Friends,

It’s graduation season.

I always share these 2 posts in May:

1. Wooderson’s Commencement Speech

   You might recognize “Wooderson” as Matthew McConaughey’s first cinematic role in the film that gave moontower its name.The speech is an all-time banger. The link includes my favorite takewaways but the speech should be watched on YouTube (link included in the post).

2. Keepsakes From Slatestar’s Fake Graduation Speech

   This should be read annually.

This year I add a third item to the commencement pack. I mentioned it on Sunday. It’s The Essential Paul Graham, a re-factored collection of excerpts organized by a few themes I find important. If you are at a crossroads or at the start of your career or even just in HS/college (especially in college actually), read it. Graham has been prolific so it’s not exhaustive but that’s also the point. It’s highly digestible in a single sitting. If you want more, the breadcrumbs are all there.

Maker’s Schedule, Manager’s Schedule (5 min read)
Paul Graham

I didn’t include this PG essay in the essentials because it’s a bit narrower but it’s a quick read that will resonate.

Excerpt with my emphasis:

One reason programmers dislike meetings so much is that they’re on a different type of schedule from other people. Meetings cost them more.

There are two types of schedule, which I’ll call the manager’s schedule and the maker’s schedule. The manager’s schedule is for bosses. It’s embodied in the traditional appointment book, with each day cut into one hour intervals. You can block off several hours for a single task if you need to, but by default you change what you’re doing every hour.

Most powerful people are on the manager’s schedule. It’s the schedule of command. But there’s another way of using time that’s common among people who make things, like programmers and writers. They generally prefer to use time in units of half a day at least. You can’t write or program well in units of an hour. That’s barely enough time to get started.

When you’re operating on the maker’s schedule, meetings are a disaster. A single meeting can blow a whole afternoon, by breaking it into two pieces each too small to do anything hard in…

For someone on the maker’s schedule, having a meeting is like throwing an exception. It doesn’t merely cause you to switch from one task to another; it changes the mode in which you work.

I find one meeting can sometimes affect a whole day. A meeting commonly blows at least half a day, by breaking up a morning or afternoon. But in addition there’s sometimes a cascading effect. If I know the afternoon is going to be broken up, I’m slightly less likely to start something ambitious in the morning. I know this may sound oversensitive, but if you’re a maker, think of your own case. Don’t your spirits rise at the thought of having an entire day free to work, with no appointments at all? Well, that means your spirits are correspondingly depressed when you don’t. And ambitious projects are by definition close to the limits of your capacity. A small decrease in morale is enough to kill them off.

Each type of schedule works fine by itself. Problems arise when they meet.

Interestingly, Graham recognizing the importance of both schedules, comes up with the same solution Cal Newport recommends: “office hours”. It’s also the same solution I basically came to — if you wanna chat, I send you a TidyCal where my time is preconfigured in an “office hours” way. I will put things in my calendar to nudge “stacking” so I can have uninterrupted half-day blocks to work.

2 final bits of inspiration for the ambitious:

• Everything that you want in this life is on the other side of “worse first”.
• Runnin’ Down A Dream: How To Succeed and Thrive in a Career You Love

Money Angle

Moontower.ai, besides being an analytics software, is also becoming a launchpad for anyone using or learning about options. To take full advantage of the free tools just sign up.

Sign up for basic access to moontower.ai

Thank you for signing up for Moontower. You are welcome to begin exploring a slate of free offerings including:

1. MoontowerGPT – a custom GPT with all published Moontower writing embedded (every night it updates based on updates to any of my web properties).

2. Moontower.ai blog – hundreds of posts organized by categories such as “Options and Volatility”, “Risk & Edge”, “How Markets Work”.

3. Moontower Resources – an archive of tutorials, release notes, cases, and even a curated list of newsletters for investment analysis

If you are interested in using options, these progressions are specifically structured to help you adopt the Moontower lens:

1. Watch the Walk-Thru Video

2. Read the Primer – it’s broken into short written essays, to make it digestible. The first 7 posts are the core philosophy. It reads quickly and is strongly recommended. The remaining posts comprise the Implementation Unit. They follow a logical sequence but can also be used as a reference to understand particular tools.

3. Check out the Moontower Mission Plan [coming soon!] – this document is a hybrid of worksheet/flowchart for various use-cases whether you are looking to put on a directional bet, hedge, or make a volatility play such as selling covered calls.

For the analytics and community features a pro subscription is required. As you may expect, a common question we get:

Do you think moontower.ai is worth the investment for someone who has limited option knowledge or time❓

This is a complete answer.

Money Angle For Masochists

Jane Street just released iPhone and Android apps for their training game Figgie.

Back in 2000, I joined the Assistant Trader program at SIG out of college. The deal was that you spend 6-18 months in rotation before they send you to headquarters for 10 weeks of intensive training. Competition to get accepted into the training was intense because it was only held 4x per year. You were given a raise from $37,500 to $50k when you got accepted to it and, if I remember correctly, another raise to $60k when you completed the course and got assigned your trading job.

[Acceptance to the class was conditional on signing an extremely strict 3-year non-compete. That non-compete had several provisions that went well-beyond 3 years and ended up being the reason I switched from oil options trading to nat gas when I left the firm.]

As an assistant trader, or “clerk”, you’d support one or more option or ETF traders during market hours then compete in classes and “mock” after work from about 4-6pm. (And for that first year out of college you’d spend several nights a week playing poker for another 2-5 hours. It was a good thing at the time. We were insufferable though. If you bugged the room you’d die of cringe to hear “I’m 60 delta to hang out this weekend”.)

Mock trading was usually a simulation of option market making in an open outcry setting. But sometimes we played games. Since I clerked for several people that became early partners at Jane Street I suspect this particular game was a precursor to Figgie.

Related reading:

• Mock Trading
• Mock Trading Options With Market Makers
• Lessons From Susquehanna
• For Fun, My Career Origin Story
• Notes From SIG’s Todd Simkin
• 5 Takeaways From Todd Simkin on The AlphaMind Podcast

A little post script

When I graduated from trading class in the summer of 2001, I was assigned to an option pit on the American Stock Exchange where the most active names were AIG, GLW, Q, and EK. My total coverage was about 30 names.

I was actually delayed by a month in getting my “badge” or license to trade — I was supposed to start the week after 9/11 happened.

Stay Groovy

☮️

Moontower Weekly Recap

• Life Settlement Arbitrage
• Weighting An Options Pair Trade

Friends,

I published a new resource:

The Essential Paul Graham (Moontower reading guide)

Description

Paul Graham is a software developer, entrepreneur, writer, and founder of the venerable VC/incubator Y-Combinator. His writing is legendary for its conversational, concise, witty, and incisive style that conveys the nature and promise of, above all, craft. The “what” and “why” of this document Over the past decade, I’ve read the majority of Paul’s essays. But like all great writing, it deserves reading and re-reading. I was delighted to discover that David Senra, host of one of my favorite podcasts, Founders, has reviewed many of Graham’s best essays over the course of 4 episodes.

After listening to his distillation of these essays and re-reading them myself I organized my favorite takeaways as well as my favorite takeaways from David’s favorite takeaways. Like a double distillation of whiskey, the remainder is “the essential Paul Graham”.

Personal thought

The insights in here would be useful to anybody. But because there is great emphasis on the imperative and difficulty of finding work that one is actually excited to do, these lessons have magnificent compounding potential. Make the ambitious teens, college students, and 20-somethings read these essays.

The takeaways are grouped according to topic. They are mostly direct excerpts from Graham but Senra’s reactions are mixed in as well. Senra has terrific taste in passages and is masterful at tying ideas back to common themes across many other founders.

• Making Wealth
• Finding and doing your work
• Determination & Relentlessness
• Insidious forms of waste

Money Angle

Know-Nothing Sizing

We’ve been talking about how the market does follow the fundamentals you are earning a return because corporate profits are there.

See prior posts:

• What Drives The Stock Market
• Nah…you just ain’t seein’ the ball

I also discussed my own approach to portfolio construction (see Inflation Replicator) which backs determines allocations not by expected return but by my tolerance for risk for various levels of confidence. You zero in on an asset allocation with question like “Are you willing to accept a 5% chance of losing 20% of your wealth in 1 year?” If the answer is “no” then you can’t be 100% invested in equities.

As far as equity risk goes, the recent post Index Investing: The Nature of the Proposition can prime your intuition for the risk of the SP500, a diversified equity index with a positive expected return, negative skew, and fat tails means for practical questions like “how likely is it to lose X% over some period of time?”

