It’s Halloween so Moontower should spook you. We’ll get to that.

But first, let’s pretend this is a normal post. I’ll follow the little formula:

1. Hey here’s some cool thing I read:

   [Inserts link] Book Review: San Fransicko by AC10 (formerly Slatestarcodex)
   

2. Offer a tantalizing bit:

   San Fransicko is subtitled “Why Progressives Ruin Cities”. It builds off the kind of stories familiar to most Bay Area residents:

   In the spring of 2021 two colleagues and I went to San Francisco. We first went to check in on the open-air drug scenes in the Tenderloin and United Nations Plaza. It was the usual scenes of people sitting against buildings and injecting drug needles into their necks and feet. There was garbage, old food, and feces everywhere. After a couple of hours, we decided to go out to eat in the Mission. Work was over. We were all looking forward to a relaxing dinner. We were eating ice cream and walking along Valencia Street when a psychotic man, perhaps about thirty years old, began following us and screaming obscenities. When we turned around to look at him, he screamed at us, “What are you looking for, huh! WHAT. ARE. YOU. LOOKING. FOR!” and started walking faster toward us. We walked faster until the man found other people to verbally assault.

   Things haven’t always been like this. San Francisco used to be one of the safest and most beautiful cities in the world…
   

3. Provide my own twisty commentary:

   The failed-stateness of San Francisco is common knowledge by now. I don’t even lock my doors when I park there. Just leave nothing in the car so I don’t have to risk a call to Safelite. [As I type that it occurs to me that Safelite’s cap-ex would have been best spent on whatever graft necessary to save Chesa Boudin’s job.]
   Oh wait, Chesa’s influence on SF’s decay is not so cut-and-dry. Why?

   Read the Slatestar review of the book!

   The post is done in a fun format. He dissects 10 of the book’s claims put forth by author and failed gubernatorial candidate Michael Shellenberger. Sometimes AC10 agrees, sometimes not, and sometimes you’re left with a non-verdict. This isn’t surprising. Books in this genre are axes because while they start with nuggets of truth, to fill a few hundreds pages with persuasion, you need to turn a lot of greys into blacks.

   Anyway, once each claim is given its trial, AC10 goes raw and says how he really feels in the actual review. I like Spock-treatment giving way to Judge Judy flow. It’s kinda like Stairway To Heaven. It starts like “oh this is interesting” nod along, nod along, ok it’s getting repetitive, now tedious, I mean it’s good and all, but also like enough already — then, finally — boom. Enough talk, weapons drawn. Energy sword cuts through the night sky as an unholy, pentatonic run screams from above as Bonzo shakes the ground, the Earth splits swallowing both civility and the quaint illusion that it ever mattered.

   [Aside: if you have never seen this deleted scene from Almost Famous, correct that when you have 12 minutes. The older brother holds the DNA from which all fanboys have been cloned and Frances McDormand’s listening expressions required not a minute less than 10,000 hours in front of a mirror. You’ll never hear the song the same way again. Cameron Crowe is a worthy rabbit hole at 2am.]

   Fun aside, the most useful exercise living inside the AC10 post is watching him reason through the claims. Since SF exists in the national conversation as a political football bouncing its way through debates on crime, public school lottos, sanctuary city status, drugs, NIMBYism, and cyberpunk levels of wealth disparity, the breakdowns have something for everyone no matter where you live. With humor and an eagle-eye, AC10 shows why his book reviews are often better than the books themselves.

Very well.

I kept the usual formula sweet and short so you will actually read the book review.

[Run along and read it]

Look at you. [deep satisfying sigh]

So kind to come back after reading that long post.

Oh wait. Is something wrong? Did your brain melt out of your cranial orifices when you got to claim #7?

I had to read it 2x just to make sure the words were in the same order as the first time I read it.

Talk about a record-scratch moment.

Naturally, I had to stop my entire life and go down a Jim Jones rabbit hole. It’s Halloween. Go ahead and indulge your morbid fascination with cult leaders and mind control. There’s a lot to learn from them in my humble-even-if-you-think-it’s-deranged opinion:

• Jonestown: The Life and Death of People’s Temple (85 min)

  This film is loaded with real footage, audio and interview. This is some crazy stuff captured on film. Be warned.

• The Jonestown Massacre: Paradise Lost (100 min)

  From the description: This feature-length docudrama tracks the final build-up to a horrific doomsday

  This is a dramatization. I watched it second. It’s more haunting than the documentary.

I watched them back-to-back in the same sitting. The way truth can be stranger than fiction is so…ugh words feel ineffectual. Trust me on this.

Warning: the expression “drink the Kool-Aid” will become offensive to you. What you think happened, isn’t what happened. Seriously, it’s an expression that needs to die.

This was all written under the influence of this song (which comes from an epic album btw)

Today’s letter is brought to you by the team at Mutiny Fund:

How can you access a multi-asset strategy concerned with protecting assets and growing long-term wealth?

The Cockroach Strategy seeks to achieve higher long-term, compound growth compared to traditional stock/bond-focused portfolios with more limited drawdowns. ​ It is intended as a total portfolio, a ‘set it and forget it’ approach that strives to give investors peace of mind and meaningful capital appreciation.

The Cockroach strategy consists of a diversified ensemble of assets including stocks, bonds, commodity trend strategies, long volatility strategies, and gold. It is designed to perform across multiple macroeconomic environments: growth, recession, inflation and deflation.

The Cockroach strategy gives investors exposure to asset classes designed to perform in each of those environments including stocks, bonds, commodity trend strategies, long volatility strategies, and gold.

Click Here to Learn More

Disclaimer: Investing is risky, and you are reminded that futures, commodity trading, forex, volatility, options, derivatives, and other alternative investments are complex and carry a risk of substantial losses; and that there is no guarantee the strategy will perform as intended.

Money Angle

This week I wrap and recap the month-long “real talk” series on trading/investing. I felt compelled to distill and consolidate these thoughts and append them to my progressing-like-molasses Moontower Money Wiki.

As a reminder, this wiki is my treatise on investing, broken into bite-size parts residing under 2 major headings:

• The Nature Of Markets
• Implementation

It’s intended to be a manual. The first part of it is only half complete and at the pace I’m moving my deadline is death.

Anyway, this month’s series has been encapsulated in:

• Special Topic: “Do You even Trade Bro?” (Link)

  It’s a touch irreverent and subdivided into:

  • The Fundamental Misunderstanding
  • A Warning About Options
  • If You Insist On Trading…
  • Is The Brain Damage Worth It?

Personal comment: If you find this stuff useful, share it. I don’t know what the right balance of how often I should even say something like that. I’m always torn between the utter naivete of “if it’s useful people will find it” and being a whore I can live with. But I’ve noticed that I keep landing in interesting conversations and opportunities as this (whatever “this” is) and I think that will be true if I keep being useful so there’s a whole virtuous loop and all that jazz that me and others have definitely spent too many words describing but the most important takeaway is that it’s real.

[I encourage anyone who thinks they have something to share to drown their self-limiting beliefs in the toilet and get on with the sharing already.]

Last Call

I posted this. Don’t judge. (I kinda did get judged but whatever. I’m secure, I swear.)

🤯

Was counting by 9s with the 6-yr-old before bed and literally just realized that the tens and ones place sum to 9 up to 90.

09
18
27
36
..

I think this is the same feeling my BIL had when he learned seahorses were real. As an adult. pic.twitter.com/NqM1yBDCkA

— Kris (@KrisAbdelmessih) October 26, 2022

To which I get this mind-blowing reply from resident math genius @quantian.

We learn of “digital roots”. It’s easiest to show by demonstration.

The digital root of 231 is the sum of the digits: 2 + 3 +1 = 6

You can do this for any number, just proceed until the final digital root is a single digit.

So for 489, we go:

4 + 8 + 9 = 21

(then 21 gets reduced)

2 + 1 = 3

So the digital root of 489 is 3.

After reading @quantian’s explanation, I summarized the conclusion:

Any number minus its digital root must be wholly divisible by 9.

So 489 – 3 = 486.

486/9 = 54

Sweet.

Gets better though.

Digits add up to 3 = divisible by 3. Add up to 9= teach them indivisible by 9. Teach them on a digital clock. I still do it reflexively 55 yrs later. My volume knob is rarely not divisible by 3….

— Joe Bang (@Jadam2122) October 26, 2022

So we can recap the rules:

• Any number with a digital root of 9 is divisible by 9
• Any number with a digital root of 3 is divisible by 3
• Any number minus its digital root is wholly divisible

Add this to any number ending in 5 being divisible by 5 and even numbers being divisible by 2 and you have a playful set of numeric wonders. And as @jadam2122 recommends, your digital clock becomes a fun toy for the kids.

And I’ll address the question some if not many want to blurt out…what’s the point?

The point is wonder.

I have zero doubt that there are readers who know the practical application of these observations (and I welcome them, and will even share the ones you send). But we are pattern-matching machines. Narratives, math, music, concepts. It’s all around us.

It’s true, in this letter, we often talk about how being a pattern bloodhound often leads us astray with confirmation and availability bias. But this ability to match patterns is also a skill from chess to trading to persuasion to self-awareness to diagnosis and to discovery. It’s a power we learn to wield. It uncovers the seams between disciplines.

If every time you saw a pattern, you dismiss it because its application was not-yet-apparent then your mental library of patterns would grow too slowly and the probability that you would match new stimuli to a small library would be tiny. You would deprive yourself of insight but also that feeling of wonder.

And that feeling of wonder is what leads to the next question.

And before you know it…you grow.

That’s why you’re here. Right?

Last Call

For all the San Fransicko talk, so much of it well-placed, it’s weirdness is exactly why it’s seductive. Yinh and I joined 12 friends on Friday night to don costumes for a night out in the Mission.

We started at Hawker Fare before hitting up Valencia Room and making it to a couple of classic Market Street spots that feel like archetypal SF — the piano bar Martini’s and the karaoke stage at The Mint.

I realized something about that seduction of SF. It’s weird and age-blind. The young and the old are out to play without restraint. It felt totally lacking in self-consciousness. I learned extensively of a sexual fetish that I’ve never even heard of before. Think of how weird that needs to be to find out about offline!

Coming back to reality was tough. When we got home after 2am I immediately went to email to check what time the 6-year-old’s final soccer game would be the next day, (since I’m the coach I should know, but I didn’t, and I couldn’t check when we were out because I, of course, left my phone in the Uber).

9am. The earliest game we had all season. Why wouldn’t it be?

Stay groovy.

Indulge me as I weave through a reflection I’ve been lingering on for a few weeks.

I was listening to software entrepreneur Travis Kimmel on the Mutiny Podcast (link). The whole conversation is fascinating and honestly quite dense when it gets into finance. There is a section where Travis, who studied philosophy, discusses the role of liberal arts in business.

He used a word that keeps unfolding itself in my head — “generative”.

He approaches the word came from its anti-thesis — skepticism. Travis is a fan. “Skepticism enforces discipline”. That’s a tight phrase describing a critical function for investors and traders — scrutinizing claims. Naive optimism can easily domino into over-extrapolation which is a fancy word for what hindsight simply calls “stupidity”.

Skepticism plays a key role in sound decision-making. The Big Five personality test has a dimension called agreeable/disagreeable. In Being A Disagreeable Investor, I point to the advantages of being disagreeable. [FWIW, I have median scores on 3 of the Big Five traits but score higher than the 90th percentile on “conscientiousness” and “agreeableness”. I interpret conscientiousness as the ability to jump through hoops. Combined with a standardized test, getting through a selective college signals high self-control + satisfactory IQ. As far as me being “highly agreeable”, I’ll just be happy that firms I worked for didn’t give people that test and screen me out.]

Back to Travis. Despite, celebrating skepticism he argues that skepticism cannot exist on its own. It must be part of a team because it is fundamentally “non-generative”. It is a razor that reduces. It does not build.

