. Heck, he addressed the alignment issues with the “back book” — I’ve talked to pod traders about this idea before and couldn’t believe he broached the topic in this call). His voice was like a lullaby from my younger years.

Patrick asks the right questions. Everything from the knowledge to the story is worth an hour of your time. It confirmed a lot of what I thought I knew and taught me even more.

A few thoughts of my own

Will says 25% of their business is still options trading but a significant chunk is now fundamental equity. The PMs are trying to earn a 3% spread between longs and shorts after stripping away beta and factor tilts. Just like other pod shops, these guys are farming pure alpha or “idio” (for idiosyncratic) and levering it to get to about a 30% return which the investor hopes to see half of after implicit/explicit fees.

It has always struck me that this is the natural progression of active management. A barbell where you pay up for pure alpha and get your beta for free.

The closet beta active management world is a melting ice cube. But the incentives and stickiness of legacy relationships both from allocators and story-telling managers will try to keep the freezer door closed as long as possible.

But I can’t say I know where the equilibrium will shake out. If you have pure alpha, you can choose your investors either by fees or by preference. You have all the bargaining power. But I’m not sure what the capacity of alpha even is. Will didn’t mince words about the competitiveness. He thinks the number of PMs that possess both the chops and psychological profile to play this game is on the order of a thousand people maybe. The pods are flush with cash and signing talent with big upfront deals like athletes. (He admit the model could be in a period of froth at the moment). Will’s belief in market efficiency sounds like “efficiently efficient”. Yes, there are 10 Sharpe strategies. They are also low-capacity. Any strategy with an obnoxiously high Sharpes is basically arbitrage counting down to extinction. But that new species pop up and then disappear is a general truism. A never-ending game of whack-a-mole.

[Aside: Anyone reading Moontower for a long time knows I don’t wade into the market-efficiency debates because they sound like academic masturbation. I have my own version which rhymes with what Will talks about — The “No Easy Trades” Principle. When I encounter someone who disagrees with this I hear one of these possible confessions:

1. “I got rich on a highly concentrated risky bet and have never considered what the outcomes would be if I re-ran my life 100x”
2. “I have no idea what I’m talking about”

I was out with a friend recently who ran a high-volume options trading business for 25 years. We talked about how nearly every time they would “exploit” some weird rev/con financing opportunity they found a way to get f’d by the borrow market. He could rattle off example after example of interesting set-ups and yet the outcomes were consistent. You’re literally paying to discover new failure modes but the way each setup arrives you feel like you can see why the opportunities are real.

Almost every time I did a trade and felt good about it afterward, I was in the pre-glow of a bad beat. The trades that feel scary are the ones that pay. And this makes sense — the price is compensation for doing what nobody wants to do. The job-to-be-done is finding a way to manage the risk until everyone who is transacting to satisfy their greed or pain is filled. The removal of that pressure is what begins to turn the trade in your favor.

Trading profitably is painful. It must be or there is no reason to be paid for it. what’s worse — just because you feel pain, doesn’t mean you will make money. The pain is the cherry on top of doing everything right. You can have pain even if you do things wrong and it will be in vain. The difference is when you do things wrong, you feel good about it in the interim because you don’t get how this works. And that fleeting satisfaction is what keeps you from learning.

I’m sorry but trading profitably means being constantly paranoid and finding a way to live with that. I suspect a subtle aspect of what makes the pods so smart is they have codified and automated the risk management in a way that guarantees the PM’s paranoia.

This is an aside because I think you need a lot of reps to grok what I’m saying and honestly most people will just go on pointing to things that don’t make sense and breathlessly exclaim “See the market is inefficient”. You don’t have a right to say that unless you tweet it from your yacht purchased with lots of receipts.

Strategically, in a game where the skill level is extremely high and evenly matched, then variance will drive a lot of the separation. So the counterintuitive response for someone dead-set on being rich but knows they are overmatched is to take a giant, high-variance bet and hope this was the lifetime it panned out.]