The key thing to notice — my personal allocation sizes relegate “expected return” to the back burner. I roll with the assumption that systematic risk is irreducible and beta returns aren’t compensation for labor/research but patience and pain tolerance. It’s a weird circular argument — there’s an equity risk premium because if there wasn’t everyone would take a riskless rate which would then lower demand for equities, once again creating an equity risk premium.

Just a thought: I don’t think the meta-game of investing is near some asymptote where we need to question the assumptions of that recursive argument. However, I can imagine temporary scenarios that would necessitate such suspicion. The scenarios would spring from some mix of incompetence to shameful incentives, but the scenarios are not stable equilibriums. One such scenario would include corporate managers en masse internalizing the logic of “meming themselves into an index” and the index committees reacting inflexibly. The long-run check on that behavior is the index committees harming their own brands in the process.

In writing this, it occurred to me that maybe one of the most underrated qualities of being a trader is to relentlessly harbor paranoia without being a doomer. If you aren’t paranoid, your imagination is lacking. But if you’re a doomer, you’re lazy. You have paranoid instincts without discipline — you mistake fuzzy thinking for critical thinking. This is the heart of the trope “do you want to be right, or do you want to make money?”. You know the type:

Ok, back to portfolio sizing. I build the portfolio from a risk-first perspective not an expected return perspective. I call this “Know Nothing Sizing”. When it comes to broad asset classes, my confidence level in the returns is smaller than my confidence level of the risk.

This is not just vibes. It’s a pillar of portfolio construction in the quant world:

Volatility is more stable than returns.

From Advanced Portfolio Management:

A large wave is composed of fewer, smaller waves riding on it, with many ripples on top of the smaller waves. The effects accumulate. Similarly, stock returns are the result of a large shock, such as the market, followed by a few smaller ones, like sectors or larger style factors, and then even fewer, smaller ones. Like waves, many of these movements have similar amplitude over time. We say that their volatility is persistent. This is a blessing because it allows us to estimate future volatilities from past ones.

From the conclusion of Matt Hollerbach’s post Convergence Time:

Stock returns have fatter tails, slowing convergence. Also investment returns, volatility and correlation seem dynamic and not static.⁴  But we have to start our study somewhere.

If investment returns are mostly random, then prior returns possess enormous amounts of error. Therefore they are always suspect. You can’t confidently learn anything about the underlying return from even moderate sample sizes. This is another reason why I don’t use trend or momentum to determine future returns.

On the other hand, small samples produce reasonable estimates for standard deviation and correlation.

Rob Carver distills it nicely in Is maths in portfolio construction bad?:

Classic portfolio optimisation is very sensitive to small changes in inputs; in particular it’s very sensitive to small differences in Sharpe Ratio, and correlations – when those correlations are high. It’s relatively insensitive to small changes in standard deviation, or to correlations when correlations are low.

It’s extremely difficult to predict Sharpe Ratios, and their historic uncertainty (sampling variance) is high. It’s relatively easy to predict standard deviations, and their historic uncertainty is low. Correlations fall somewhere in the middle.

If we assume we can’t predict Sharpe Ratios, then some kind of minimum variance (if we have a low risk target or can use leverage) or maximum diversification portfolio will make theoretical sense

If we assume we can’t predict Sharpe Ratios or correlations, then an inverse volatility portfolio makes the most sense

Outside of the universe of large cap stock indices it makes a lot of sense to use the relatively predictable components of asset returns – volatility and correlation.

Using volatility as an input makes a lot of sense – it’s highly predictable, and will help reduce your exposure to potentially problematic assets.

If we assume we can’t predict anything, then an equal weight portfolio makes the most sense.

I’ll add a few comments and then a practical thought for you to consider as you ponder your portfolio.

1) A reminder that volatility understates risk in the presence of extremely strong skew.

See:

• Lessons From A Skewed Coin
• Skew Is A Hall Of Mirrors

2) The equal-weight or 1/N sizing rule is a better candidate for the name “Know Nothing” since that’s what you’d do if you didn’t even have an estimate for the volatility. Equal-weight makes more sense for sub-portfolios like a collection of start-ups or angel investments but it’s rare for someone to have their entire net worth in such an illiquid basket.

3) Finally, a thought to consider.

There is a 100% chance that at some point in the future you are going to look at a statement and find a single security, private fund, or magic coin in a 50%+ drawdown assuming no leverage.

(I’m much less certain if you use stop-losses or momentum rules.)

And if we want to measure real instead of nominal returns, I’d make that statement about any asset classes like “equities” or “bonds”. It’s not only happened before, but here’s an uncomfortable truth — the worst is always in the future.

This fact is reminiscent of one of these strange dorm-room kind of conversations that option traders have about what shape a platonic volatility term structure should have. They generally conform to a power law, y = axᵏ, but I’ve been around traders must smarter than me debating what the bleak truth might mean for that specification. As far as I know nobody trades on such debates but hey the portals are there for inquisitive minds. Since it’s not 2am I’m gonna stay focused on more present matters.

Even though it sounds bleak, it’s not a doomer comment in any practical sense.

Even if that happened in Amazon today and you had been invested in Amazon for 20 years, you’re still way ahead.

No matter what, you’re going to invest because there is no alternative. But understanding that reality is important to make an honest decision about how concentrated you want to be.

The conditional probability of a drawdown of 50% while the world doesn’t end is still tiny. Said otherwise…most of the ways we drawdown 50% do not coincide with the world ending. The lowest bar of risk management means avoiding that happening to your portfolio independently of it happening to everyone else.

Money Angle For Masochists

A reader sent me this amazing note (lightly edited). Eliciting a response like this is always the lofty goal.

I was going through your earlier posts today. (this and this)

I got the general idea that you’re replicating the payoff by buying some amount of shares by shorting some amount of t-bills for a while, but for some reason, the terms never truly sank in:

C = S * N(d1) – X * N(d2) [assume rfr=0, etc.]

I didn’t quite follow why

1. S * N(d1) represented the “expected value of the shares going in the money”, and
2. why we specifically have to short X * N(d2) worth of t-bills to self finance, and why X * P(ITM) < S * delta in your post initially

Today I was playing with MoontowerGPT and it really sunk in using this example.

I asked it to give me a discrete distribution for a $100 stock such that the expected values summed to $100.

So like:

I wanted to price the 102 call intuitively, and then the terms all made sense.

1. S * N(d1) represents the portion of the $100 expected value that comes from all prices above 102. (i.e. 105 * 0.25 + 110 * 0.25 = 53.75) and
2. the amount of t-bills to short is (102 * 0.5 = 51)

so the call per BS would be worth $2.75 (53.75 – 51)

…but also I realized:

C = [(110 * 0.25) + (105 * 25)] - [(102 * 0.25) + (102 * 0.25)]

re-arranging the terms, that’s

C = (110 - 102) * 0.25 + (105 - 102) * 0.25

which is really the weighted average of the payoffs of the call option in different scenarios above.

Like woah, everything just came down to weighted averages!

Anyways, nothing too revelatory here, but using MoontowerGPT for example has been amazing, and I felt that moment where everything came together (similar to when I watch a 3Blue1Brown video), thought I’d share! 🙂

Stay Groovy

☮️

Moontower Weekly Recap

• “Until you have it all you won’t be free”
• Using Options Better (including practical tips)

Friends,

I saw this chart on LinkedIn and the call of mental math immediately lured me onto the rocks.

Since 1972, the SP500 is up 250x.

So what’s the CAGR (compound annual growth rate)?

One can open the calculator on their phone and type 250^(1/52) – 1

I cannot. I am impelled to estimate the answer. By what? I don’t know, probably the same ghost that makes people play games like Wordle.

I figured I’d share how I did this because practicing mental math is fun.

Recipe:

1. Immediately recognize that 250x return is about 8 doublings (2⁸ = 256)
2. If we estimate a 10% log return per year, Rule of 72 predicts in 50 years you double 7 times since at 10% you double every 7 years.
3. Log returns are handy because they are proportional to time. If you doubled 8/7 or 14% more cumulatively, then your return per year must have been 14% greater than 10% or 11.4% compounded.

This reasoning got us quite close to 250^(1/52) – 1 = 11.2%

Shortcut for estimating a 50-year compounded return: 10% (1 + doublings/7)

Compounding feels unnatural. If we compound at 11.2% instead of 10%, over 50 years we get an additional doubling!