Seeing it phrased this way was a personal revelation. It unlocked a reinterpretation of my work history. It goes like this:

• The first 12 years of my career I was on the trading floor. I was in the mix of hundreds of people. It was social and often raucous. I got to see what my competitors were doing because they stood next to me all day. When a smart competitor did something others did not it was like watching an “alien move” in chess. Why did they do that? What were they seeing? By observing what happened before and after, you could use pattern-matching to reverse engineer decisions and strategies. This allowed you to learn more from a given sample of trades than you could in fully electronic markets where you can’t easily tie the tape back to its actors. High learning rates are addictive. The job was fun.
• When I moved upstairs to the hedge fund my early impression was it appeared quiet and academic. Without the roar of a pit to direct my attention, I had to re-train my senses and build new tools to “see” markets. Since I was hired to build the commodity volatility business I also had to guide decisions about infrastructure. My first few years at the fund were long hours and lots of collaboration with dev teams. I loved it. For new reasons. I was building. It was highly generative.
• Once the cockpits and engines were built, it was time to pilot the plane. Like the trading pits, I was back to the daily dogfight. Trading is a constant parade of mid-air decisions for 7 hours. Except this was a lot less fun than the pits. On the floor, there was a Ralph Wolf and Sam Sheepdog camaraderie that came with being shoulder-to-shoulder with your adversary. Everyone is both an opponent but also a possible future employer/employee. My first backer was a guy in my pit who worked for another firm. The people who have my old job are friends from my pit days. Upstairs, you have your team to talk to which is great, but it’s one outlet. Otherwise, you’re always chatting with brokers. Voice brokers can be friends but they are always balancing a fiduciary conflict. There’s no escaping the poker dynamic of those interactions.

With the lower learning rate off the floor, only occasional forays into building after the initial heavy lift, and a dip in social stimulation (I’m no life-of-the-party but self-identify squarely with extraversion) the job became tedious.

This arc combined with writing as a larger part of my life and the urge to self-align with projects where “agreeableness” holds more value to make leaving the gig inevitable. When I think about work, I realize that the right fit for me will need to tilt more towards being “generative” and I never saw it in those terms so clearly. So thanks for the language Mr. Travis Kimmel.

If interested, here’s how I personally apply this to myself.

I’m not much of a consumer. I rarely buy stuff and I don’t collect anything. Every piece of matter that seems to accumulate in my life feels like a liability I have to service. Things own me, I don’t own things. I feel bad when I don’t maintain things, but I also have zero desire to maintain them. So minimalism is less of a design aesthetic and more of a gate-protector of my time (ironically, I’m not much a fan of minimalist, cold modern spaces. I like rich environments that feel tied to the past with taste in ways I don’t possess but love to admire).

I feel like I was supposed to be some kind of bizarro librarian. Bizarro because I don’t read that much. But I collect ideas. I collect them for synthesis. Ultimately, I want ideas to be combined so they are useful.

Collection and synthesis are generative functions. A team needs both with skepticism sprinkled in to “enforce discipline”. The functions are then passed to a do-while loop known as practice.

The requirements of practice act as a filter on the vastness of ideas one could choose to collect and index.

Applying this logic personally, I’m increasingly of the mindset that my constraint is “how do I teach” effectively. “Effectively” means arming others with the ability to improve their outcomes from learning. I’m not interested in teaching trivia. I want to enable agency in service of growth.

Finding smoother ways to both represent and communicate lessons is a generative task. If I shed restraint for a moment, I admit it’s actually compulsive. It stirs me in ways that the video game of trading does not.

I’m more interested in being obsessed than the actual output of a job (in the case of trading, the output is cash baby). But I’d rather be obsessed than rich.

Some are obsessed with being rich. Some have obsessions that lend themselves to getting rich (the best athletes, programmers, portfolio managers). I think my best chance of being happy with how I spend my time is being obsessed. And who knows, maybe that will lead to getting rich.

(I was born in America and have gotten lucky enough to consider myself rich by any broad objective standard. I purposefully live in a place that makes me feel like a small fish in a big pond so I don’t think of myself as rich but I’d be an ass to bring that attitude to a global perspective. Words have scale dependence.)

Today’s letter is brought to you by the team at Mutiny Fund:

How can you access a multi-asset strategy concerned with protecting assets and growing long-term wealth?

The Cockroach Strategy seeks to achieve higher long-term, compound growth compared to traditional stock/bond-focused portfolios with more limited drawdowns. ​ It is intended as a total portfolio, a ‘set it and forget it’ approach that strives to give investors peace of mind and meaningful capital appreciation.

The Cockroach strategy consists of a diversified ensemble of assets including stocks, bonds, commodity trend strategies, long volatility strategies, and gold. It is designed to perform across multiple macroeconomic environments: growth, recession, inflation and deflation.

The Cockroach strategy gives investors exposure to asset classes designed to perform in each of those environments including stocks, bonds, commodity trend strategies, long volatility strategies, and gold.

Click Here to Learn More

Disclaimer: Investing is risky, and you are reminded that futures, commodity trading, forex, volatility, options, derivatives, and other alternative investments are complex and carry a risk of substantial losses; and that there is no guarantee the strategy will perform as intended.

Money Angle

This month’s consolidation of ideas on the meta of trading continues with:

Trading Is A Team Sport (13 min read)

It covers:

• The importance of building a team
  • The value of multiple perspectives
  • How a team reduces bias in practice
• Building the team (mostly in a retail context)

Last Call

I just want to give some love to a few people doing great work. Notice how related and leveraged their journeys are to the permissionless internet. It feels like the singular most important force, for good and bad, of the past generation.

Paul Millerd

Paul is a friend who I’ve gotten to know from ping-ponging lots of ideas with over the past few years. I highly recommend his book Pathless Path (my review and notes).

He just published his 200th newsletter issue and it’s an amazing summary of everything he’s been sharing. It’s full of concise representations that you can carry with you as make decisions about your own path.

See The Great Digital Creator Arbitrage Opportunity (Boundless)

Kyla Scanlon

Kyla is a juggernaut creator on TikTok, Twitter, Youtube, Twitter, Substack and now Bloomberg who is pumping out funny, provoking, and highly educational finance content covering topics du jour. Unlike the common grift that typifies this niche, Kyla is the real deal, bringing the right mix of knowledge, skepticism, and humility to a fundamentally complex subject.

You can follow her on your preferred platform from her website:

https://kylascanlon.com/

so much of my life has been people taking chances on me and i have been trying to find a way to express gratitude around that but it's something that is so meaningful yet so hard to tangibly describe

— Kyla Scanlon (@kylascan) October 18, 2022

You gave them a reason to put that faith in you. You thank them by continuing to be you.

You might find that to be an agitating answer and that's exactly why they have been taking chances on you.

— Kris (@KrisAbdelmessih) October 18, 2022

Noah Bragg

Noah founded potion.so

I used it to create another website this week using Notion as my CMS or “content management system”. The website is a private project I’m doing with a few local collaborators but this showcase is filled with inspiration.

The latest website I built was up and running in minutes with a clean URL which is simply the domain I bought. I will be building another website soon for another project and it will also be built on Notion using Potion (my current online home is already built that way).

Noah is highly responsive and patient in dealing with a tech-handicapped fogey like me.

Millions of users, including many Moontower readers, are organizing their knowledge in Notion. You are one step away from turning that into a clean, beautiful, online property.

[None of these people pay me for endorsing them. In fact, it’s quite the opposite. I pay all three of them for their work.]

I threw a $500,000 purchase price and a 7% 30-year fixed rate into a mortgage calculator. That’s a payment of $3,327.

Earlier this year, if you secured a mortgage at 3%, you could have bought a home for $790,000 and had the same payment.

Since housing hasn’t dropped 36% this year homes have gotten much more expensive to own. Considering you can buy 1-year t-bills yielding 4% that are state-tax free and nominally risk-free, the investment case for RE is looking pretty poor unless rents skyrocket or real estate craters to bring cap ratios back up.

If the higher rate environment leads to a recession and lay-offs then I’m doubtful that rent increases are going to be the primary normalization pathway. It feels like employment trends will be a clue to how quickly housing will re-price lower (it’s already started of course). The yield curve is inverted, so the bond market is suggesting that the rate hikes in the near term will slow inflation and the economy.

This is all just simple observation. Like looking out the window. And as one does, when they sit at a window, one muses. And muse I shall.

Musing #1: Bid-Ask Widening

A year ago the people that paid ridiculous prices for RE were market orders. “Fill me at any price”. Many of them were immediately in the money (ie they probably could have turned around and sold a month later for more. Maybe not net of transaction costs but you get the idea). This isn’t shocking. When optimism turns to euphoria, the rate of change of the returns themselves can explode into a parabolic curve. Of course, such curves are unsustainable. The smug moment of being in the money is short-lived in the same way that a fund that buys a ton of stock going into the close usually gets a favorable mark on their daily p/l. Their sloppy buys drove the price higher in a short period of time. The real sellers didn’t have time to react before the close. But as soon as they check the comps overnight, you can be sure the supply is coming tomorrow morning.

I think of it like water going down a drain…once most of the water is through the drain the remaining liquid swirls quickly around the drain before you hear that sucking sound. Whoosh. The last bid is filled. With maximum punnage — the liquidity is gone.

In the meantime, many other buyers were priced out. You can think of them as limit bids. It’s an imperfect analogy but it will suffice. As things go south now, some of those bidders might be anchored to their original bids which were “cheaper” than where the home traded. However, if they get filled on the way down, they actually have more negative edge even though they got this theoretical house for a cheaper price than the original buyer. You could belabor this with a stylized model but understanding this concept is a big step towards understanding trading.

Anyway, the old limit bids are probably the new ask and the real bid/ask spread is wide. Prospective buyers are adjusting their bids much lower to keep the monthly payment constant or at least manageable, but sellers who likely have cheap financing from the prior low rate regime do not have to cross the spread. If current prices are 5% off their highs but the new mortgage math means homes they should be 20% lower (similar to the stock market) the current listing prices are the “asks” of a wide market.

Buyers lifting those offers are giving up edge for convenience/immediacy. That’s the usual reason people willfully give up edge for anything. Sellers hitting bids either need to (relocation, getting laid off, divorce, or any other life thing that shuffles liquidity needs) or they think rents aren’t going to increase as part of the normalization process.

Musing #2: Price Can Ruin Any Investment Idea

Always promotional, the real estate industry in an effort to pump bids, always finds an angle. They look at CPI and rates increasing, and peddle “RE is an inflation hedge”.

I mean, sure. But price matters.

By that logic, RE was also an inflation hedge 6 months ago, so are real estate prices supposed to be higher today given the elevated inflation of the past 6 months?

A few weeks ago Tom Morgan published Eight Investing Gems, which was a list of underappreciated, evergreen concepts sourced from investment professionals. I was flattered to be asked and my response fit well here:

Markets are biology, not physics, and that’s important because every good idea can be ruined by price. For example, real estate with a mortgage might be a good inflation hedge, but if history has taught everyone that lesson then it will be less true going forward. In other words, the price today already incorporates that (imagine paying 3x for your current home… how’s that going to work out as an inflation hedge?)

Prices are what matter. Not blanket, lazy sentences like “RE is an inflation hedge”. You’re not trading sentences.

[It’s also not clear that RE is an inflation hedge during periods of inflation]

Musing #3: Bullwhips Everywhere All The Time

Investopedia:

The bullwhip effect refers to a scenario in which small changes in demand at the retail end of the supply chain become amplified when moving up the supply chain from the retail end to the manufacturing end.

With Covid closings followed by re-opening, this effect has received lots of attention. It’s not new. The famous beer game lets you play as a retailer, distributor, manufacturer, or wholesaler to make ordering decisions that balance your inventory against your customer’s demand. Orders are a proxy for demand, but the lag times in delivery lead to over and underreaction in ordering decisions.