Sorry, back to the body.

In short, I don’t consider what these pods are doing to be investing. They are trading but on a medium time horizon. It’s called “fundamental equity” but let’s say the holding periods are under 2 years and probably more like 1 (if someone knows the stats please share) then this isn’t about “realized” fundamentals. This is about anticipating change in sentiment around expected fundamentals. This feels like a game of nearer-term info, flows, positioning, and game theory. A re-rating game. A game that was much more similar to what I did (although it sounds more complex than vol trading which has more to do with flows and is yet even smaller capacity) than what I imagine value investors do.

My thoughts on value investing are mixed. And I’m being liberal with the word “value”, recognizing that cookie-cutter implementations of “value” are the equivalent of accounting fails (like not updating the meta-principles to handle object-level changes in importance to things like goodwill or brand equity). I assume there are value managers who can spot high-multiple value names because they have a “g” column in their Pandas dataframe (just kidding — I meant in their spreadsheet — we are still talking about value investors here). The problem with these managers and their “long-term” theses is they want you to buy the brand name vitamin instead of the generic and when you ask for the quarterly bloodwork to see if it’s making a difference they say you won’t see the benefits until you retire. The blood results are just “noise” they’ll tell you.

On the other hand, if the manager’s signal reliably swamped the noise then they wouldn’t give that away. They’d try to get pod shop fees. Market efficiency is fractal — there’s a market for the assets and for the labor that moves the assets. I’ve alluded to this before in The Paradox of Provable Alpha and Will’s interview made me think it’s only going to be a more relevant paradox going forward.

Learn more:

🧵BEAT THE PODS: A 7-POINT RECIPE FOR SINGLE MANAGERS (Brett Caughran)

This is a long but good thread by @FundamentEdge

This pairs well with Ted Seides’ interview with Jason Daniel and Porter Collins, 2 of the investors made famous in The Big Short from their work with Steve Eisman:

🎙️Big Shorts and Big Longs (Capital Allocators)

These guys had a stint at Citadel where they learned the intricacies of the pod model. It didn’t resonate with them and for reasons that confirm my own interpretation — pods are more like traders than long-term investors. They had 2 big insights:

1. The pod model is so prevalent (and it is smart) that if you don’t understand the dynamics they impose on the market, you’re playing with one eye closed. They have respect for the model (and how Citadel implemented it) even if it’s not their game.
2. They realized the model left some forms of edge behind because of its nature. They could make picking that up part of their own niche. This is touched upon in Caughran’s thread above.

🔗Multi-Manager/Pod/Hedge Fund 101 (7 min read)

Byrne Hobart’s primer from his evergreen Capital Gains Substack

Money Angle For Masochists

I published a big post this week. Big enough that it warranted a map. You will get technical knowledge, some trading bits, and ideas that are worth assimilating into how you think about investing. In fact, you’ll even see opportunities that arise because of the different lenses investors and traders bring to markets.

The map:

Outline of the Risk Neutral Probability Lessons (Moontower)

And if you want to jump right in:

Understanding Risk-Neutral Probability (Moontower)

The post was the culmination of connecting lots of dots. I started thinking about it after watching a short YouTube clip on my flight to Vietnam back in March. I hope you enjoy it. I’m biased but think the points are underappreciated (or at least that’s how I justify the 30-40 hours I put into it).

A nice affirmation

I hadn’t looked at my website analytics in a while (it’s a bit more annoying to do so since a lot of the posts I wrote this year are these longer technical ones that I host on Notion).

When I logged in for a gander I found that several trading and brokerage firms are linking my material through their internal wikis or intranets. When I write these posts, I often see them as a useful aide for a senior trader who doesn’t feel like explaining some concept to a trainee. “Ahh, there’s some stoner blog called Moontower that wrote about this, just search for it on there”.

Anyway, it’s a nice affirmation. I probably won’t be thrilled when the LLMs are quoting me but ya know, it’s America — corporations are people, computers are people. Maybe only people aren’t people.