• At 10% CAGR wealth grows by 2^7 or ~250x
• At 11.5% CAGR wealth grows by 2^8 or ~500x
• At 13% CAGR, wealth grows by 2^9 or ~1000x

Rule of 72

Formally, the rule of 72 says that if you earn 10% per year, it will take 7.2 years for your money to double. A derivation of rule of 72 can be found here.

If you already know how it’s derived then you can guess that I prefer rule of 69.

[Let’s the Beavis chuckle pass]

If you double wealth, then your log return is ln(2) or .69

.69 / 7 years ~ 10% annual log return

The rule of 69 is very close to rule of 72 but is derived from continuous compounding instead of annual.

I prefer log returns because they are directly proportional to time.

From Using Log Returns And Volatility To Normalize Strike Distances:

The expression e^x is a total quantity of growth. It’s actually assumed to be

e ^{1 * x} where the 1 represents 100% continuously compounded growth and X represents a unit of time. The natural log or ln(e^x) then solves for how much time (ie x) did it take to arrive at the total quantity of growth assuming 100% continuous compounding. 

A key insight is that we don’t need to assume a 100% rate and x to be time. We can simply think of x as the product of “rate multiplied by time”. This allows us to substitute any rate for the assumed rate of 100% to find the time. Once again we turn to BetterExplained:

If you review that section of the post a few times and make up a few examples for yourself, you’ll never get confused about e or ln again. You might even start thinking about all numbers in terms of their logs.

For any number X:

• log (base-10) ~ “how many orders of magnitude to get to X?”
• log (base-2) ~ “how many doublings to get to X?”
• ln (aka log base e) ~ “compounding continuously at 100% how long will it take to get X”

  In this last example, it takes one unit of time to get to 2.718 compounding continuously at 100%. If our unit of time was a year, then 100% return compounded continuously would turn $1 into $2.718

  In the earlier examples, if you compounded continuously at 69% you’d double your money in 1-year. At 6.9% continuous compounding, it takes 10 years. At .69% continuous compounding it takes 100 years.

Generalizing

Continuously compounded growth rate = 10%* 7 log₂(wealth)/years

Compactly:

.7 log₂(wealth)/years

or

Compound growth rate = 70% * (doublings/years)

As long as you keep this in terms of doublings, ie log₂(wealth), then you can compute the compounded growth rate in your head.

Testing it remembering that the SP500 250x return was about 8 doublings in 50 years:

70% * (8/50)

70% * 16% = 11.2%

If you can count doublings then you can easily dazzle your friends with how fast you estimate a growth rate for any number of years.

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Money Angle

You know who was a vocal fan of the type of HS math we played with above? Charlie Munger

From The GOATs Parting Wisdom:

When I was introduced to the math of Pascal and the elementary probability, I saw immediately how important this math was. My math teacher had no idea that he’d come to a part of the math that was very important in the regular world to everybody, but I saw it immediately and I just utterly mastered it. And I used it. I’m still using it. I used it routinely all my life quite intensely.

And when I got to study in the Harvard Business School, in the early days at the Harvard Business School, they were proudest of something called decision tree theory. And they taught it at the Harvard Business School, a lot of pomp and ceremony and many examples, all these graduate students.

Decision tree theory, it’s a Harvard Business School — in those early days, what they were teaching you was that Pascalian probability math works in real life. Here’s the Harvard Business School needing to do remedial high school math to a bunch of graduate students, and they weren’t wrong. They were right in those days to teach decision tree theory because other people hadn’t mastered probability math the way it should be mastered.

My teacher in high school, if you don’t pay attention to anything else, this stuff you ought to master. And he should explain how carny operators and casinos take advantage of ordinary people. It should have been taught, and it wasn’t taught right in high school, and it wasn’t taught right in college and it wasn’t taught right. Finally, the Harvard Business School got so they taught high school math to graduate students. And you can say how could that be correct? But it’s because the earlier education was so ineffective.

He also knew about investing apparently.

“The Art of Stock Picking” (thread by @AlphaPicks)

This Munger thread opens:

This is the best speech that Charlie Munger ever gave. He explains how an investor can beat the stock market. The 20-page transcript is a treasure trove and a must-read for all. Today, we’re sharing the key points and the full speech…

The following excerpt reinforces the spirit of the compounding math above (emphasis mine):

Another very simple effect I very seldom see discussed either by investment managers or anybody else is the effect of taxes. If you’re going to buy something which compounds for 30 years at 15% per annum and you pay one 35% tax at the very end, the way that works out is that after taxes, you keep 13.3% per annum.

In contrast, if you bought the same investment, but had to pay taxes every year of 35% out of the 15% that you earned, then your return would be 15% minus 35% of 15% or only 9.75% per year compounded. So the difference there is over 3.5%. And what 3.5% does to the numbers over long holding periods like 30 years is truly eye-opening. If you sit back for long, long stretches in great companies, you can get a huge edge from nothing but the way that income taxes work.

Even with a 10% per annum investment, paying a 35% tax at the end gives you 8.3% after taxes as an annual compounded result after 30 years. In contrast, if you pay the 35% each year instead of at the end, your annual result goes down to 6.5%. So you add nearly 2% of after-tax return per annum if you only achieve an average return by historical standards from common stock investments in companies with tiny dividend payout ratios. [Kris: Stop investing specifically for dividend cash flow…if the company’s earnings are growing, its price will increase and you can sell shares to create your own dividend on your own schedule. Plus companies that don’t pay dividends but whose earnings are growing are presumably re-investing internally at higher returns on capital then what you are going to do with the taxed cash. This is not a blanket truth, but the blanket love of dividends is worse, especially if companies cater to investors who crave them.]

Munger does warn:

But in terms of business mistakes that I’ve seen over a long lifetime, I would say that trying to minimize taxes too much is one of the great standard causes of really dumb mistakes. I see terrible mistakes from people being overly motivated by tax considerations.

Money Angle For Masochists

Volatility risk premiums or VRPs are measures of implied volatility relative to realized volatility. Implied volatility typically trades a bit rich. Also, most dogs don’t bite. It’s a broad statement. I am presenting it without a prescription because that’s not the point of this note.

Instead, I just want to share a recent example of how a very fat VRP ended up compressing back to typical levels. As a ratio, an extended VRP can normalize by any mix of the numerator (implied vol) falling and/or the denominator (realized vol) rising.

You can read the entire post at moontower.ai:

A Demonstration of VRP Normalizing

It opens:

The recent Bitcoin “halving” was completed on 4/20/2024. A special date because…it’s a palindrome. (Umm, why else would it be special?)

This was also a neat opportunity to show how a volatility risk premium can normalize from extremely high levels.

Stay Groovy

☮️

Friends,

One of the memorable ideas from Peter Thiel’s Zero To One is the 2×2 grid with quadrants of definite/indefinite + optimism/pessimism.

Luke Burgis has a concise discussion of it in Are you a Definite or Indefinite Optimist, or Pessimist?.

Thiel laments the influence of either type of “indefinite” mindset.

Luke agrees:

This also comes down to the key question of agency. The “indefinite” doomers and optimists lack a sense that they are personally responsible for anything, and so are less likely to contribute to bringing about the future they believe will happen.

This means there is an aspect of reflexivity involved, of course. Perception creates reality. If enough people are indefinite optimists, then nothing will happen (because not enough people will take concrete action) and the future will actually become worse than the present.

“Indefinite optimism” leads to option hoarding. I’ve written about this in The Option Cage (12 min read). The popularity of that post affirms the sense that we are intrinsically repelled by optionality mindsets propagating beyond the realm of tactics and into a way of life. The seduction of such nihilism is liberating yourself from specific commitments. It’s a way of lowering the stakes for your ego. It’s a pre-excuse. You can always hide behind “I never went all-in”.

But there’s no reward without risk.

Sure, there are lucky exceptions. Probably more than ever these days if we’re being honest. You can become a rich cog in a wildly profitable business. You ride a great wave, get overpaid considering how little risk you take, and now complain that you make $500k a year and feel broke. That’s the universe reminding you that maybe your fat paycheck is downstream of the same forces that make everything feel so expensive. It’s tied together. You can’t with a straight face think that your pay is justified while the inflation in your consumption basket is not.

(Yes, you work hard. Yes, your skills might be more scarce than what it takes for a typical job. And you are very much rewarded for that. But risk is required for a truly asymmetric outcome.)

Risk requires uncomfortable levels of commitment. Risk, or even better, “accountability” (from the most popular twitter thread I’ve ever seen), is incompatible with an appetite whose primary macronutrient is optionality. That friend that always bails on their plans sees all their commitments as options not futures. The plan was just an insurance policy against “something not better coming along”.