Bullwhips feel like an apt analogy for the over and under reactions that happen in our largest markets:

1. The underbuilding of homes since the GFC. Builders’ PTSD and higher lending standards for the past decade have contributed to a housing shortage. In the past, I might have associated building velocity with the credit cycle, but the excess of the mid-aughts seemed to have chastened builders despite the loose monetary conditions of the 2010s.
2. Energy prices, in the wake of shale’s “growth at all costs”, busted in the mid-2010s. They surged back recently as the reality that fossil fuel transition will take longer than expected has collided with underinvestment in production. Drillers were scolded both from their investors (overproduction) and would-be investors (ESG).

[Just FYI, def not advice:

I sold my energy overweights in the Spring and recently started dollar-cost-averaging back in as I add investment exposure in this pullback. Overall, still overweight cash which I’ve been moving directly into T-bills. I’m in the midst of trying to do a rebalance from RE to equities but need one leg to close first so I don’t get middled. I hate illiquidity. In case curious, my prior energy exposure was XLE in an IRA, but I’m re-entering via deferred WTI futures. Instead of a div yield, you get a theoretical roll return. I am not an especially active trader/investor so I figure I’ll share stuff like this when I’m actually doing something. Again, I’m more weighted in cash than most sane people and don’t consider myself a good investor — I mostly try to avoid disaster. I just want to have my assets match my future liabilities — if I want to get rich, I’ll try a higher signal route of relying on myself not random number generators.]

• Musing #4: Too Many Assholes Playing A “Loser’s Game”

Read this essay:

Too Many Assholes (7 min read)
by Jared Dillian

Jared is an author. He’s published a couple books, one was fiction. He was an index trader for about a decade before becoming a full-time writer amongst many endeavors. Jared is an exceptional financial writer. I read his professional letter regularly for most of the past decade.

This particular essay starts out:

This will be the only financial essay I write, I promise.

His substack is about culture and life not investing. So when he paused to write a single finance post in this collection, I paid attention. It felt very familiar. It has the same feel as his paid daily writing.

I want to offer a perspective on his writing. When people ask him for a free sample of the paid letter he doesn’t give them out. It’s for the same reason I give when people ask me if they should sub to his letter. The individual letters are not useful if you are looking for a great stock tip or definitive proof that the letter will make you money. So if you ask for a single letter, you miss the point. He’s capturing the broad strokes and he’s repetitive. And this is valuable in its gestalt.

I’ll re-hash my Twitter thread on Jared’s post:

This essay could have been called “play the cards not the man” but Jared is a snappier writer so he cut to the heart. It sounds like a folksy kind of essay but it’s deep. If you can internalize his essay you risk making small mistakes, you’ll almost definitely get the timing wrong, but there will be no catastrophes. Since survival is the goal in what Charley Ellis called the “loser’s game” this essay is an irreverent treatise in financial self-preservation.

Jared brings up contrarianism which by definition is required fo outsized returns. But at the turns in markets, the contrarian instinct is defensive. Yes, it can be expensive mid-trend but I’m not advocating for perma-contrarianism anyway. Sometimes contrarianism is common sense when LPs in private funds are climbing over each other to pay 20x revenue for profitless companies.

Options trading provides a well-balanced education in contrarianism. You spend a lot of time fading “point spreads that went too far” so you learn to deal with the discomfort of positions that are against the crowd. And of course, you do need to manage risk around that carefully (position limits are key because once a price enters la-la land there’s no restraint on it go to la-la-la land). At some point, you are selling because you are approaching “there’s nobody left to buy” territory and that is the exact point in time when it’s hardest to do that.

Playing the hindsight game, in the Spring I sold my energy stocks (a touch early but again it was a small mistake) despite being bullish. The thinking: Everything about oil looks bullish but everyone else sees that too. It’s insane to be bearish. But then you have to switch into the mind of a seller…there is no opening seller. So the price must contain a massive premium in it to attract any sell flows.

And that is enough to pull the trigger to sell for me. Yes, I could be wrong, but the risk/reward said “sell”. No fundamentals. Pure psychology.

[This isn’t any kind of victory lap. I’m losing money because I’m basically a long only investor and my current life is not a trading seat where I have the advantage of being in the mix.]

The question to focus on is “What psychology is in the price?” The price includes all the spreadsheets already. It’s the sum of the emotions and the nerds.

Jared focuses on sentiment. It’s not too useful when the game is played near the 50-yard line. In that zone, I’m perfectly fine to outsource to passive collection of market risk premium. With stocks, you know the proposition — earn 5% over the risk-free rate, give or take 15%, and experience a double-digit peak-to-trough drawdown every other year, and something like a 50% drawdown once a decade. Fat tails. That’s the deal. Over the long-run you’ll make money, but sizing that proposition is a personal matter.

The psychology matters more at the turns. The edges of the field. Marching through the redzone, from the 20-yard line to the goaline, can feel dramatic in compounding space. The 5-yard line to the goaline — this is the blow off top in Doge or the Volkswagon short squeeze in 2008…where the bulk of a total return can come from a short time. This is when things are obviously unstable. Sticking around to find out which down is gonna be the pick-6 is baggie roulette.

You don’t need to be some market genius when things feel crazy. Just realize that the only way the price can make sense is if someone crazier came along. Unless you have a very special edge in that game (I suspect at these critical turns the internal mechanics of liquidity are understood by a handful of insiders/clearing firms/exchanges, perhaps it’s a short squeeze, that connect the trading world to the credit/banking world. If that’s the case, you, sitting at home in your pajamas, are playing no-limit hold’em with a worse than random hand against people who know their cards.)

If you don’t have a hero instinct and just try to get the broader picture roughly right you can avoid the giant mistakes. That’s 95% of the battle. 2021 was stupid euphoria. That was obvious even in real-time. Sure you could have been early to that realization and looked foolish for a while but zoom your perspective out and ask yourself:

“Am I feeling fomo or fear?”

That will tell you what everyone else feels and that tells you what’s in the price. You know what that’s called: empathy. You are putting yourself in the minds of others and therefore the price. It sounds like soyboi shit. But that shit is full is wisdom if you can channel it.

Today’s letter is brought to you by the team at Mutiny Fund:

How can you access a multi-asset strategy concerned with protecting assets and growing long-term wealth?

The Cockroach Strategy seeks to achieve higher long-term, compound growth compared to traditional stock/bond-focused portfolios with more limited drawdowns. ​ It is intended as a total portfolio, a ‘set it and forget it’ approach that strives to give investors peace of mind and meaningful capital appreciation.

The Cockroach strategy consists of a diversified ensemble of assets including stocks, bonds, commodity trend strategies, long volatility strategies, and gold. It is designed to perform across multiple macroeconomic environments: growth, recession, inflation and deflation.

The Cockroach strategy gives investors exposure to asset classes designed to perform in each of those environments including stocks, bonds, commodity trend strategies, long volatility strategies, and gold.

Click Here to Learn More

Disclaimer: Investing is risky, and you are reminded that futures, commodity trading, forex, volatility, options, derivatives, and other alternative investments are complex and carry a risk of substantial losses; and that there is no guarantee the strategy will perform as intended.

Money Angle

I’ll be squirting out some new posts about trading over the next weeks. They aren’t technical. Here’s the first:

Permalink: Trading Vs Investing

Trading is a business. Like a casino. You spread the risk over a bunch of tables and let the law of averages1 do its magic. Investing, whether it’s as a shareholder, LP, or creditor (ie allocating capital in the primary or secondary markets, but not as a member of management) is something you do in a business. You can invest in a casino. You can invest in a bank. You can invest in a trading business. The point is that investing and trading are actually different.

The distinction seems subtle because the language and mechanics of investing and trading overlap. Traders talk about diversifying as much as investors do. Restaurant owners don’t. Traders and investors both talk about position sizing. Software founders don’t. This makes it easy to confuse trading for investing but the former is a business, not an investment strategy. You would not compare Optiver, Jane Street, or SIG’s returns to a portfolio manager’s. Trading firms think in unit economics just like any business (“how many fractions of a cent of edge do I get per contract?”). The portfolio manager doesn’t have a similar analog. However, if we look at asset management, it collects fees. So if we zoom out, we are at the business-level of abstraction yet again.

There’s an interleaving of concepts that binds notions of “trading” to “investing” in a way that can mislead investors. When they trade are they trading like they are a business, like they are providing a service (temporary liquidity in exchange for a theoretical fee which resolves the desire for a buyer or seller to transact in the absence of a natural counterparty) or are they rebalancing investments? The distinction is one of framing and like all frames, it has a tyrannical grip on one’s downstream decisions. The subtlety can be confusing to new investors who can’t escape terms like “daytrading” or that Robinhood calls itself a “Stock Trading and Investing App”. You wouldn’t take a Porsche off-roading any more than you should confuse these 2 endeavors.

And yet you might for all the superficial similarities I already described. It’s totally understandable. To create the appropriate distance between activities of “trading” and “investing”, I’ll offer 2 thoughts.

• Time Horizon

In trading, the bets have endpoints. Whether it’s an upcoming catalyst or event, an option expiration, or time to roll a future there is a time when you get to “see the river” to borrow a poker term. Price and reality must converge. Extrinsic values go to zero. Future prices meet spot prices. With equities, the metaphor needs massaging. Perhaps news or earnings is more like the “flop” or the “turn” whereas M&A activity serves as a defacto endpoint.

With investing, the duration of the trades is typically much longer. Stocks are perpetual claims. Perhaps semantically awkward, I prefer to re-brand investing as “re-investing”. This focuses us on a company’s need to compound returns on capital internally. If an oil company sits on massive reserves, but the price of oil shoots to a price that destroys all future demand, the stock would plummet because it no longer has a forthcoming stream of earnings. Yes, its book value would immediately increase, but that is a smaller portion of its discounted perpetuity value.

The “re-investing” frame explains why a market would discount such a one-time windfall. You can even think of a “cheap” stock as a company that the market has decided has a low future return on invested capital. By not increasing their bids, investors are manifesting trader thinking — they are focused on return per trial. Thinking of investments through the lens of how a company re-invests, stretches “repeated game” thinking longitudinally into the future as opposed to traders or casinos who think of edge per trade cross-sectionally.

• Seeing The Present Clearly

Since the compounded return of an investment depends on how a company re-invests, it requires distant foresight into an inherently complex system. Long-term investing, like long-term weather forecasting has an irreducible bar of uncertainty that sits unpleasantly high off the ground. There’s only so much you can say about a system governed by chaos, biological, and evolutionary forces as opposed to tidy physical properties. Feedback loops are long, causation is opaque, and the signal-to-noise ratios are too low to prove an edge. This leads to a paradox. If a manager’s edge is unprovable, then there’s a chance you can actually access it, you’ll just understand it post-hoc. If the edge was provable, the manager would extract all the excess alpha for themselves by either choosing strategic investors or charging ransom fees.

Trading on the other hand is a provable edge. Because it’s a business. You rake a tournament, take the profits off the table and hunt for new players. Markets might imply or try to tell us something about the future. The business is to find market prices that say something contrary but have visibility to resolving and taking both bets. Arbitrage is an extreme example of this. If one person thinks the USA basketball is 90% to win the gold and another thinks the field is 15% to win the gold you can bet against them both and get paid $105 while knowing you’ll only owe $100.

The business process around this involves measurement, not prediction. There’s no thematic vision of what the world looks like 10, 20, 50 years hence. Instead, you find others who express strong opinions that disagree and build a machine that lets you bet against both of them. You are passionately agnostic. You are in the business of seeing today clearly. Not having visions of the future. That’s your customer’s job. That’s the investor’s job.

A Skinny Bridge

Coming from the trading world, I’ve wrestled with my understanding of investing. I don’t believe in crystal balls. I don’t think any “long term” investor can prove they are special because of the limits of data and sample size. Putting faith in track records feels like betting on coins that just had a long streak. There are a lot of funds out there, it’s inevitable some will have long streaks by chance. Survivorship bias makes the proportion of lucky funds even more visible.