This brings me to today’s read:

Committed: How to give a damn about your work (7 min read)
by Rick Foerster

I’ve spoken to Rick. He walks the walk. This article starts strong and gets better:

In an apathetic world, full of short-termism and an addiction to the slow drip of incentives, the treasured virtue is commitment.

We are surrounded by conditional people, who need to “be engaged” or receive the whip of stimulation to get moving. They wait, until the move is obvious and success certain.

But we unlock the best in life when we become committed, even in the face of uncertainty.

Further reading:

• I’ve excerpted one of my favorite antidotes to nihilistic option mindests from
  Venkatesh Rao

  : Fixed Point Futurism

In my market-making life, I often had positions that were net short extrinsic option premium but long convexity. (A common junior option trader question would be to ask the candidate to create a structure that had that profile. A good answer is — a vega-neutral iron fly which can be roughly by shorting 1 ATM strangle and buying roughly 1.4 25d strangles. Vega-neutral butterflies were often quoted in the gold options market. They wouldn’t ask for it by name but the structure would usually be a iron fly with a strange ratio that amounted to zero vega.)

With that niche bit of trivia, I present this week’s sponsor: Helium

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Money Angle

My recent post, Nah…you just ain’t seein’ the ball addresses the lazy confession you hear when professional investors moan “the market doesn’t care about fundamentals”.

At the end of that post, I pointed to research that shows that in the long-run fundamentals remain the largest driver of returns.

• Total Shareholder Return Linking The Drivers of Total Returns to Fundamentals by Michael Mauboussin
• Pods, Passive Flows, and Punters by Drew Dickson

Good businesses pay off. While the wrong price can ruin any investment that math becomes less relevant the longer the holding period (this is Buffet’s “pay a fair price for a great business” compounder philosophy).

Here’s 3 more bits that show the stock market is still governed by the force of financial gravity (profits):

1) What’s Driving Stock Market Returns (3 min read)
Ben Carlson

It’s ridiculous to assume this means the gains in the stock market are somehow rigged, fake or manipulated.

There is no man behind the curtain pulling levers to ensure stocks go up.

In fact, over the long run, fundamentals still play an important role in the stock market’s success.

There have been times when prices have gotten ahead of themselves but for the most part stock prices have been going up because earnings have been going up.

Another myth of the stock market is that all of the gains are due to multiple expansion. While it is true that valuations have been slowly rising over time as markets have gotten safer [Kris: I’m not sure about “safer” but I expect valuations levitate over time and a priori risk-adjusted returns to get worse], multiple expansion has probably played a smaller role than most people assume.

The late-John Bogle had a simple formula for expected returns in the stock market that looks like this:

Expected Stock Market Returns = Dividend Yield + Earnings Growth +/- the Change in P/E Ratio

In his book Don’t Count on It, Bogle applied his formula to each decade in the stock market going back to the turn of the 20th century to see how well fundamental expectations matched up with the actual returns.

The difference between the two is essentially human emotions.

Bogle published the data through the 2000s so I’ve been updating his work into the 2010s and 2020s. Here’s the latest data through the end of 2023:

There has been some multiple expansion in the 2010s and 2020s but nothing like the 1980s, 1990s or even the 1930s. Earnings growth has been the main driver of stock market returns since the end of the Great Financial Crisis.

2) Why Stocks Move (Twitter thread)
Brett Caughran

Brett is very much in the gears of fundamental pod shop investing providing extensive training to portfolio managers.

Excerpts:

• I’m here to assert: fundamentals are all that matter (with an investment horizon longer than 3 months). Sure, not in a given day, week, month or quarter. Shorter movements in stock prices are certainly influenced by positioning, sentiment & flows.
• But extend the horizon even a few months (let alone a few years) and one thing hasn’t changed in markets over the last two decades, and won’t change in the next two decades: fundamentals are deterministic to stock prices. The analysis I will present below is a ~3 month analysis of why stocks move.
• There are two very common proxies for “fundamentals” when looking at a stock, 1) revisions, i.e. how consensus estimates are changing and 2) consensus expected growth…To try to make this point, I did an analysis of the top & bottom 25 stocks in the S&P 500 this year. I applied a very typical “why did the stock move” decomposition analysis of revisions, P/E and growth algorithm shift to try to isolate why these stocks move. [see the thread for the details].
• By no means am I saying that fundamental equity investing is easy. I’m showing you an ex-post analysis. Monday morning quarterback. The hard part is using process & judgment to identify these dynamics ex-ante. What I’m telling you is fundamentals still matter. Don’t fall into the trap that fundamentals don’t matter. They have this year, and they always will.

Personal bit of color for what it’s worth: a friend of mine is one of the largest and best performing fundamental pod managers on the street. (When I hear what goes into the process I’m convinced the average professional investor looks like a bear on a bicycle compared to what’s happening at the right side of the power law performance curve). I think this friend would very much agree with Brett. Take it as you will.

3) A simple theory of the stock market (7 min read)
Steve Randy Waldman

This post is more of a red pill compared to the others. I’m quite sympathetic to its argument as stock returns maybe have become a load-bearing pillar of the “affluent professionals — call them the top 30%”

Excerpt:

Equity holders who have come to rely upon high equity returns regardless of the timing or valuation of their purchases. Equities fluctuate, sometimes wildly, but the most enfranchised citizens now expect an upward ratchet over a five to ten year horizon. Speculators’ own self-fulfilling behavior joins forces with tacit but determined state support to deliver on that expectation.

While sympathetic, I don’t yet subscribe to Waldman’s deeper suspicion because I haven’t seen the turn card on the flop. Like what happens to the stock market if earnings have a sustained fall without cover for major intervention (like if the last major earnings cliff wasn’t caused by a virus).

Waldman himself includes this chart of corporate profit margins in the post:

A conspiratorial mindset should should be pulled away from the derivative of the function (stock prices) and focused on the function itself — profits margins. Profits varied around 2.5% while the boomers were still hippies, bounced about 5% when I was a kid, found a new home around 10% in the age of smartphones, and then nearly doubled again since covid. The time for profit margins to double roughly halving along the way. There are so many forces that could go into a picture like this plus technicalities of how accounting and tax laws may have changed that I’m not going to embarrass myself with any guesses.

But the output is unmistakable: earnings are growing from both the top* and bottom lines. Again the chart Ben Carlson posted:

When you zoom out, the SPX time series is still tracing what it always has.

*For the top line: see S&P 500 REPORTING YEAR-OVER-YEAR REVENUE GROWTH FOR 13TH STRAIGHT QUARTER

From My Actual Life

Last week I mentioned our household’s new discovery — comedian Nate Bargatze. He has 2 Netflix specials his most recent special is on Amazon Prime. The following bit comes from the new one and just gets me and the 10-year-old dying every time. (Apologies but I could only find a TikTok link and it includes close-captioning which is an absolute affront to the craft of stand-up)

@bestandupI’ve never seen the real internet #natebargatze #eagle #baldman #bestandup

Tiktok failed to load.Enable 3rd party cookies or use another browser

Another skit we find re-watching too much is this one from Nate’s appearance on SNL a few months ago. The writing and delivery is perfect.

@bestandup

I’ve never seen the real internet #natebargatze #eagle #baldman #bestandup

♬ original sound – bestandup

That skit reminded me of being in 5th grade when a set of twins from South Africa transferred into my elementary school. I’ll never forget how in a proper English accent, the first thing I ever heard of one them say after raising his hand on the first day: “Will we be using the Imperial or Metric system?”

If the accent wasn’t enough I didn’t know what the words they dripped from even meant.

Mental note: put gum on their chairs. Welcome to 80’s grade school in NJ nerds. No one gets out of here well-adjusted.

☮️

Stay Groovy

Moontower Weekly Recap

• don’t become “the thing”
• Index Investing: The Nature of the Proposition
• The first community zoom for moontower.ai subscribers (thread)

Friends,

We’ll cut straight to the links today.

The Serendipity Machine (7 min read)
by

I started lurking on Twitter about 8 years ago. I didn’t start tweeting until 2-3 years into lurking. I started as a reply guy as one must if they aren’t already a somebody. I joined Twitter with the specific goal of learning how to invest which is different than trading. After getting the hang of it (Twitter not investing) I published my recipe for using Twitter. It’s still valid except I don’t use Tweetdeck anymore.

I included several outstanding guides to getting the most out of Twitter in that post. This new post by Nabeel Qureshi is a tremendous addition packed with smart advice on both what to do and what not to do.