This is a discouraging place to settle. Attempting to invest in a trading business as opposed to doing the trading business, leaves you in the same epistemological rut as choosing any business to buy. They are just businesses, to be compared with any other business. In fact, the search is pointless. Most are capacity constrained which means the best ones don’t need your money anyway. Where does that leave me? I don’t trust most people who would take my money to manage it and I don’t have the expertise to invest to the impossible standard of risk-reward that the business of trading anchored me to. And I need to take myself seriously — I just spent this entire essay explaining how it’s a fallacy to compare trading to investing in the first place.

Is there a reconciliation?

I think so. I see a skinny bridge between the business of trading and what it prescribes for investing. It lies in portfolio construction and asset allocation. At one level of abstraction, the investors with their coherent visions of the future are simply tourists in the traders’ casinos. But if we zoom out and aggregate the consensus of competing investors we end up with a total market price. It’s not one market however, it’s many. There are equities, bonds, and commodities. They exist across geography and sovereign systems. These are the legos that can be stacked to construct payoff shapes — carry, insurance, momentum. Those can be described in other language as well — concave/convex, convergent/divergent.

The asset classes themselves contain a risk premium above risk-free rates (by induction — stocks should earn more than t-bills because you need extra compensation to hold something that tanks every now and then). By combining these asset classes under battle-tested principles of risk management, the hope is to capture the weighted average risk premium of your allocation without relying on forecasts. Just like trading businesses. Just like casinos2.

Wrapping Up

Trading and investing are sufficiently different that you should be conscious of what mode you are in when you click a buy or sell button. The awareness will likely lead you to pressing buttons less often, or systematizing when you push the buttons. Unless you’re in it for the thrill, you want to minimize your points of contact with the fee-generating businesses that want you to feel like you are doing a good thing by “investing”. You are doing a good thing when you invest, but be careful — sometimes what looks like investing is trading. And the bar for doing that productively is much higher than they want you to believe.

Last Call

I’ll be in NYC this week for the StockSlam Sessions with Steiner and Tina.

Paul Millerd recently interviewed Steiner. My favorite thing about talking to Steiner is his experience and perspective on high school kids. It’s easy to focus on negativity, but Steiner teaches at a diverse public school in NJ and sees so much positivity and optimism in how the kids treat one another. I get it, that doesn’t get the clicks. The incentives aren’t really for truth so we shouldn’t be stunned when the happy news is more correct (this would actually make a neat Bayesian homework problem to make the point).

Steiner’s experience is anecdotal so I’m not generalizing. I’m just saying — this isn’t going to be negative, click it anyway:

Training Elite Wall Street Traders (podcast/video)

From Paul:

This conversation was a delight and I think you’ll enjoy it. We cover:

• Ending up at Penn and not really knowing what he was going to do
• Figuring out he enjoyed math and finance
• Getting a job at SIG
• Joining the training team
• Leaving finance to spend more time with his kids
• Becoming a high school teacher
• How he thinks about teaching & mentorship
• His 20-year journey in creating his game “Stockslam”

From My Actual Life

I’m going to the Greek in Berkeley tonight for the 3rd time in as many weeks. We are seeing the Aussie band King Gizzard and The Lizard Wizard. They are the most prolific band of the past decade. They release more than 1 album per year. Last month they dropped 3 albums. Not a typo. They have played over 100 different songs on their current tour and the range of music goes from metal, to pop, to spoken word. They are far out. The music videos are a trip too.

Funny thing about these tickets. I bought them a year ago thinking they were for 2021. I didn’t realize the date was off by a year until the morning of. And this worked out for the better because tonight’s a date night. Yinh and I are celebrating our 13-year wedding anniversary. We got married in Mexico and I remember the all-nighter she needed a few days before the flight to get this document to the printer in time to get into to the guests’ welcome bags:

At my mom's house and found…

The mock US Weekly my wife made for all of our wedding guests pic.twitter.com/3zXZQrFbTG

— Kris (@KrisAbdelmessih) August 3, 2021

Lately, I’ve been watching Pirates of Finance episodes during my weekly cardio sessions. Jason and Corey are a special combination when they just riff on whatever pops in their head. A recent episode, The Gamification of People, provoked some musings.

Where Exactly Are We Racing To

The pirates revisit Malcolm Gladwell’s discovery that the best hockey players in Canada were disproportionally represented by athletes whose birthdays were just after the grade cutoff. So children who are the oldest in their class or hit puberty in their class first have an advantage.

If you are a summer birthday you understand this. The school year starts, and some student brings Rice Krispy treats for the class and you think “this mf is a whole year older than me”. Jason remarks that even though he has no kids, he has heard that parents in affluent suburbs hold their kids back at a young age so they can be swept up by the positive reinforcement loop of being a better athlete or student. A ”snowball effect” builds as a confident child draws more attention from coaches, gets into the higher track in class, and is even less likely to be diagnosed with ADHD.

Via WaPo:

Researchers found the youngest children in a grade — those born in August, just before the cutoff — were significantly more likely to be diagnosed with ADHD compared with those who were born the next month and became the oldest in their class.

Corey notes that as knowledge of Gladwell’s chapter in Outliers spread, the efficient market mechanism kicked in. Parents started holding their children back a grade. Jason, who admittedly has no kids, sounded skeptical. Jason, if I was in the comments section of the livecast, I would have told you — the practice is called “redshirting”. Like the NCAA athletes.

Our local school district is extremely strict about not allowing it. By making the date cut-off a redline, they don’t have to deal with every case-by-case plea to hold kids back. In fact this week, I was chatting to a mom of triplets at my kids’ school, who despite a totally valid reason (in my totally unqualified opinion) for holding the kids back, did not get an exception.

The impulse to redshirt your kid, even though you risk them being bored by playing “down” a level, for a competitive advantage is classic Moloch — a race to the bottom. If a parent doesn’t hold back their kid in such a community are they now doing them a disservice? I mean what a miserable question to entertain. But here we are.

A few years ago, schools in our area decided to move the scholastic calendar to start in early August. Why? So they can have more time in class to prepare for the end-of-year standardized state tests. What has been the cost of this intervention? Togetherness. My kids now go to school a full month earlier than their cousins in NJ. The end of August is a classic time for vacation with both camps and school out of session. I know, I know — violins. I won’t turn what amounts to a high-class problem into a crusade, but the point is the school is reaching for an artificial advantage. If every school adopts this calendar, the advantage goes away and we are just worse off. It’s all frustratingly familiar.

Let’s go back to Corey’s point about market efficiency. Mechanically speaking, he’s right. But it’s actually more interesting as a demonstration of the flaws in market-maximalist thinking. If you graduated from U of Chicago, turn back now. You’ve been warned.

The market is a servant of our collective values. If we choose the wrong values we are asking to be consumed by the “paper-clip maximizer”. This is exactly why AI research is so concerned with safety. We tell the system what to optimize for and it will do so faithfully — but without an appreciation for what we forget to tell it.

Market-based thinking needs to be accompanied by a responsible understanding of our values. This runs head-on into an accounting problem — “not everything that we measure matters, and not everything that matters can be measured”.

A specific instance of this is negative externalities. The textbook examples are companies that socialize the costs of pollution while capturing private profit. More oblique examples abound in Corey and Jason’s conversation. How does the UI of investment platforms “nudge” our behavior? Are those nudges good for the clients, the company, or both? They give the example of a robo-advisor that tells you the concrete tax cost of selling appreciated assets. It’s an effective speedbump because investors hate paying taxes. It seems like a win for both the advisor and client. But how do we compare the sure tax savings against the theoretical risk reduction that happens by cutting concentration? This is hardly straightforward. You don’t have to be THAT cynical to think that a tie goes to the robo-advisor’s interest. Would a more nuanced speedbump that considers the trade-offs of different actions fulfill fiduciary responsibility better? Is it worth the brain damage to clients?

I don’t have answers to any of this. One of my beliefs is that our dashboards of cost/benefit are woefully underpowered. Partially because of incentives — commercial interests talk their own book. But also because of irreducibly complicated chains of causation. Even if you could construct higher fidelity models of reality, internalize all the externalities, and identify the “best” values you’d still fail. Because on average people don’t really want the truth. We are cognitive misers. We either want the laziest solutions or we want to keep our delusions intact.

I’m pro-markets. But any platonic idea that they are “free” and not downstream from laws motivated by imperfect actors is an illusion. That markets do a generally effective job in allocating resources reminds me of that Twain bit: It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so. Misplaced confidence is more dangerous than things we know are dangerous because things that appear safe become load-bearing. If a money-market account defaults, that is far scarier than BTC going to zero because we size our exposures in proportion to how safe they are.

We need to be careful about what values we ask markets to chase. Free market maxis love to cite the law of unintended consequences against nudgy top-down policy. That’s valid. But the sense that markets, whose guardrails emerge from human negotiation and therefore limited foresight, aren’t immune to unintended consequences is a fantasy.

No idealogy is so important that we can’t inquire — who’s serving who?

Ouija Boards

Corey and Jason struck another nerve. They get into the topic of sales. They acknowledge that while they have an idealistic aversion to sales, that’s not a practical position. Everything is sales because sales is persuasion. From getting clients to finding a mate. No controversy there.

Consider the used car dealer’s tactics — lying, creating urgency, and so on. Yes, it’s cringe, but…it’s also a strawman. The best salespeople don’t look like they are selling. And they often aren’t in the conventional sense. They aren’t trying to convert you, they just cater to your bias. That sounds nefarious but it doesn’t have to be. If I am in the market for an investment fund, tell me why I should want yours. I’m buying one either way, put your best foot forward. It’s hard to distinguish “talking your own book” from “the manager is employing strategy X because they believe in it”. They are already betting their career on it. Where does belief end, and conflicted interests begin? It’s a tough question. Sure, the benefit of a doubt needs to be earned but assuming everything is a scam will leave you in a cave.

Back to the tactics. The pirates mention “mirroring” and saying people’s names (“John Smith, let me tell you something about this car”) as examples of manipulation often found in sales guides or books like Cialdini’s Influence (brief notes from an interview with the author here). Corey acknowledges that some people do this naturally.

I felt seen.

If a server tells me their name, I use it. I tell myself this is a way to be kind. I take the Zeroth Commandment seriously. But am I post-rationalizing an adaptive behavior? Have I figured out that being kind is a way to get what I want? Am I manipulative?

I feel like I’m shooting airballs here because I just don’t f’n know. There are 2 kinds of people. Those that are full of shit and those that admit it. It’s a bit of a cope, but I’m old-fashioned in thinking intentions matter. It makes you sound smart to moan about the road to hell being paved with such intentions. It sounds smart because there’s truth to that. But it has less to do with intentions themselves and more to do with reality being sloppy spaghetti. The arrows of causality are far more bi-directional and recursive than our coherent explanations suggest. Well-intentioned people often come off looking like Steinbeck’s Lennie strangling the objects of their affection by not knowing any better.

Still, discounting intentions fully in deference to optimization is a cope of its own. Incentives are Oujia boards. They guide us to what we want while we tell ourselves stories about how our beliefs make sense. We spell out the letters of whatever serves us individually.

And then we look at one another “Did you move it? I wasn’t moving it. What does it spell?”

J-U-S-T-I-F-I-E-D

Today’s letter is brought to you by the team at Mutiny Fund:

How can you access a multi-asset strategy concerned with protecting assets and growing long-term wealth?

The Cockroach Strategy seeks to achieve higher long-term, compound growth compared to traditional stock/bond-focused portfolios with more limited drawdowns. ​ It is intended as a total portfolio, a ‘set it and forget it’ approach that strives to give investors peace of mind and meaningful capital appreciation.

The Cockroach strategy consists of a diversified ensemble of assets including stocks, bonds, commodity trend strategies, long volatility strategies, and gold. It is designed to perform across multiple macroeconomic environments: growth, recession, inflation and deflation.

The Cockroach strategy gives investors exposure to asset classes designed to perform in each of those environments including stocks, bonds, commodity trend strategies, long volatility strategies, and gold.

Click Here to Learn More

Disclaimer: Investing is risky, and you are reminded that futures, commodity trading, forex, volatility, options, derivatives, and other alternative investments are complex and carry a risk of substantial losses; and that there is no guarantee the strategy will perform as intended.

Money Angle

With the StockSlam Sessions rapidly approaching, I want to thank Jeff Malec at RCM Alternatives for inviting Tina, Steiner, and me to his show. You can listen to the pod or watch on Youtube. Steiner is an offline guy, so foremost this is a nice introduction to him.

• The Game of Trading with SIG Alums Kris A, Tina L, & Steiner (Link)

  We have a little saying over here on The Derivative, “The More, The Merrier”, and on this week’s episode of The Derivative, we’re not chatting with one guest, but THREE! Class may no longer be in session, but we are taking a trip down the SIG/Susquehanna memory lane and having our own class reunion with Kris Abdelmessih, Michael Steiner, and Tina Lindstrom.
  

  If you’re interested in learning how big trading firms find and teach their traders, hold on to your seat because these three give you the answer key! Kris, Tina, and Michael are in session with Jeff and discussing competing with peers, finding an option’s fair value, making markets, and being in the game of trading, educating kids with board games, and of course Steiner’s new trading board game: Stock Slam! Discover how the game works and how you can join up with these three in NYC for a live session in this three-of-a-kind episode

We are doing these sessions because trading is a neat laboratory to learn about decision-making. Weighing risk-reward, thinking adversarially (this thread by @0xDoug is in my hall of fame), resisting confirmation/hindsight biases, using probability, considering counterfactuals, not “resulting”, and much more. So much of my writing focuses on these “meta” topics because trading gave me a better education than school ever did.

If we can help people practice thinking this way, it’s a like growing new brain lobe that’s adaptive for many real-life situations.

The following is adapted from a thread I wrote that demonstrates an idea in a trading context:

People understand that even though insurance has negative expectancy it can still improve a portfolio that is focused on compounded returns. It makes no sense to look at the line-item of insurance divorced from the optionality it gives you in the rest of your portfolio.

(I could pull lots of links on this idea, but let’s be brief).

This concept is fractal. Let’s zoom in on the smallest portfolio — a spread. You don’t necessarily care about the p/l of any individual leg of a spread trade but the performance of the spread overall.

Before we consider a spread, let’s just look at the single position. Suppose you buy something for $4 when it’s worth $5 but then sell it for $4.50. You made both a:

• +$1 expected value trade
• -$.50 EV trade.

If you knew it was worth $5 you negated half a good trade with a bad trade.

In real life, you often might like the price of a spread but it’s hard to tell which leg is the “good side”. That’s one of the reasons you trade the spread. Once you do the spread you don’t care about the individual p/ls.

Another reason you may do a spread is that you might like a trade (ie maybe vol is cheap in X) but can do it bigger if you spread it. This is one of those questions that comes up a lot on real trading desks. Do I like the outright, or do I like the trade better paired against something else (and assuming I can do the trade bigger if I spread it)? Do I like being long z units of X exposure, or do I prefer 5z units of (X-Y)? The answer depends on understanding the distribution of the outright vs the spread and the relative price of each within those distributions.

Finally, there’s the general lens of how I approach trading (which I discuss in the RCM interview). Liquid markets tell us a lot about “fair value”. If we take fair value as the consensus “outside view”, then we can examine illiquid markets for pricing discrepancies compared to that outside view. Of course, those markets have their own idiosyncracies, so you need to take an “inside view” and normalize as much as possible to the liquid reference asset. This is a standard way to identify possible opportunities. It’s a mix of art and science. The science is in the measurement but the art is in handicapping how much the differences should matter. This isn’t arbitrage. It’s informed betting. If you need certainty, you will either be too late or the strategy will have the lifespan of a mayfly.

[I actually googled “shortest lifespan” and was met with irony:

We often hear that mayflies, like the whiteflies of the Susquehanna River, have the shortest lifespan of any animal on Earth, just 24 hours for many species.

SIG is named after that river.]

Now let’s broaden the concept to investing. For that, I turn to Byrne Hobart’s paywalled post Assuming Efficient Markets to Exploit Market Inefficiencies:

If there’s an efficient market A and an inefficient one B, A is easier to trade in, but B is probably the one that’s mispriced. So that price inefficiency partly represents a measure of how hard inefficiencies are to exploit! In the case of Druckenmiller’s recession call, he actually made the paradoxical judgment that inefficient market B was priced incorrectly relative to A, but that A was the one to bet on—because the specific inefficiency at hand was that a recession was likely and it wasn’t being accurately reflected by anything.

This raises an important point, because there are two broad ways to look at relative inefficiency. One is to just stick with the relative argument: if stocks are pricing a boom and bonds are pricing a recession, bet that one of these will go away. But that’s a frustrating conclusion to draw, because it basically amounts to saying: The market is telling me something important, and I don’t care what it is. The relative-value bet works equally well regardless of which thesis is right, but it’s still outsourcing a lot of judgment to the market. And annoyingly, once the valuation gap closes, you have two problems: first, you haven’t figured out why the discrepancy existed in the first place, and if there’s an inexplicable 1-standard deviation change in some correlation, there is no law of the universe saying it can’t go to 2 or 3. (There is a weaker law saying it can go to 20, when enough levered participants are betting on it.) The other problem is that real-world theses produce additional ideas; an argument that the economy is going into a recession has second- and third-order consequences, and generates more ideas.

This kind of tradeoff, between a low-risk claim that two views are contradictory and a higher-risk claim that one of them is right, extends far beyond finance.

Through games, direct instruction, and making connections between abstract concepts and examples in the wild, Tina, Steiner and I want to see if we can help others get better. And selfishly, I want to think better, so I’m stoked to be a part of this.

*Applications are closed and invitations already went out but these sessions are an experiment to guide how we test and improve the transfer of knowledge. If you didn’t get accepted it’s because space was extremely limited compared to applicants. This is not meant to be exclusive, we are going to figure out how we can spread what we learn. As Axl once said, we just need a little patience [bandana sway].

Last Call

A friend recently mentioned that she willfully puts on blinders about big questions. She prefers to focus on the practical because it can be painful or lonely to dwell on the large problems we see in society.

I’m sympathetic to this view. It brings me to a conclusion I’ve come to over the last few months. You can’t tear down people’s constructs without offering another way. It’s a riff on “the best way to complain is to build.” If you succeed in providing people an alternative the old will crumble away on its own. You don’t blow up someone’s house without having a better one waiting for them. With a bow on it.

It’s the same reason you wouldn’t tell young kids you can’t pay the rent. They can’t do anything about it. Being around Steiner again has been inspiring because he really understands this. Steiner doesn’t criticize unless he has a solution. He can lament, but won’t pontificate. He recognizes that whining without proposing thoughtful solutions is not just annoying, it’s intellectually lazy.

From My Actual Life

Kids are funny.

Still 🤣this am about this exchange.

My 9 year old iMessaged his mom from his iPad while we were at the concert to complain about his little bro pic.twitter.com/FY46gcVvnO

— Kris (@KrisAbdelmessih) September 8, 2022

Took him 2 nights to notice the note under the pillow. Walks out of the room this am "how does the tooth fairy know my name?!!"

He believed the story and backfit a narrative that his bro was in the other room while he was in the bathroom so he wouldn't have seen her come either. https://t.co/Tda0NBVXz3

— Kris (@KrisAbdelmessih) September 20, 2022

The paradox is that you write to become more fully yourself, but then you find it hard to live with the self you’ve become. I do what I can to remain a possibility instead of a reality. Thus the flow. And, next week, the effort to erase this too.

-Freddie deBoer on why he feels the need to write frequently. I don’t think you need to be a writer to appreciate that feeling.

Friends,

I’ve got this friend and neighbor who I hike walk with after we drop the kids off at school sometimes. It’s like 90 minutes of dorm-room musings befitting of the Moontower scene. Those conversations have influenced a few of these weekly letters.

This recent one was no different. It got me thinking about diversity.

See, this friend has an early-stage startup in the education space. The internal research at his company parses diversity across many dimensions. You are familiar with the capital “D” types of diversity — race, religion, gender, age, sexual orientation, socioeconomic, etc.

Interestingly, he expressed concern that his team might not be diverse enough. Not in a visible way. The team runs the gamut of the capital “D” diversity categories. But he was interested in cognitive diversity. He was concerned that an intellectual echo chamber of fancy-college liberals could lead to blind spots in their collective decision-making.

Now I don’t have much team-building experience. So I flexed some knowledge I recently read. (This is why people read right? To at least have a tennis racket when they find themselves on the court of conversational Wimbledon.) And now you too shall witness the fact that I read a book. Confer prestige heavily and without reservation, my esteemed landsmen.

Nah, really I actually read a book and it said some cool stuff. I’ll get to that in a sec. First, I want to re-surface some points professor Mauboussin made about cognitive diversity. He described it as the training, experience, and personality that make an individual unique.

He writes:

I think one can make the case very seriously and quite rigorously that social category diversity contributes to cognitive diversity, but it is cognitive diversity that we’re after.

He describes a less-talked-about form of diversity as well.

“Values diversity”. You might think about it as a sense of purpose, and on that, you actually want to be low. We want a common mission, even if we are of very different backgrounds, we’re pulling in the same direction.

In other words, my friend’s instincts about diversity are correct. Visible diversity is an imperfect proxy for intellectual diversity.

Back to the book I was reading — Superforecasting by Phil Tetlock and Dan Gardner. The book’s main thesis, which falls out of the lessons from the Good Judgement Project, is that it’s possible to become a well-calibrated forecaster in complex (but not all complex) domains. How good can you become? The best are able to consistently beat prediction markets, something even demonstrably above-average forecasters struggle to do.

This is rightly provocative because markets are effective truth-finding mechanisms. They are an ancient way of coordinating human behavior (democracy is another example of a human-coordination machine…for a contrast between markets and democracy see Dinosaur Markets).

If you read this letter regularly you know I have a lot of respect for the efficiency of markets. It’s not a strong-form academic belief. It’s more of an informal razor: “my null hypothesis is there’s no easy money and the burden of proof is on investors who think otherwise”. The academic compromise is markets are “efficiently inefficient”, reflecting the idea that there’s a cost associated with finding inefficiencies so some amount of inefficiency always exists to justify the hurdle of hunting for it.

To appreciate why markets, under certain conditions, triangulate on the truth, I paraphrase Tetlock’s explanation of how the “wisdom of crowds” works:

Bits of useful and useless information are distributed throughout a crowd. The useful information all points to a reasonably accurate consensus while the useless information sometimes overshoots and sometime undershoots but critically…cancels out.

The Role Of Diversity In Truth-Finding

The “under certain conditions” is an important asterisk. The expression “wisdom of crowds” is actually a modern idea that plays off the “madness of crowds”, a term coined nearly 200 years ago by journalist Charles Mackay. For the crowd to generate wisdom, it needs diversity. In other words, the errors in judgment need to be uncorrelated to cancel out.

In Tetlock’s studies, they tested the forecasting abilities of individuals. They were rigorous in their experimental design. They were curious how teams of forecasters would perform against individuals. They further experimented with the composition of those teams.