Plentiful, high-paying jobs in the age of AI (18 min read)
by

I really like this essay because it grips you with a clickable headline that speaks to common fears but proceeds to not just speculate but teach.

The best part of this post is hinted at in its subtitle:

Comparative advantage is very subtle, but incredibly powerful.

I make the same mistake Noah addresses in the post that most people make: we confuse the concepts of comparative advantage with competitive advantage. The difference is crucial and the engine’s of Noah’s argument.

It’s a great learning post and personally I find the marriage of comparative advantage to opportunity cost the best way to remember its meaning.

The concept of comparative advantage is really just the same as the concept of opportunity cost. If you Google the definition of “comparative advantage”, you might find it defined as “a situation in which an individual, business or country can produce a good or service at a lower opportunity cost than another producer.” This is a good definition.

Money Angle

I follow economist Steve Hou on Twitter. This is a good podcast episode and still relevant despite being over a year old:

🎙️Market Huddle interviews Steve Hou (3 hours)

The theme:

This week we welcome Steve Hou from Bloomberg. Steve recently did a presentation at the Bloomberg Portfolio Conference where he spoke about investing in a new inflationary regime, and it’s our great pleasure to talk about his research.

The interview is long because they step through Steve’s presentation (link to slide deck). Steve believes we have entered a period of structural inflation as many of the forces that came together to create disinflationary growth over the past 40 years have unwound and in even reversed.

He labels:

The “Four Ds” of inflationary undercurrents:

1. De-carbonization and commodity underinvestment
2. Demographic ageing of working age population
3. De-globalization and supply chain re-shoring
4. Dominance of fiscal policy over monetary policy

He then shows how various asset classes have responded under the regimes of the 4 quadrant model (inflationary growth, deflationary recession, and the cross-regimes of disinflationary growth and stagflation). But rather than just show us the average returns Steve shows us the distributions of those returns which creates various smiles and surfaces.

The slides are easy to read and worth your time. You can grasp broad, useful heuristics quickly about how asset returns relate to macro drivers. A few ideas that stuck out to me:

• There is a trade-off between assets that have high inflation beta and their Sharpe ratio.

  In other words, assets that protect you from inflation are expensive. No free lunch. But his framework does lend itself to a frontier where you can choose your tradeoffs based on how eagerly you want to hedge inflation. I have seen this idea before in research that shows commodities are crappy stand-alone investments but can still improve portfolios by zigging when you need them to. See Diversification Imperative.

• Steve expands on the point I alluded to on Thursday: TIPs are often unsatisfying inflation hedges.

  The reason is that TIPs are still bonds. So when inflation is anticipated they should appreciate, but rising inflation often coincides with rising rates which hurt bond prices. If you hold TIPs until maturity then the returns should compensate you for realized inflation but if you’re not sticking around for the long-run then you’ll find the underwhelming as the 2 drivers that set mark its prices can partially offset each other and mute returns.

• Bloomberg created a “pricing power index” to identify equities that should perform well during periods of high inflation.

  Contrary to what you expect, it’s not companies that have high-profit margins that comprise the index — it’s companies whose margins are stable. In other words, profit margin volatility is a better proxy for pricing power.

• Bloomberg also applies the bond concept of duration to equities to compute a “low duration index”. That slide points specifically at the FOVL ETF by iShares.

Money Angle For Masochists

There was a confident fellow on twitter a couple weeks ago that ventured into the options section and became a main character (for the healthy readers who need translation — “he stepped in doo doo”.)

He mansplained “I don’t think you know how options work” to a few long-time derivs traders including our dear friend Tina. He argued that by selling deep ITM calls on DJT (the Trump stock) you could short the stock without paying the steep borrow rate. This can be easily disproved by options 101 put-call parity but alas he dug in deeper. The thread is performance art plus an education in why options are the real underlying market.

I didn’t pile on so much as try to point out some of the subtleties that were not part of the main discussion but easy to overlook:

Link to thread

I try to be nice on the internet but Tina and several of the attacked are friends so the need to subtweet the clown got the better of me. I chose the GI Joe “learning is half the battle” PSA format which ties back to using Twitter to improve without the side effects:

From My Actual Life

Recently discovered the comedian Nate Bargatze. This humor leaves me crying. It’s very reminiscent of Sheng Weng — observational humor wrapped in deadpan story-telling. Domestic life as a middle-aged dad and husband, being raised in the 80s…straight in my veins. Nate is totally clean and the jokes are free of politics. Even the 10-year-old was laughing aloud.

Speaking of the 10-year-old…as a 5th grader, he’s camping with his school for the next week. I never did anything like that with my school but apparently this is a thing in CA. In my town, there are 4 public elementary schools that feed into 1 big middle school so it’s a cool way for him to hang out with 5th graders from the other schools as a preview (we moved intra-town during COVID so he transferred elementary schools…between that and sports he seems to know much of the town’s 5th graders anyway).

He’s beyond excited for this trip…meanwhile I need to bring tissues for his mom at drop-off.

I said for his mom. I’m not crying, you’re crying.

☮️

Stay Groovy

Friends,

Some helpful stuff to start your week:

💪🏽Everything I knew about stretching was wrong (7 min read)
by @tylertringas

This post about mobility opens with:

In the past 12 months my body’s mobility and flexibility went from abysmal, a source of persistent pain impacting my quality of life, to pretty darn good. I’m not about to become a stretching influencer, but after a year of researching, trial and error, and hard work I feel back on track and like I have tools that will really serve me and my body for decades. I’m honestly grateful for the big wake up call and I thought I would I share the most important things I learned.

😌Three intriguing findings about pleasure and happiness (9 min read)
by

The skeptics know a lot about psychology. They may believe that the replication crisis shows that you can’t trust anything that comes out of a psychology lab, that traditional psychological research has been superseded by neuroscience or computational modeling, or that the humanities provide us with a richer understanding of how the mind works. These are concerns worth taking seriously.

Still, I’m bullish on psychology and psychological research. In my post Psychology is OK, I list ten robust findings that psychologists have discovered (or at least substantially built upon) in the last few decades, most of which are of interest to non-specialists. Here they are again.

1. Babies have a surprisingly sophisticated understanding of the physical and social world before their first birthday.
2. Our conscious experience of the world is sharply limited; if our attention is elsewhere, we often fail to see what’s right in front of our noses. Check out this classic demo.
3. Memory is not an accurate recording, and despite what many of us think, our recollection of the past is highly distorted. False memories are not difficult to implant, and if you think you have an accurate memory of something that happened a year ago, you are almost certainly wrong.
4. Perception is a complex inferential process; what you see is influenced by your unconscious expectations of how the world works. As a vivid example, developed by Edward Abelson, B looks lighter than A because it’s in shadow, we have an unconscious assumption that shadows darken objects, so the mind “corrects” for the extra darkness. If you cover up the rest of the scene, isolating the two squares, you’ll see that A and B are the same color.

5. All sorts of psychological traits are heritable to a strong degree—not just the obvious ones, such as intelligence, but also surprising ones, like how religious you are.
6. Many sex differences are culture-specific, but others, such as differences in desire for sexual variety, are universal, showing up everywhere in the world.
7. We overestimate the likelihood of infrequent but conspicuous events, such as plane crashes and shark attacks.
8. There is a universal list of things and experiences that frighten people regardless of where they have been raised, such as snakes, spiders, darkness, and heights. This suggests that our fears have been shaped by natural selection.
9. There are universal features of physical attractiveness—such as facial symmetry—and even babies prefer to look at faces with these features.
10. Studies of people from dozens of different countries find that, as we pass middle age, we get more agreeable, more conscientious, and less neurotic.

I want to continue this theme here and give concrete examples of psychological studies that impress me and that I hope will impress you. I’ll zoom in on three papers on happiness and pleasure—a topic everyone is interested in. After reading about these findings, you’ll be bullish about psychology too.

Read the whole article to learn about the 3 recent findings. They have to do with:

1. “pleasure of anticipation and the pain of dread”
2. “a wandering mind is an unhappy mind”
3. …and one that poses a challenging puzzle about what we optimize for that Bloom says “I’ve talked to enough people to know that many see this as a no-brainer—but they don’t agree on which answer is the obvious one.”

Quotes

I have a friend that says, excellence is defined for each person by the most excellent thing they’ve seen. So if you’ve seen something more excellent, it’s actually an advantage for you because it stretches your definition and the definition that you then go to fill up.

Patrick O’Shaughnessy chatting with Daryl Morey

Finally, I must address the topic of whether the effort required for excellence worth it. I believe it is—the chief gain is in the effort to change yourself, in the struggle with yourself, and it is less in the winning than you might expect. Yes, it is nice to end up where you wanted to be, but the person you are when you get there is far more important.