The eye-opening results underscore the importance of diverse thinking:

• Teams are more effective
  • The results were clear-cut each year. Teams of ordinary forecasters beat the wisdom of the crowd by about 10%. Prediction markets beat ordinary teams by about 20%. And superteams beat prediction markets by 15% to 30%.
  • “Emergence”: teams are more than the sum of their parts. This cuts both ways…even actively open-minded individuals could surrender to “groupthink”
• “Diversity trumps ability”
  • This provocative claim highlights how the aggregation of different perspectives can improve judgment. The key to diversity was, unsurprisingly, cognitive diversity.
    • The revealing result: When they constructed the superteams they optimized for ability and those teams happened to be highly diverse because the superforecasters themselves were highly diverse. They did not optimize for diversity first, but it turned out the most diverse teams were the most effective.
• The asymmetry of the extremizing algorithm
  • The “extremizing algorithm” is a technique where you boost a 70% prediction closer to the extreme, perhaps bumping it to 85%. It’s a technique that is employed when the forecasters have diverse perspectives because it leads to better-calibrated forecasts.

    You do the opposite (push the forecast probability closer to 50%) to combat “groupthink” if the team is comprised of people who think the same or possess similar knowledge. (The use of the extremizing algo allowed teams of regular forecasters to actually perform better than some superteams!).

    My own observation: this is the same logic by which correlated observations “shrink” the sample size, an idea familiar to data analysts.

Example Of Cognitive Diversity

My friend with the start-up gets it. He is concerned that the visible diversity on his team might be a poor proxy for what he really wants — cognitive diversity. If you are an oil company you need geologists, finance people, managers, political connections, real estate expertise. This is a clear example of needing to pull together many object-level competencies.

But cognitive diversity is not just “what do they think about”, but “how do they think”. For an example of what I call meta-cognitive diversity, Tetlock uses the “hedgehog” vs “fox” duality. As a pre-defense of Tetlock, he warns about overstating this dichotomy. (He exemplifies non-binary thinking throughout the book, doing an honest and eloquent job of pointing out tensions and caveats, not unlike the superforecasters themselves).

I’ll take a stab at describing hedgehogs and foxes:

• Hedgehogs
  

  Hedgehogs are specialists. The 10,000 hours crowd. The natural endpoint for the logic of economic comparative advantage or simply the rightful throne of the devoted craftsman. The “specialization is for insects” objection is too reductive. We are better off when Eddie Van Halen wants nothing else than to just be Eddie Van Halen.

  But there are trade-offs. Hedgehogs often filter observations through the lens of their expertise. (My online friends have a good-natured running joke that I see everything as an option — classic “when all you have is a hammer, everything is a nail” thinking). But a camera lens’ usefulness depends on the context. Sometimes that fisheye or telephoto lens is exactly the wrong tool for the job.

  This is inconvenient for the status-aware hedgehog whose incentive to remain consequential leads to motivated reasoning and self-delusion. Academic researchers who become famous for writing about an idea that catches fire have a lot to protect. They become fast friends with Mssr. Confirmation Bias and Madame Overconfidence, the very enemies they used to fight when they were building their reputations of good work. It’s like America fighting against the same Afghans they armed as rebels in the 80s. As DiCaprio’s character in Up In The Air would attest, the warm embrace of fame beats the cold loneliness of cultural anonymity.

• Foxes

  Foxes are generalists. Businesspeople, investors, politicians, administrators. It’s an imperfect description of course but you know the type. The disadvantages of being an “inch deep and a mile wide” are established. That person is never going to design a bridge or coach a professional sports team. Some are self-aware enough to recognize when they “know enough to be dangerous”. Many are not. Their advantage, however, is their mercenary relationships with lenses. The ego cost of finding the most useful lens is much lower, making foxes at least psychologically fit for reasoning across domains.

Remaining careful not to play into false binaries, the hedghog/fox continuum reminds me of the importance of shifting between diffuse and focused thinking modes. Diffuse thinking (see More Shower Thoughts Please) provides both inspiration and the ability “see over the neighbor’s fence” while focused thinking enables us to synthesize those scattered insights into a useful output. Most of my posts start either in the shower or when I’m taking a walk. (I strongly recommend this old New Yorker piece Why Walking Helps Us Think). “How we think” is a dimension of diversity.

The Complicated Discourse Around Diversity Is Inevitable

When I described the thrust of this piece to my wife, Yinh, she yawned. “So you’re writing a post saying ‘diversity is good’? Who is this news to?”

I immediately got nervous that I was belaboring an obvious point. I asked her why she thought it was so obvious and she started citing studies and initiatives that could easily have 10x’d the length of this post.

Now I can take feedback, but I’m not above quibbling en route to my final destination. So let me get this straight. You read a bunch of stuff arguing that diversity is good, now it’s obvious to you and presumably everyone else who reads, so I shouldn’t spend any time making arguments that diversity is good. I mean, this post is to a Moontower reader as that other research was to you. Next time just put my head in the washing machine woman.

But she still has a point. Diversity, in its many forms, is widely celebrated. In-breeding is taboo. I was just watching the National Parks series on Netflix with the kids and learned that rainforests, the most biologically diverse ecology on land, are the origin of more than 25% of modern medicines. So why do I feel the need to cheerlead an “obvious” point?

The short answer is I don’t think the case is closed on the merit of diversity. I know it’s exhausting to hear me say this, but it depends on contexts. For example, whenever America’s dysfunction is compared to a homogeneous European country, I scratch my head. If we are tribal in nature, our default wiring might simply make governing a melting pot inherently more difficult. I think diversity makes us stronger overall, but some measures of local harmony should expect to suffer. I’m even open to the possibility that tolerance runs counter to our natural instincts. (It just makes a normative approach to overriding our base impulses require extra care. Law-making is always a tug-of-war between collective values and the animals within us.) In other words, I can appreciate how diversity can be a headwind.

But there’s more.

Even if we wave a wand and agree that diversity is an unalloyed good, there remains the harder question. At what cost? The lightning rod version of this question is you have a white student and black student who look the same in all other ways and you need to choose one (the premise is unrealistic, but this is the collapsed version of how these questions get passed around the media and people extrapolate entire political identities on how they’d answer such a fake question). If everything else is the same and there is a non-zero probability that social diversity leads to cognitive diversity, then the optimal (although not necessarily morally fair which is a different criteria battleground) decision gate would say select the black kid (assuming the majority of the student body were white).

Still, even if we agreed on that, a harder question remains. What if the black kid had a slightly worse score on a standardized test? From a strictly efficient-utilitarian point of view (again, moral consideration aside), then we are faced with trade-off on a diversity-competence frontier. In a purely academic sense, I was likely an inferior hire at SIG, but perhaps something about how I thought or acted might have made my “diversity” or “complementariness” worth more than just hiring yet another 1600 Math SAT kid from MIT (or they just exhausted the supply of those, I’m not trying to flatter myself here). The point is that the merit of diversity is fairly intuitive, but doesn’t lend itself to legible number-crunching in the way test scores do.

Pricing “diversity” could very well be a fool’s errand. But I have one final bit of intuition to sprinkle on the problem. In There’s Gold In Them Thar Tails: Part 2, I rehash how nature uses diversity as fuel for evolution.

1. Diversity is an essential input to progress. Nature’s underlying algorithm of evolution penalizes in-breeding.
2. In addition to a loss of diversity, signals decay as you get closer to the extremes. This is known as tail divergence. The signal can even flip (ie Berkson’s Paradox).
3. The point where the signal noise overwhelms the variance in the candidates is an efficient cutoff. Beyond that threshold, selectors should think more creatively than “just raise the bar”.

At some point, incremental diversity is worth more than incremental “signal”. Evolution acts like a basket of options (I really am a hedgehog). It sees a mutation. If it’s useless, discard. If it’s adaptive, exercise it and let it multiply through the population out-competing those without the adaptation. When discernment becomes random, select for diversity. The downside is limited, the upside is massive learning.

Wrapping Up

Diversity is valuable. The word is highly politicized today. There are many arguments, with varying degrees of merit, harping on diversity in the name of fairness. Those are debates that need to be had. But this is not that debate. This has been an argument that diversity is important as a matter of efficiency and flourishing. Perhaps the argument isn’t needed, but I suspect that many reactionary arguments against the equity angles of diversity may dilute the value of diversity as a general concept.

We have seen diverse dimensions all around us: social, cognitive, and values themselves. It’s worth unloading the hangups artificially narrowing the meaning of a beautiful word — “diverse”.

Today’s letter is brought to you by the team at Mutiny Fund:

How can you access a multi-asset strategy concerned with protecting assets and growing long-term wealth?

The Cockroach Strategy seeks to achieve higher long-term, compound growth compared to traditional stock/bond-focused portfolios with more limited drawdowns. ​ It is intended as a total portfolio, a ‘set it and forget it’ approach that strives to give investors peace of mind and meaningful capital appreciation.

The Cockroach strategy consists of a diversified ensemble of assets including stocks, bonds, commodity trend strategies, long volatility strategies, and gold. It is designed to perform across multiple macroeconomic environments: growth, recession, inflation and deflation.

The Cockroach strategy gives investors exposure to asset classes designed to perform in each of those environments including stocks, bonds, commodity trend strategies, long volatility strategies, and gold.

Click Here to Learn More

Disclaimer: Investing is risky, and you are reminded that futures, commodity trading, forex, volatility, options, derivatives, and other alternative investments are complex and carry a risk of substantial losses; and that there is no guarantee the strategy will perform as intended.

Money Angle

I’m trying to read books again. I’m like the opposite of a junkie. I start and just give up. I struggle to watch movies for similar reasons. It’s hard for me to sit still and be passively entertained for extended periods of time.

[I recently admit that I haven’t seen Animal House, I saw Trading Places after I had been a trader for a decade, I saw Caddyshack 2 years ago. I’d like to claim ESL but I was born in Brooklyn. Also I’d be doing a disservice to immigrants, many of whom have large movie repertoires because it’s an effective way to learn English. I have no excuse. I could have watched more classic movies instead of fraying the tape of the Dazed And Confused VHS.]

In an era of amazing tv shows, my diet mostly consists of those that come in 30-minute episodes. I’m making my way through all the seasons of Curb Your Enthusiasm again. I’m also watching it backwards. For example, when season 3 ended, I go to Season 2, episode 1. This isn’t the first time I admit to being a serial killer. Pun intended.

Back to books. To get my groove back, I committed to reading 1 chapter a day. It worked. The streak is intact and I got to cross a title off the list that I’ve wanted to read for a long time: Superforecasting — The Art And Science Of Prediction by Phil Tetlock and Dan Gardner.

I really enjoyed this book and would consider it canon for aspiring analysts and traders. You can find my notes below. Here are the high-level takeaways:

• The world is complex (a butterfly flaps its wings and small change in initial conditions leads to disproportionate outputs). So our ability to forecast is existentially limited.
• But some people are demonstrably better forecasters and it’s not just luck. They are consistent.
• Those people are not geniuses. But they have a mix of qualities and procedures that enable them to forecast at a high level.
• The key to getting better, same as in sports, is useful feedback and iteration. It takes hard work, “deliberate practice” and a commitment to get better.
• Getting better is necessarily a conscious, painstaking process because our natural biases conspire against our judgment in areas where causality is opaque. Which are most questions of interest.
• How groups can hinder or improve forecasting. The role of diversity in group decision making.
• In many contexts, making accurate predictions is actually undesirable. Regrettably, I want to shout Moloch everywhere I look. The expression to look for in the notes: “kto, kogo?” It’s a disheartening idea.
• The leader’s dilemma: balancing decisiveness in the face of uncertainty and intellectual humility
• Objections, progress, and goals in the endeavor of forecasting

  Continue to…

  Notes On Superforecasting (Moontower Book Guides)

Last chance to apply to the free StockSlam workshops I’ll be hosting with Tina and Steiner in NYC the first week of October.

Details and application:

Announcement:

Please join @moreproteinbars and I for 1 of 3 evenings in NYC in the first week of October.

We are calling them the StockSlam Sessions.