Richard Hamming from You and Your Research

Refer a friend

Money Angle

Years ago, Khan Academy created a game out of RISK outcomes to teach how the invisible hand of markets form consensus, and idea that underpins how price signals marshal resources.

Great 2 minute video:

Sal Khan:

The point of using the boardgame RISK is just to have something that the market can predict. And the big takeaways from this should be whether or not markets are good at predicting complex phenomena. The whole point of this is to understand how markets work, how markets are tied to actual reality, how prices and probabilities are related – prices of securities and probabilities of various events happening.

I think in the everyday world, when you think about the stock market, people don’t realize that those are real people dealing. But here you see the people and you see the excitement, or when people get down on the stock you can see it very viscerally.

[camera pans]

Now you can see people are starting to get comfortable, they’re starting to understand how the trade works, they’re starting to understand the dynamics of the RISK game, so you’re getting a lot more professional trading behavior going on.

A lot of students here, it’s the first time they’ll have experience with a market, this idea of buying and selling things. Even a lot of the parents have never actually bought and sold securities like this before and have seen how the price of a security can connect with some form of reality.

[Kris: love this line]

One thing about simulations is you learn something while you’re in it and then you go home and you think about it and you learn a lot more.

Money Angle For Masochists

Besides mock trading a way prop firms teach market-making and handicapping is to play Trade or Tighten. You can do this with your family, friends, colleagues.

Here’s the rules courtesy of Austin Zhang:

1. Mutually agree on a quantitative figure (e.g. the temperature of a randomly chosen city) and the size of the contract (e.g. $1 per °C)
   
2. Without looking up this value, players must take turns making markets on this figure. This means they must state a price they would be willing to buy at (bid) and a price they would be willing to sell at (offer).

   ✅Neither the bid nor offer may be less aggressive than the previous market.
   ✅At least one of the bid/offer must be more aggressive than the previous market.
   

3. At any point, a player is allowed to trade against any other player’s market. Play continues until a trade occurs.
4. Once a trade occurs, play stops. The contract settles at the value of the agreed figure

This is a commonly played trading game. It’s a good way to guarantee a trade happens between two parties that want exposure. It’s also a fun way to test your intuition.

It’s a lot like Liar’s Poker but you aren’t limited to serial numbers on dollar bills.

This is still played by prop firms.

• Citadel’s “superdays” for trading interns (thread on Wall St Oasis)
• IMC’s Launchpad program in Sydney (LinkedIn post)

Here’s another free resource I found for the codex that aspiring quants might enjoy:

MIT Sloan Business Club’s The Quant Bible (via coursesidekick)

50 pages of nerdom

From My Actual Life

We took the boys and ourselves to the Warriors/Pacers game Friday night at Chase.

I got the tickets for face value from a friend. We didn’t pay for parking (my friend game me a nice tip that just requires a 14-minute walk). We didn’t buy gear or booze but we did get food.

All-in it still cost $1k.

We don’t go often. It was the first time the younger one saw an NBA game live. It was my first time seeing the Dubs at Chase instead of Oracle. Yinh last saw them 9 years ago — at the game Klay dropped 37 in the 3rd — still the greatest live sports moment I’ve ever seen (even better than the Yankees 7th inning comeback in game 6 of the 2000 ALCS to beat the Mariners for the pennant).

If you choose to live in NYC or the Bay Area you just get numb to the costs. Like looking at doctor bill. Numbers feel made up. They should just put one of those parody inspiration quotes on the invoice — “This is America, get fcked or make more money”.

That sounds dark but it’s a direct understanding of your choices. Many have noticed.

Here’s the deal. You can ask normative questions about what should be. If you don’t, apathy wins. But this is in tension with the plainest truth — you can complain but unless you’re going to take an active part in the process to slow the inflation rate you are just wasting mind cycles on things you can’t control. You can only focus how you allocate your budget once you’ve decided your going to live here. This is trade or tighten in real life.

Randall’s rant reaches back to me every time I need reminding (NSFW: language)

Anyway, I was watching this clip from Woodstock ‘94 again and Shannon Hoon refers to the $135 ticket price. That’s $285 in today’s bucks. Coachella tickets are 2x the inflation adjusted price. And Shannon is long gone. Now that’s shrinkflation.

One last one. This is definitely NSFW (language again) but this is just one of those clips I’ve been quoting since I was a teen. Specifically the “does that include me?” line which can weasel its way into many a context.

That line is also how I remember the difference between a Python “)” versus “]”.

I warned you. No tears if you get offended.

☮️

Stay Groovy

Moontower Weekly Recap

• Primer #10: Trade Expressions & Structures
• gpt sparks one up at the moontower
• 21-year-olds making 7 figures on a W2

Friends,

A week ago I did the second installment of the Financial Literacy Series for a group of local kids. It was mostly ad-libbed but you can see the outline here if you want to replicate it in your own community:

🐖Financial Literacy II: Entrepreneurship

In the session, I defined a business as:

a good or service that seeks to make a profit by improving people’s lives

Profit is not a perfect thermometer. This was a reductionist lesson with kids in mind but it holds up well enough. The real key to the statement is “improving people’s lives”. Not everything that does that will make a profit and not everything that makes a profit is improving people’s lives but “improving lives” is the North Star.

Hold that thought.

Today is the 5 year anniversary of 40 people letting me spam them once a week with my “musings”. Moontower was born. Thanks to a loving audience of family and friends willing to indulge me.

In the past month, Moontower sites have gotten over 250,000 views, with over 75% of it coming from this letter. (And saying so is about as much effort I’m going to put into fishing for sponsors).

Before plowing ahead with a Money Angle I’m excited about, here are the principles that have sustained Moontower over the years. They were discovered by trial-and-error, but if you have a hankering to get started on something maybe it can provide some clarity a bit earlier in the process.

1. Serve. It’s the definition of a business — improve people’s lives. In this specific case, with:

   a) knowledge

   b) perspective (or at least healthy provocation), and

   c) hopefully enough turns of phrase to have it beat someone else’s summary of a and b

2. My recipe which you are welcome, invited, and encouraged to steal:

   a) break ideas down into components

   b) be repetitive (ie write 5 posts on how compounding or logs work, but each from a slightly different but overlapping vantage point)

   c) recap

   d) spot concepts in the wild — relate them back to the fundamentals

   e) cadence — keep showing up. The exposure is critical for a reader to consolidate concepts. To serve and not simply be spouting trivia, I need to stock your mental library so you can pull out the relevant volume when the situation calls for it

In equation form:

The key to such an equation of course is the exponent.

The goal I have for you when you read Moontower is the same goal I have for me when I write it — thicken the mental muscles. Every centimeter of hypertrophy must gel into a dense structure of links and callbacks. But even as you climb there’s a familiar, wide foothold just below each new height. You can retreat back to the last checkpoint or post, catch your breath, consolidate.1

You wouldn’t write like this in many high performing contexts because the goal is sometimes to weed people out. To find out who can get the farthest the fastest with minimal assistance. But this isn’t my concern. I write like I like to learn. Slowly. With the space to indulge the side-quests. And my simple bet is I’m not special — many people (enough to fill a basketball arena at least) will relate to learning this way.

It turns out a lot of neat serendipities fall out of pepe-le-pew-clinging to a basic formula. If you go into something like this with no expectations it’s going to be surprisingly rewarding. If, instead, you indulge the whim with an outcome in mind just be aware that there is a see-saw between growth and extraction that balances in proportion to time horizon (said plainly — there’s no payoff for a long time so bake that into your expectations).

My robot friend, in response to me lamenting how hard it was to squeeze sub growth organically, gave me what I need to hear: “MT is a slow burn”. It pays off with consistent reading rather than occasional nibbles. It’s never going to have a mass audience. But as long as it always serves the reader, it’ll get the readers it deserve.2

The principles extend way past writing on the internet. But writing to you every week has made them more apparent to me. So thank you for helping me internalize and feel these principles, not just be intellectually aware of them.

David Senra’s Founders podcast is one of my favorites. In fact, he’s given me much of the language I use to understand the formula (not personally, I don’t know David, but a tribute to his show is that by listening you feel like you do!). He signs off every recording like “that’s 325 episodes down, 1000 more to go”. And the “1000 more to go” never decrements.