I'll explain the details below but know they are 100% free (although space is limited)

Apply here:https://t.co/OU41w6nJEi

— Kris (@KrisAbdelmessih) September 9, 2022

Last Call

A year ago, I talked about seeing comedian Sheng Weng at the Punchline in SF:

His powers of observation on the mundane details of daily life are Seinfeldian. His signature tone and voice deliver self-skewers that you can’t help but turn on yourself.

One of our friends said it was the hardest she can remember laughing for so long. Sheng’s a craftsman and the more you listen to him the better it gets.

He’s actually Yinh’s college friend (they bonded over their rhyming one-syllable Asian first/last name combos). This spring we were supposed to go down to LA to see the taping of his Netflix special (Ali Wong produced it) with my friend Khe and his wife. We had to audible at the last second and missed it, but…it’s finally out!

Check out Sweet & Juicy (Netflix)

Speaking of Khe, he has been a most generous sherpa to so many people trying to raise their productivity game. He’s an alien jedi.

Check out his upcoming bootcamp. Oh yea, it’s totally free.

If you are curious at all as to why I’m always touting Khe and his community, do it.

Sign Up For The Free Bootcamp

The $10K Bootcamp is a free 3-day event hosted by Khe Hy from RadReads. During this free event, we’ll teach you how to design a system to achieve your goals (while working waaay less). You’ll learn how to:

• Stay focused on the most important things in life
• Think bigger (versus making smaller things better)
• Stop putting things off until some imaginary future date
• Invest in improving your mind, career and relationships

Event Details:

• Cost: Free
• Tuesday, September 20th, 11:30 am ET (view in your time zone)
• Wednesday, September 21st, 11:30 am ET (view in your time zone)
• Thursday, September 22nd, 11:30 am ET (view in your time zone)
• Free access to all recordings

From My Actual Life

I saw Nine Inch Nails last Sunday night at the Greek in Berkeley. (Between Leon Bridges last week and the upcoming King Gizzard and The Lizard Wizard show I think I’m asking to be swallowed by the Earth. The Hayward fault runs beneath Cal’s football stadium and the theater. At least I’ll be in my happy place when the worms eat me).

I never owned a NIN album but since I’m alive I know like 6 or 7 songs. Any preoccupation I’ve ever had with Trent Reznor revolved around him renting 10050 Cielo Drive in the Hollywood Hills — the home where the Manson apostles murdered Sharon Tate and her celebrity friends. The recording studio in the house was called “Le Pig”, a reference to a song on the Beatles’ White Album from which Charles Manson inferred a lot of craziness. The killers smeared the word “pig” in blood on the home’s front door. Downward Spiral and Broken were both recorded at Le Pig. The music video for Gave Up features images of the house and studio. (Not to be extra creepy after I already used the word “serial killer” once in this letter, but the house I used to own here in CA looked similar to that infamous abode before we renovated it).

But I must admit. NIN is in the running for best show I’ve ever seen (n of roughly 200). The gulf between the recorded & live experience is indescribable.

The Greek felt like a rave at a temple. In black t-shirts.

Nine Inch Nails at the Greek in Berkeley with @drunkengrass pic.twitter.com/v488aa3CC0

— Kris (@KrisAbdelmessih) September 12, 2022

Uploading vids from NIN last night.

I need to go back but there's only a few dates left. Flying solo this week with kids otherwise I'd want to make the Vegas show in a few days 😔 pic.twitter.com/KPlHnv0sea

— Kris (@KrisAbdelmessih) September 13, 2022

I learned a new term.

“To Go On Account”

A pleasant term used by pirates to describe the act of turning pirate. The basic idea was that a pirate was more “free lance” and thus was, more or less, going into business for himself. — The Pirate Glossary

It applies to several parts of today’s letter. Oh and don’t miss the special announcement at the end.

Friends,

Last week, I shared the Engine Model. It was a blueprint for designing an integrated life. I paused my regular workflow to write that post for myself as my trip transitions from a three-lane expressway of exploration to a local 2-lane highway. I like doing meta-writeups like that for the same reason I like reading others’ frameworks…it’s a form of “trail magic”.

Via thetrek:

The term “trail magic” was coined by long-distance hikers to describe an unexpected occurrence that lifts a hiker’s spirits and inspires awe or gratitude. “Trail magic” may be as simple as being offered a candy bar by a passing hiker or spotting an elusive species of wildlife.

For those on a similar journey, or see a similar juncture in their future, I hope the post can at least provoke if not be practical. One area I wish it was more practical, was on monetization. That’s a tough topic, so let me back up.

Reputation is the longest-duration asset you have. [The great grift of 2021 will forever be trapped in the amber of my mind as the moment a bunch of business-famous influencers decided the bid to sell their reputations was juicy enough to finally smack. It was a calculated bet on the shortness of your memory.] If you are not a sociopath, your ethical boundaries extend beyond the borders drawn by law. But the law alone seems to fence some people in just barely. Oh my god, fan me now. Watching literal lawmakers insider trade is an act of contortion so lithe it allows them to limbo even under that low bar.

[Collecting myself.]

Where was I? Oh yes, being an f’n normal human. So in that post I didn’t wade into specific monetization models because I don’t know much about them.

Instead, I address them in principle:

Once you begin thinking of your work as an engine, as self-integration, and not a single bilateral transaction with one employer (or overlord if you are especially cranky about your choices) you have replaced an existential problem, namely the rejection of over-compartmentalization, with a technical problem. The technical problem is “how do I sustain such a life?”

This is new to me and I’m learning on the fly so I’m not the best guide here. But I can offer my philosophical perspective, knowing that it will likely evolve with experience. I still think it’s important to lay out principles as a tether to your values as you head out into the unknown. 

1. Extract less value than you create

   This is obvious. Strip-mining is not a renewable strategy. I’d rather underpromise and overdeliver. This isn’t altruism, it’s good business. If you leave the high-pressure race, you have chosen to focus on the long-term. The advantage is you can use a different playbook that relies more on compounding which pays off with time, instead of quick, but hard-to-repeat scores.

   From Working For Free:
   

   In business, I always enjoy the Costco example. Charlie Munger has written:
   

   “When other companies find ways to save money, they turn it into profit. [Costco] passes it on to customers. It’s almost a religious duty. [They] sacrifice short-term profits for long-term success”.

   It’s not as hokey as it sounds. Think of it this way. They are hiding profits in the customer’s own pockets. They will be return customers. That profit is hidden from competitors’ wandering eyes and the IRS. The strategy commits Costco to keeping the customers happy because the profit is realized over the long-term. It’s simple but requires rare discipline.

   The profit that “sits in your client’s pockets” has a bookkeeping entry called “trust”. The fact that it doesn’t capitalize as an asset on your personal balance sheet is a shortcoming of accounting. You can’t let it fool you from the reality that you have stored your future income with your clients and in their word of mouth.
   

2. Price your attention carefully

   When you consider a project, you must decide how much to charge. If the project requires diesel fuel and you are a sports car, it might not run or it might be inefficient. This feels like a one-off transaction. You should probably quote a “go-away” price. At some price, you’ll suck it up. But this should be rare.

   You want projects that have recyclable exhaust. If you suspect the exhaust is especially powerful, maybe you charge less. The point is to price your time or effort holistically. What is the first and second-order cost/benefit of taking on a particular project?

   An example of holistic thinking: I don’t paywall my letter because the loss of subs would cut off a valuable inbound fuel source. The cash would not be worth it. Instead, I reframe the forgone income as “marketing cap-ex”.

I don’t know much about monetizing an integrated body of work. I’m not especially commercial-minded. But I have friends that are further ahead on this path that I can lean on. In thinking about creating your engine, realize you are not alone.

Identify your own principles. It’s a way to stay “green” as you experiment with sustainable business models that empower you to stay on the path.

Sponsorship

In the past year, I’ve been approached by companies that want to sponsor this letter. Extra cash would make it easier to justify doing stuff like hiring a designer. I have some fairly irreverent ideas for Moontower swag that would be decidedly, umm, [lowers voice] befitting of the namesake?

So I was open to the idea. Especially since I will never paywall this letter. The only issue was most of the potential sponsors didn’t get me too excited. And the higher their bid, the less exciting they are. Go bumhunt somewhere else.

When I write to “find the others” I mean it. You make this effort worth it for me. You see, if I had to pick a single external metric to grade the body of work I’ve been calling Moontower, it would be the quality of its subs. By quality, I mean thoughtful people who care about getting better as co-passengers on this ferris wheel.

Out of respect to both you and me, I’ve been guarded about who I’d let get mindshare here. While I haven’t done a formal survey (I’m working on one though), I can tell this readership is smart and has many ultra-successful people within it. Almost all of you want to invest better and live better. You’re a pretty dream demographic to marketers. Fortunately, instead of me wrestling with which sponsors to match with, the answer landed in my lap.

My friends Jason Buck and Taylor Pearson asked me to sponsor the letter. They manage a fund of funds that comes from the “all-weather” style of investing. Many of you are familiar with that term because of Ray Dalio, but Bridgewater is to Kleenex as all-weather is to “permanent portfolios”. I have been invested in Jason and Taylor’s fund for nearly a year and I’m doing my own research now on how to be more hands-on transitioning my own portfolio to be more “permanent” ¹.  The exhaust of this research will be making its way into these letters so we can learn together.

In addition to the sponsorship and in keeping with my desire to keep this totally inclusive to everyone I have added the ability to be a patron of Moontower.

If you hit this button you will see the choices.

If you pay you don’t get any special posts, but if there were interest amongst patrons for higher levels of 2-way interaction I’d be happy to explore that.

There’s no pressure. It’s not like tipping in U.S. restaurants where it’s expected because servers don’t make a serious wage. I pay for about 20% of the publications I sub to. And it’s never about “is it worth it?” for me. It’s just, “do I want to support this?” I turned the feature on this week and there is seriously zero pressure. I already get a lot from your attention.

[For the more accounting curious…since I’m not a W2 employee and I incur expenses to run these sites and have a home office, any income I receive up until my costs are recouped is like an untaxed dollar. We aren’t talking real money, but eventually, I expect to have built a biz where I re-purpose a portfolio of solutions to my own problems so that it solves other people’s problems too. So these moves can be seen as practice with live rounds.]

By the way, a quick shout-out to my first paying sub, Max S., who signed up shortly after I turned that feature on. As soon as I get some swag made, I’ll be asking for your address man!

Today’s letter is brought to you by the team at Mutiny Fund:

How can you access a multi-asset strategy concerned with protecting assets and growing long-term wealth?

The Cockroach Strategy seeks to achieve superior long-term, compound growth compared to traditional stock/bond-focused portfolios with more limited drawdowns. ​ It is intended as a total portfolio, a ‘set it and forget it’ approach that strives to give investors peace of mind and meaningful appreciation.

The Cockroach strategy is designed with the view that all economic periods can be categorized within the four regimes of growth, recession, inflation and deflation.

The Cockroach strategy gives investors exposure to asset classes designed to perform in each of those environments including stocks, bonds, commodity trend strategies, long volatility strategies, and gold.

Click Here to Learn More

Disclaimer: Investing is risky, and you are reminded that futures, commodity trading, forex, volatility, options, derivatives, and other alternative investments are complex and carry a risk of substantial losses; and that there is no guarantee the strategy will perform as intended. 

Money Angle

I feel lucky that Jason Buck reached out to sponsor the letter because I love what he’s doing (Yinh and I were early investors in their latest fund). In addition to managing a fund, Jason is co-host of what I think is the most underrated show on investing YouTube, Pirates of Finance.

In season 3, Jason and Corey Hoffstein changed the format so that there is zero preparation. The conversation is totally off the cuff. And it totally slaps.

It is free, buried booty that our theoretical economist says can’t exist because of efficient markets. But it exists. I’ll prove it by digging up 3 themes from their amazing recent episode Decision-Making Under Uncertainty and mix them with my own thoughts. We’re blending Moontower and Pirate rum up in here today.