221 Sunday Moontowers down, 1000 more to go.

Refer a friend

Money Angle

I’m excited for this one. Back in December I noticed an old tweet thread called Intuitive Understanding of Options by @KeyPaganRush. I reached out immediately — “Would you turn this into a guest post for Moontower?”

@KeyPaganRush is not in finance (not to stoke imposter syndrome in finance folks but I’ll tell you I meet a lot of non-finance folks whose understanding of finance would make finance folks question whether they were the proverbial fish trying to climb a tree). KeyPaganRush was up for the task. It would take the next few months since he could only work on it during the weekends and with me advising on it there was a lot of asynchronous back and forth. KeyPaganRush tried to incorporate Black Scholes formula but at first it felt bolted on. I pushed him to go deeper. This would add a lot of time but what’s the rush? Get it right the first time and it lives forever as a useful reference post online.

3 months later the post is done. I’m super proud of KeyPaganRush for pushing through and thrilled to have the post alongside the rest of the educational option posts at Moontower.

Please follow KeyPaganRush and sub to his YouTube channel for more learning. He hasn’t posted in awhile on it but maybe the boost will encourage more output to all our benefit!

On to the post:

🖼️A Visual Primer For Understanding Options by KeyPaganRush

It starts:

The magic of the post is every concept with a fancy word in the table of contents is visually explained to the level of a 14 year old (and this is if I use the conservative boardgames age recommendation scale — Splendor is the most egregious example of this…10+. Huh? You don’t even need to read. Seriously, that game is a 6+)

The appendix works through numerical examples that elucidate how that formula corresponds to option p/l being determined by the spread between the implied and realized volatility.

Table of contents

An intuitive understanding of options

• Probability distributions
• Option prices as segments of distributions
• Vega
• Theta

Central moments

• 2nd Central Moment: Implied volatility
• 3rd central moment: Skew
• 4th central moment: Kurtosis

Appendix

• More practice
• Summary Tables
• Conclusion
• Further reading

Related

Recently, the awesome science channel Veritasium covered the Black-Scholes equation! It was awesome to see them cover a topic I actually know about in a way that a mass audience can understand. Even my 10-year-old enjoyed the video. They use lots of neat graphics and photos to chronicle the history of the equation (and because we learn about Ed Thorp at home it was fun for Zak to have him appear in the video!). And when they panned to the floor traders with their smocks on I got to exclaim “that used to be me” which triggered a bunch of great questions from the kids.

Enjoy:

From My Actual Life

8 years ago today I was in NYC on a business trip. I was at a dinner with some brokers. I checked my phone on a urinal break and noticed my family chat was blowing up — my sister just had a son. She was at a hospital in central NJ. I walked backed to the table — “Sorry fellas, I gotta skip out”. I took the next bus from Port Authority to my mother’s house in Monmouth County, borrowed her car, and surprised my sis and her husband and got to meet my hours-old nephew. They thought they saw a ghost when I walked in — “why aren’t you in CA?”. The biz trip was wall-to-wall meetings so I never bothered to tell them I was on the East Coast.

I visited with them for an hour and had to get back to my hotel in NYC to grab my things and on to JFK for an 8am flight back home. Exhausting night but it redefined how I think about St. Patrick’s Day ever since.

Also having my own kids, St Patrick’s is less about beer and more about green toilet water and a trail of gold chocolate coins leading to a box of Lucky Charms on St. Patty’s morning. I went to Safeway at 11pm last night. It was sold out of Lucky Charms but I literally got the last 2 nets of gold coins and the last remaining leprechaun treat:

Proud text to my wife:

☮️

Stay Groovy

Friends,

I’ve noticed the same thing as Visa — the gaps in people’s lives when the metaphorical camera’s not rolling.

[This week, while watching the amazing creation of the blue LED I noticed it again in Nakamura’s life. You can brush the technicalities aside and just appreciate an extraordinary human story in that video.

The nondescript gaps in a narrative can be hard to notice because our minds rely on memorable signposts to chronicle stories. But I hope after today’s musing you will also start noticing and celebrating those gaps — because they are the seeds, light, and water of the achievements that make into our stories. By normalizing your recognition of them, you will have another weapon to fight your biggest battle — the battle against fear.

[Related aside: The writer

argues that our largest failures are often “failures” of nerve. I profoundly agree. I often think about nerve as having something to do with time. Like, if you are in a major rush you are more likely to have nerve. Urgency manufactures nerve in the same way you’d ignore the speed limit if your aunt was in labor in the passenger seat of your car (this happened to me 1 week after I got my driver’s license en route to my goddaughter’s birth).

But recently, I’ve been thinking Chris Rock’s observation that “life is long, especially if you make the wrong decisions” is an argument for having nerve. Having a long time horizon increases the ROI on explorative gaps. Nerve can come from fight-or-flight but also from taking the long-view. Like many things, it’s the “medium” perspective or horizon that is self-defeating — in this case by assassinating nerve. To use poker-speak, if you find yourself calling a lot you’re making a mistake — before you call ask yourself if you should really be folding or raising.]

A personal perspective on gaps

I hit a reset button in 2021 leaving a great job once I was sure I didn’t want to keep doing it for another decade. It turns out that having a good career but feeling antsy about it mid-life is very common. You should see how many people reach out wanting to chat about transitions (btw @khemaridh & @p_millerd have really done great work on decision-making and framing in these transitions)

Speaking from experience, transitions are hard especially if you don’t know the object level “job” you are transitioning to. All the expected difficulties (what’s your identity, sucks to be making little $) apply. But as someone still in the thick of it I’m confident that it will work out so long as I feel both “flow” and validation that I’m adding value. Sustainability (ie monetization) is a challenging technical problem (but that is even true for companies like twitter or any number of early stage startups looking for product-market fit.)

Even if a transition feels right you still need to be careful because “unsustainable forever” is definitely wrong but “unsustainable as an investment in finding the right match of me to work” is necessary. When you get off W2 autopilot, you are threading a different needle than the one you have when your 9-to-5 is a drag and you’re side-hustling your exit strategy. (Make no mistake — you are threading a needle in either situation unless you work for someone and are genuinely stoked about it).

There’s always “voice” that tempts to take away the uncertainty — “you can go back to having a job” but I know it would be swapping one pain for another. Incubating any risky endeavor requires some amount of mental shelter from that “voice”.

That shelter is exactly what Visa points out and how I see it personally — when you read a biography or hear a person’s story there’s gaps. This person did X and 5 years later they did Y. In biography form we don’t bat an eye. But that person lived through those 5 years. It wasn’t a blink for them. They tangled with everything and just because the tangling wasn’t legible in a tidy chapter doesn’t mean this years were insignificant. Hell, they might be the prereqs.

I’m an immigrants’ kid. I’m not free of the scripts at all. But I reframe them lest the self-doubt keeps me from hunting down my match. The grand upside is coming out of this with true self-determination. If you are going to gamble, do it for a big prize.

The game, the practical challenge is to get where I want to be while being who I want to be. I could have gotten financially to where I’d like to be with the job but I wasn’t enjoying the path anymore. It felt low stakes as far as what it meant to my identity. Likewise, I could be more of a whore in my current path but that would also betray my taste (also, to channel the slow productivity lessons it’s bad strategy).

My last few years of p/l at the job were my best and yet I felt nothing. That told me a lot. It confirmed feelings that started years earlier that I pushed down to the cellar.

Let me be clear. None of this advice. It could be cope for all I know. But it’s most definitely a bet. These years that don’t leave receipts will very much be ones that I remember. Self-doubt and all. I’m not comparing myself to Arnold or anyone but it’s hard to deny that our internal representation of our lives is like a personal movie. It would be tempting to get up and go to the bathroom at this part. But there’s a lot of detail in the dialogue, not everything has to be explosions.

[And if your a touch older you know life off the immediate achievement carousel goes down a lot easier when you have a elementary age kids that still wanna play with you].

Refer a friend

Money Angle

A fun question that came up in

conversation with Tyler Cowen:

Tyler Cowen (00:55:08):

But I would stress the point that high rates of growth decades on end, the numbers cease to have meaning because the numbers make the most sense when the economy is broadly similar. Like oh, everyone eats apples and each year there’s 10% more apples at a roughly constant price.

As the basket changes, the numbers become meaningless. It’s not to deny there’s a lot of growth, but you can think about it better by discarding the number and presumably AI will change the composition of various bundles quite a bit over time.

Dwarkesh Patel (00:55:40):

When you hear these estimates about what the GDP per capita was in the Roman Empire, do you just disregard that and think in terms of qualitative changes from that time?

Tyler Cowen (00:55:47):

It depends what they’re being compared to. There’s pieces in economic history that are looking at say, 17th, 18th century Europe, comparing it to the Roman Empire. Most of GDP’s agriculture, which is pretty comparable, right?

Especially in Europe, it’s not wheat versus corn. It’s wheat and wheat. And I’ve seen estimates that, oh, say by 1730, some parts of Western Europe are clearly better off than the Roman Empire at its peak but within range. Those are the best estimates I know and I trust those. They’re not perfect, but I don’t think there’s an index number problem so much.

Dwarkesh Patel (00:56:24):

And so when people say we’re 50% richer than an average Roman at the peak of the Empire, this kind of thinking doesn’t make sense to you or does it?

Tyler Cowen (00:56:33):

It doesn’t make sense to me.

And a simple way to show that, let’s say you could buy from a Sears Roebuck catalog of today or from 1905 and you have $50,000 to spend, which catalog would you rather buy from? You have to think about it. Right?

Now, if you just look at changes in the CPI, it should be obvious you’d prefer the catalog from 1905. Everything’s so much cheaper. That white shirt costs almost nothing. At the same time you don’t want that stuff. It’s not mostly part of the modern bundle. So even if you ended up preferring the earlier catalog, the fact that you have to think about it reflects the ambiguities.

This reminds me of a personal peeve. The vacuous expression “beating the market”.

Reducing investing success to “beating an market-cap weighted basket” is incoherent without a concept of goals but as far as I know nobody has tabulated a relevance-centered benchmark that tracks corporate share of global GDP weighted per capita divided by the amount of ATP it takes a human to satisfactorily get through a day in the year 2024.

Money Angle For Masochists

I added an outstanding post to the top of the Moontowerquant Career section.

Version with my emphasis:

🔗Buy-Side Quant Job Advice

I read it a few times. It’s both amusing and practical.

Landscape

• Every firm is a bit like Orwell’s “Animal Farm”: all employees are created equal, but some employees are more equal than others. In PEs and VCs, quants are not at the core of the business, and in a good portion of asset managers, pension funds, and family offices, quants are not working on the most exciting problems. You probably want to begin your career in a place where quants are first-class citizens and are using their brains. I will focus only on hedge funds and prop trading firms.
• the top 20 hedge funds have generated 19% of the total profits (out of maybe 50,000 HFs). In the past three years, the top three hedge funds (Citadel, Millennium, DE Shaw) have generated 38% of the total PnL.

Recommended Reading

• Subscribe to Matt Levine’s “Money Stuff” newsletter; read his past articles too. They are informative, funny, and have aged well. They are free. They are just too long.
• Read a few entertaining books for fun and profit: “My Life As A Quant”, “Against the Gods”, “Red Blooded Finance”, “The Education of a Speculator”, “The Man Who Solved the Market”, “A Man for All Markets”, maybe a Taleb book (but don’t take it too seriously).
• People ask brain teasers, and I can think for a couple of reasons. First, to probe basic modeling and math skills. Second, because it is a focal point: everyone knows they are a likely topic. So I am not testing your intrinsic ability to solve a puzzle, but your ability to learn about puzzles. And there is a pattern to puzzles, which can be learned. Work through all of Peter Winkler’s books. And various firms, including Jane, IBM, etc. have puzzle sites.
• Applied probabilistic modeling and statistics are very important skills to have. Physics is still a good major to hire from, because it is a model-based discipline, as opposed to a technique-based one, and you will be exposed to many models. Take classes at the MS level. Read at least the following books:
  • “All of Statistics” (both volumes) by L.Wasserman
  • “Applied Probability Models” by S. Ross
  • “Convex Optimization” by S. Boyd and L. Vandenberghe
  • “Numerical Linear Algebra” by Trefethen and Bau
  • “Linear Algebra and Learning From Data” by G. Strang
  • “How to Solve It” by G. Polya Note

    I don’t recommend any finance book. You’ll learn on the job.

Read the following three essays. They are short and full of useful advice.

1. You and your research by R. Hamming This is the most practical of my recommended readings. Please read this over and over again. My favorite sentence is: “I started asking, ‘What are the important problems in your field?’ And after a week or so, ‘What important problems are you working on?’ And after some more time, I came in one day and said, ‘If what you are doing is not important, and if you don’t think it is going to lead to something important, why are you at Bell Labs working on it?'” If you have time, read “The Art of Doing Science and Engineering: Learning to Learn” by the same author
2. Real-life mathematics by B. Beauzamy. By a mathematician actually doing applied mathematics. Favorite sentence: “Real-life mathematics does not require distinguished mathematicians. On the contrary, it requires barbarians: people willing to fight, to conquer, to build, to understand, with no predetermined idea about which tool should be used.”
3. Ten lessons I wish I had been taught by G.C. Rota. Although this is a bit more academic, it is extremely useful. For example, the first item is on “lecturing”, but it’s really about communicating ideas effectively. Favorite lesson (from Feynman, actually): “You have to keep a dozen of your favorite problems constantly present in your mind, although by and large they will lay in a dormant state. Every time you hear or read a new trick or a new result, test it against each of your twelve problems to see whether it helps.”
   

Non-obvious points in the essay

• non-alpha related jobs can be extremely intellectually satisfying. Thinking about data, execution cost measurement, optimization, risk–these are all very deep subjects and you can have a great and long career in any of those. The road to hell is paved with mediocre alpha researchers who did not achieve their goals and burned out by the early 30s. Maybe a life of purpose is not the first thing that comes to mind when working in finance but, as much as it is in your power, pursue it.
• As a pet project, over the years I have asked many (many= 50-100) successful traders, algo developers and portfolio managers what makes a great analyst for their team. The answers have been remarkably consistent.

1. Curiosity. People who read articles and scientific papers on their own, maybe during weekends, for the sheer pleasure of finding things out.

2. Creativity. Like obscenity, hard to define but easy to tell it when you see it. I guess, something like this: looking at the same thing everybody can look at, but noticing something different, and proposing an original course of action. Most ideas do not survive scrutiny, but a few are brilliant.

3. Humility. When something does not work, admit it early and openly, examine the reasons why, and move on. In practice, humility (as described to me) is both willingness to take responsibility and openness to experience.

4. Integrity. Following the letter and the spirit of the rules– the team’s, the firm’s, the regulators’.

A few personal comments on this list. First, these qualities are highly correlated; their definitions even overlap. There’s a single trait that perhaps explains 85% of their occurrence. I can’t determine whether this trait is innate or cultural, but I’m fairly confident that by the time you join a firm as a researcher, you either have it or you don’t. Interestingly, not a single person highlighted “capability”, “mental throughput”, or “puzzle-solving” as a quality; yet, we partly select based on the ability to solve puzzles—go figure. In fact, many people I interviewed said that everyone can proficiently perform [task x] or work hard to execute instructions. Also, no one mentioned soft skills like empathy, communication skills, etc. Indeed, some of the very best investors I know, while being very good people at heart, have the social skills of a thermonuclear reactor. Finally, every manager I interviewed sees their employees as researchers, not soldiers or doers.

• Scout Mindset

  Maybe this is a good time to recommend a book on this subject: “The Scout Mindset” by Julia Galef, which explores the differences between explorers and soldiers.[Kris: See A Few Blurbs From Slatestarcodex’s Review of Scout Mindset]

• You can be successful (especially as an alpha researcher) in one of two ways.
  1. First one: You identify a completely new opportunity. Example: Gerry Bamberger at Morgan Stanley in the 80s developed statistical arbitrage. Also in the 80s: the early index rebalancing strategies, and convertible arbitrage.
  2. The second one: You apprentice in a team that has a successful strategy, learn the trade, and improve it marginally. Unsurprisingly, the overwhelming majority of successful traders belong to the second class. The lesson: try to join a team and a firm that has a habit of being successful. Don’t think you can make a huge difference, and don’t fall for the poetry of the underdog.
     
• Don’t be paranoid. No one is going to steal your idea. The real risk is that they will not even listen to you.
  

He ends with a statement that I feel goes from insightful to cliche back to insightful for each decade you’re in the business until your 50. At which point only the sociopaths, alimony payers, and overly fertile still remain. (Calm down, I’m mostly kidding)

A final and non-strictly professional piece of advice: you will spend more time working with your colleagues than with your partner or spouse or family. If you have to suffer at work, try to suffer successfully by sharing a strong common purpose with your colleagues, then by pursuing it in the best possible manner. The accumulated wealth from having worked at several firms will not come from your W-2s, but from the relationships and friendships you will have developed along the way.

☮️

Stay Groovy