Why ETFs Might Be Unsuitable For Some Strategies

ETFs are liquid structures designed to faithfully track NAVs (“net asset values”) because the arbitrage mechanism is outsourced by the issuer to an Authorized Participant. These AP’s are a subset of the market-making community.

The Pirates wonder:

Is the ETF structure, whose allure is transparency, the correct home for opaque, illiquid, or bi-lateral (ie there’s credit risk in the basket) instruments such as inflation swaps? What about semi-liquid holdings like corporate bonds or even TIPs?

The answer to such questions partially rests on the liquidity of the underlying holdings. Consider a question they allude to but I’ll make explicit:

If you hold long option or long convex positions via ETFs (or for that matter directly) will you be able to monetize them when they pay off?

This is a real and highly underrated concern. Bid/ask spreads are positively correlated with volatility. So how useful is it if the paper profit on a convex position can’t be crystallized because the bid-ask is wider than the parted Red Sea?

Suppose you buy a way OTM put option for $1. It explodes to $20 but the bid-ask is now $16-$24. Sure, you can sell it for a 16x return, but when that option was originally valued for $1, the pricing incorporated the idea that in some rare states of the world the option is worth $20. If you can never realize that $20, then you entered into a pretty negative expected value situation when you paid $1 for it in the first place.

Trading is hard enough, you can’t afford to not maximize small edges. In a separate interview Corey talks to option trader Darrin Johnson.

I paraphrase Darrin:

When you sell tails, you need to capture the entire premium. The hit ratio of selling tails is high but when you lose you lose many multiples of the premium. If you fail to collect the full premium, it will not make up for the losing trades. The difficulty of selling tails is even trickier yet.

Darrin explains how betting against longshots leaves you uncertain if you have an edge in the first place. In my words: good luck differentiating between a 50-1 shot vs a 100-1 shot. That’s the difference of 1 probability point but it’s massive in payoff space. [I discuss that idea further in Tails Explained.]

When volatility increases, transaction costs go up for everyone. Since market-makers are part of “everyone” then the cost of their own hedging (ie replication) goes up as well, so they charge wider-bid ask spreads to keep them whole. MMs represent the marginal supply of liquidity so can they pass the transaction costs of their own “COGs” to those demanding liquidity. We know the house wins both ways, but the house edge itself is correlated to what markets are doing. If the house’s margins above their “COGs” expand in times of stress, you need to haircut the expected risk mitigation from defensive positions. That cost will show up when you try to roll or monetize.

There are cases where that bookie’s vig will not be too punitive even in a volatile market. For example, if the option you buy is now so far ITM that it no longer has meaningful extrinsic value, then you can simply trade the underlying to monetize (although re-hedging will put you face-to-face with the market-makers again).

This brings us to the next theme.

Destination vs Path

If you have a view about the expected return of an asset in 5 years should you care about the path? Depends who you ask. Anyone marked-to-market (HFs, market-makers, futures traders) will say yes especially if they are managing money for others. PE, RE, and bond investors are more likely to say no. The Pirates have a nuanced discussion about whether it’s even possible to manage to path versus manage to terminal value.

I’m biased by my path-or-die experience in trading. Mark-to-market is the goddess of tomorrow, you can’t afford to piss her off.

Here are a collection of arguments that I offer her as tribute.

1. Bond investors who ignore path are fooling themselves.

   In Why Volatility Still Matters To Buy-And-Hold Investors, I summarize one of Cliff Asness’ pet peeves:

   You may hear some people say they want to buy an individual bond rather than a bond fund. They worry that bond fund prices move around and have no real expiration, so when interest rates rise your losses are somehow more real. But if you buy a bond and hold it to maturity you can put your head in the sand, and never lose.

   
   This is nonsense.

   
   You have lost in a real sense since the money you are being returned is worth less in a world in which rates have risen to compensate for inflation. The bond fund is effectively taking your loss today rather than later. If you sell your bond for a loss, you can reinvest at a higher yield going forward. That’s a similar experience to just being in the bond fund. Holding to maturity does not mean you have less risk. It’s an illusion. A real vs nominal illusion.
   

2. Using stale marks to “smooth volatility”

   Having a preference for private assets that are less volatile simply because their marks are stale is like not getting bloodwork because you don’t want to find out your cholesterol and blood sugar are too high.

   The slow-to-mark investments are still volatile. The fundamentals of the private business are correlated with the public market volatility.

   Even if you don’t believe your investment should be marked down, then you should be sad you can’t redeem your private investment at par to rebalance into public stocks after the market drops 20%. Giving up liquidity without a premium because it will behaviorally “save you from yourself” sure feels like you sold the option to rebalance at zero.

   I walk through that argument in How Much Extra Return Should You Demand For Illiquidity? (7 min read)

3. Market prices are clever. They can balance the wagers of path vs terminal value investors simultaneously!

   In What The Widowmaker Can Teach Us About Trade Prospecting And Fool’s Gold, I show how the calendar spread options are priced so that the path of the gas price is highly respected, even if there’s strong consensus about the terminal value of the spread (ie the March-April futures spread which is a pure bet on in winter gas being in short supply).

   The OTM calls are jacked, because if we see H gas trade $10, the straddle will go nuclear.
   

   Why? Because it has to balance 2 opposing forces.

   1. It’s not clear how high the price can go in a true squeeze or shortage
   2. The MOST likely scenario is the price collapses back to $3 or $4.

   
   Try to think of a strategy to trade that. Good luck.
   

   Let me repeat how gnarly this is: The price has an unbounded upside, but it will most likely end up in the $3-$4 range. The vertical spreads all point right back to that price range.
   

   The market places very little probability density at high prices but this is very jarring to people who see the jacked call premiums.
   

   That’s not an opportunity. It’s a sucker bet.

   Another common example:

   In options land, many investors like to buy 1×2 ratio spreads because the payoffs look amazing for low-probability events. For example, if a stock is $100 and you can buy the $115 call and sell 2 of the $120 calls for zero premium, you think to yourself:

   a) “If the stock does nothing or goes down I break even”
   b) “If the stock goes to $120, I make $5” (or $1 if the stock goes to $116)

   c) “I don’t start losing money until the stock goes over $125. That’s 25% away! This is risk-free return”

   Nah dog. That’s first-time-at-the-rodeo thinking.

   The reason the 1×2 is so cheap is the call skew on the $120 strike is pumped up because someone has been buying them like crazy. That’s where the bodies are hidden. The question you need to ask yourself is “conditional on the stock going to $120 did it get there fast and sloppy, or slow and grindy.” If it goes there in a fast way, the market-maker community will be short beaucoup gamma and be scrambling to buy the $120 calls back. You sold some teenies and went to Santorini and are now getting a margin call on the beach because the 120s you’re short are blowing the f out.

   The path-aware trader is plotting how to be long the scenario where your vacation abruptly ends.

4. If path is so important, how can you manage to it?

   a) Avoid excessive leverage

   b) Pre-determine when you will cut losses (beware this can be a big topic with lots of room for disaster)

   c) If you insist on betting on terminal value, do it in fixed premium ways where your max loss is bounded. Now you don’t have to worry about mark-to-market risk.

   In There’s Gold In Them Thar Tails: Part 2, I cover the topic of path, how to exploit investors’ lack of appreciation for it, and how Jon Corzine became a symbol for path-blindness.

“Long-Short Portfolios All The Way Down”

You’ve heard the expression, “turtles all the way down”.

Corey says “Long/short portfolios all the way down”.

This is an acknowledgment that every trade you make is relative to something else. If you buy a stock denominated in dollars, you are betting that the stock will outperform dollars. It’s a powerful idea. If you want to short XOM but can’t get a borrow, you can buy all the components of XLE except XOM while shorting XLE. Voila, you are now short XOM.

The pirates offer more great examples:

1. Rebalancing

You start with a 60/40 portfolio and stocks go up so the new portfolio is 65/35. You can think of a regular rebalance to get you back to 60/40.

Or you can re-frame the accounting to an algebraic equivalent:

You own a 65/35 portfolio + a long 5% bonds/short 5% stock overlay

It seems like semantics, but just as different words can refer to very similar things, there remains meaning behind the distinctions. And the subtlety here is useful because it forces you to look at the accounting of subsets of a larger position. Corey argues that this lets you think about how things are contributing to your portfolio at any given time or even over time

Bingo.

This lens is the gateway to better p/l attribution. In the 65/35 example, the intuition is fairly basic. Rebalancing trades profit when the market mean reverts and lose money if the market trends. Gamma-scalping works the same way. It’s just rebalancing for option traders. If you trend, your “daytrading p/l” will be negative if it is dominated by gamma scalps and you’ll regret going into work that day (because you will presumably have been hedging your growing delta, for example, you sold the VWAP but the market closed on its daily high.)

I agree with Corey. Seeing the world as long/short portfolios focuses you on the relative nature of every decision! Every time you are long X, you are short [not X]. If you buy a house and it goes up in value along with every other house in your state, when you sell it, did you really make money if the neighboring cost for shelter has appreciated all around you. Start seeing your decisions as long/short portfolios and it has a funny way of focusing you on what you’re specifically rooting for.

2. Corey poses another thought exercise:

Which do you think has a higher tracking error to a passive 60/40?

a) Replacing the passive equity with small-cap value exposure

b) Layering 60% exposure to the SG CTA Index on top

I promise the discussion thread will make you smarter.

I’ll sprinkle in a related idea that comes from options land.

It’s natural for vol traders, especially dispersion traders, to think about positions as a series of long/short portfolios. That’s because all dispersion is “dirty” dispersion. [If you need a refresher see Dispersion Trading For The Uninitiated].

If you sold SPX index vol and only bought vol on value names, your net position is:

• short growth volatility
• long value volatility (you are net long, because if you tried to balance your gross index and single name greeks, you’d necessarily have to overweight the value names. This is extra true if you theta-weight the spread since the value names are lower volatility than the growth names.)

If you had this position on before Softbank started buying the hell out of tech calls in the summer of 2020, you got rocked.

But if you put that same position on right before the Covid vaccine was announced, you killed it as value names surged while growth names barely moved relative to their vols.

Index traders are keenly aware of these “synthetic risks” because at some point you’ve been unknowingly exposed to a risk factor that took a bite out of your p/l. That prompts you to slice and dice your risk to further your understanding of positions. Risk management evolves one bruise at a time. The inevitable body shots and jabs hurt, but also teach. You just have to get your overall controls robust enough to survive the haymaker.

[Speaking of teach…did you know that if a stock is halted, you can compute what price the market is implying it will open at? Just compute the price the SPX cash index would need to be at for the futures to be priced fairly to back out the halted stock’s implied price.]

Corey is spot on. It’s long/short portfolios all the way down. This is native vision for derivatives traders.

In closing, know that I’m not just shouting my friends when I say to watch Pirates. That’s seeing causality backwards. Jason is sponsoring Moontower and I met these guys in the first place because I was attracted to how they think (well that’s half of it…there are plenty of brilliant people out there I have zero interest in hanging out with. These are friends that got through the important funnels after I noticed they were smart.) I always learn when I listen to these guys. They’re entertaining and always have good stories.

Actually, you know what? F those guys. Hoggin all the cool in the room.

Last Call

This was a dense issue. Reading is the worst. I know.

Instead of more links to ignore, I will leave you with an invitation to learn in-person.

Me and 2 old friends who all traded at SIG together are going to host 3 free teaching sessions in NYC the first week of October.

We are ridiculously stoked to meet many of you. That said space is limited so there’s a short application.

You can find the details and application in this thread:

Announcement:

Please join @moreproteinbars and I for 1 of 3 evenings in NYC in the first week of October.

We are calling them the StockSlam Sessions.

I'll explain the details below but know they are 100% free (although space is limited)

Apply here:https://t.co/OU41w6nJEi

— Kris (@KrisAbdelmessih) September 9, 2022